January 2023

Falling inflation-rising markets?

View from the Square

Falling inflation-rising markets?

Last year was largely about trying to preserve value. We hope this year will be about seeking opportunities to grow capital. The UK Government seems to be taking the view that the Russian invasion of Ukraine, and the ongoing inflationary consequences, is a Black Swan event (that is almost unique in nature). This gives them confidence in resisting inflationary wage demands that may build in an ongoing, self-fulfilling cycle.

Inflation does seem to be coming under control in the US, where market implies yields in a year's time are around 2.5%. This at least suggests global equity market headwinds may reduce but, with a huge budget deficit, the US itself looks likely to see a weaker currency - and this may help UK import costs.

2023 could be the year not only for stock picking, but country picking as well, as some migration from Wall Street flows to other emerging nations. This trend, which is already evident as a result of the US/China cold war, is leading to onshoring and the identification of beneficiaries from (at least) a pause in globalisation trends. Energy markets have been volatile in the past year, and the current tension over Taiwan is putting a focus on the manufacture of sophisticated semiconductor chips. This issue is also seen in rare earth minerals, where China has a global monopoly.

Mexico feeds off the US economy and the Asian region will benefit from the post Covid revival of China; China is now not always the lowest cost producer in the region. Brazil and other Latin American countries are developing strong technology expertise and industries. That said, China is projected to be the strongest growing economy at c.5% for 2023 in a low growth world and merits attention.

The UK has relatively poor economic prospects. It is becoming clear that the NHS requires drastic remedial action, and that provides a general platform for strike action for other actors, such as the RMT. However, domestic stocks which have demonstrated a capacity to survive and thrive, are drawing the attention of foreign capital. That, and a more stable currency and Gilt market, could well result in further takeover bids.

On a macro basis, the US fiscal deficit and the money supply growth required over various crises since the Great Financial Crash in 2008; the Covid crisis; and liquidity injections to the system to offset the economic shock of the Ukraine invasion, all point to surplus US$ in the global financial system. While currencies are hard to predict, this does seem to point to potential weakness in the Dollar. This is a climate that tends to favour Gold as a store of value. In the recent past Bitcoin, frustratingly, stole that role but this seems far less likely now.

The other major beneficiaries of a weaker USS are Emerging Markets, whose debt is often in that currency and their export pricing too. Countries close to the two major economic powers, the US and China, are likely to benefit from these trends. This year looks likely to require flexibility and targeted fund deployment and if our main assumptions are borne out, we would hope to see positive absolute and relative portfolio returns.

W.Forsyth, Executive Chairman and Investment Director



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