WILL 2023 BE BETTER THAN 2022?

21.12.2022 Equity markets, and growth shares in particular, endured a torrid 2022. Will 2023 be a better year?

2022 was an extremely challenging year for equity markets as high valuations, accelerating inflation and rising interest rates all took their toll. For 2023 the key question is how fast inflation will fall back to more normal rates. A review of major inflationary bottlenecks reveals that energy prices have peaked and that food prices are close to a peak. Similarly supply chain disruption continues to abate while excess demand, caused by the rapid spending of lock-down savings, has dissipated in the face of the cost of living crisis.

However, the labour market remains an important source of inflationary pressure. In the United States there are almost two job vacancies for every unemployed person while in the UK there is around one job vacancy for every unemployed person. This reflects weaker post pandemic labour supply and strong employer reopening demand for workers. As a result of the current bargaining power of workers,  wages have begun to grow at a rate that is inconsistent with inflation targets. Indeed, average earnings, excluding bonuses, are currently growing at a rate of around 6% in the UK.

So central banks are likely to keep raising interest rates until there is clear evidence of a better balance between labour supply and labour demand emerging. Subsequently cuts in interest rates are unlikely until wage growth is more consistent with the inflation target. In the UK this would amount to average earnings growth in the three to four percent region.

So, for equity markets the key variable is very much the unemployment rate. A speedy adjustment in the labour markets of advanced economies, in the first half of 2023, would see central banks pause the cycle of interest rate rises. This would set the stage for a second half equity market rally.

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This post was written by Robin