Number one on the list of five key focus areas for 2023 investors is the inflation crisis.

In my 20 years following markets, monthly inflation data overseas and quarterly in New Zealand has been a lower impact data point for markets, given less weight versus employment and GDP data readings.

We are now in a new environment where every investor and trader should have inflation data on alert with market sentiment moving quite dramatically on each reading.

Inflation has slowed in the United States for multiple months now from its June peak of 9.1 per cent to 6.5 per cent in the latest January reading, so this trend seems to be on track to move into the 4 per cent range by year end in my view.

Moving from 4 per cent to 2 per cent will be a multi-year challenge as many parts of the inflation basket are stickier and will be the new norm for businesses holding pricing high. New Zealand and Australia still have readings in the 7 per cent range, but I expect we’ll see demand forcing spending and improved supply chain dynamics.

Wage growth hasn’t caught up with inflation and a weaker employment market may be needed to slow inflation and keep a cap on wages. As we know when inflation of goods and services goes up, wages have to follow. This then further increases food and living costs and the cycle only breaks when demand destruction occurs and supply side forces balance out dynamics.

Watch the central banks

Investors will be watching for the pause and hold in 2023 of interest rates from global central banks. We have seen rapid tightening but forward swap curves are starting to price a halt and central banks are signalling a slowdown in the pace of hikes.

In my view we are closer than ever to seeing this end in tightening by mid-year and bond market pricing is ahead of the central banks.

The bond market is usually known as the smartest in the room and has already moved well out of lockstep; Fed funds rate forecasts and our own swap curve pricing in New Zealand are predicting a slowdown, big inflation decline and recession to hit GDP.

The RBNZ rounded out 2022 in hawkish fashion, increasing the OCR by 75bps to a 14-year high of 4.25 per cent, and forecasted hikes of 100bps on the horizon. Officials expect the OCR to peak at 5.50 per cent in September this year and remain at this level through to June 2024. This seems wishful thinking vs history in my view that we can stay at these levels to mid-2024.

Strong job market, talent shortage

Currently holding up the economy is a strong job market and talent shortage. The unemployment rate is at a record low in the 3 per cent range in New Zealand, but wage growth isn’t matching inflation. Staff shortages are creating a sub crisis in sectors and low inbound migration continues to create a unique dynamic for the employment market and the biggest chance of a soft landing for the economy if rates stay low.

NZ has approximately 170,000 people on the government Jobseeker payments and it’s reported that nearly 100,000 of them are work ready but still unable to find employment. Moving more people into employment is an upside positive for the economy and return of migration.

Bigger markets like America continue to add net jobs despite kicking off this year with 56,000 technology staff being laid off at big firms like Google, Microsoft, Salesforce and Amazon, with no major layoffs in the largest employers and government hiring.

Close look at earnings

With 2022 behind us, Wall Street is now primarily focused on the profit outlook for the coming year, but also the last quarter
of 2022 results. Earnings have been holding up better than expected but we have seen companies starting to lay off workers (especially in the technology sector) and growth/margin concerns. Earnings per share growth has consensus expectations of +3 per cent in 2023.

Recent easing of China’s zero-Covid policy represents one upside risk to S&P 500 profits via stronger 2023 global growth.

The biggest risk in 2023 is a potential recession, in which case S&P 500 EPS could fall 11 per cent to $200 and the index could trough at 3150 (-19 per cent). Goldman Sachs economists assign a 35 per cent probability that the US economy enters a recession during the next 12 months, significantly below the consensus forecast probability of 65 per cent.

The economy

The forthcoming recession is one of the most predicted, and debate over hard or soft is the focus of discussion in 2023 as slower GDP growth is inevitable at this point. With funding cost pressures the RBNZ will get the demand slowdown they want to bring inflation towards target and pull-back in spending. Consumer confidence has plummeted to record low readings in recent Westpac and BNZ surveys as businesses and consumers feel uncertain along with an election year ahead.

Although NZ did have stronger GDP in the September quarter with December likely a wild card now after seeing weaker retail spending data. The RBNZ expects four quarters of negative growth from the June quarter of this year onwards (-0.5 per cent, -0.3 per cent, -0.1 per cent and -0.1 per cent).

Forecasts are one thing but reality can be vastly different in the uncertain environment we are in. The September quarter of 2022 was a good example, with the major banks forecasting GDP growth of 0.9 to 1.3 per cent and the actual reading coming in at 2 per cent better than expected.

The year ahead

Kicking off 2023, equity markets at the time of writing are positive +5 per cent and the so-called January effect provides some hope after the bear market drop of 20-30 per cent+ in major US indices during 2022.

January effect shows when the first five trading days are up over 1.4 per cent after a negative prior year, the S&P 500 has been up an average of 26 per cent in the year. This is just one interesting data indicator but has worked seven out of seven prior instances with gains from 13 per cent to 38 per cent. Most Wall Street forecasts are divided, however, with forecasted lows of 3000 on S&P 500 to highs of 4800 from the most optimistic.

Our local market will have a tougher battle vs rising term deposit rates being a yield driven equity market. Risk-free rates in the 5 per cent range will be very tempting for many investors in an uncertain environment both economically and politically.

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