A challenging year for the economy, a better year for the financial markets.

Market strategist Tilmann Galler of J.P. Morgan Asset Management expects a challenging macroeconomic environment this year. He stresses, however, that this need not be synonymous with a rough year on the capital markets and expects good opportunities for returns, especially in investment-grade bonds.

He has summed up his outlook for 2023 in ten hypotheses:

1. Below-trend Growth, a Recession in Europe

Growth is weakening bit by bit and we are facing a recession this year, at least in Europe. How deep this recession is will be decisive for the equity markets. For the moment, the markets have only priced in a slight recession or even a soft landing.

Inflation is squeezing real wages, generating a crisis in consumer purchasing power. Granted, there is still a cushion in place from heavy government support measures put through during the pandemic. These are supporting consumption, but consumer confidence in Europe is being hit hard in particular by skyrocketing energy and electricity prices.

When combined with weakness in the industry, this will drive the expected recession.

2. Inflation in the US and Europe Weakens Considerably

The year is starting in a stagflationary environment. However, inflation is not only likely to recede but to weaken significantly. This will send out an important signal for central bank policy. A respite from upward pricing pressures in commodities would do much to lower inflation.

Easing supply-chain bottlenecks and falling transport costs on global container routes are clear signs that this is happening. Energy prices could also help out. Oil prices hit their hitherto cyclical highs last March at dollar 123. If they settle in at double digits, due to the weaker economy, basis effects will be disinflationary.

Even natural gas prices have pulled back and are now 75 percent below their August peaks. Even if US inflation were to halve, it would still be high, at 3 percent to 4 percent. This will keep central banks on high alert, especially against a backdrop of a robust job market and rising wages.

3. Central Banks Call a Halt to Tightening Cycle

As inflation momentum slows, central banks should soon reach the end of their current tightening cycle. But it is too early to call a pivot in key rates, given that real rates are still negative and central banks have never ended a tightening cycle when real key rates were still in negative territory.

During the first half-year of 2023, we expect inflation and key rates to converge and the rate-hike cycle to at least pause for breath.

4. Bond Yields Fall

The bond markets are likely to react this year to a slackening in the headwinds of further rate hikes, and the inversion of the yield curve is likely to slow. Inversion will end completely, once markets start pricing in accommodative central bank policy again.

Shorter-dated bonds are closer to current inflation, while longer maturities target overall economic growth. With growing concerns about the economy, yields on longer maturities will also adjust downwards. From a tactical point of view, longer durations are attractive.

5. Investment Grade Bonds Beat High Yield

In the wake of the big bond market crash, we are hearing talk of «bonds are back». High-yield risk premiums have not yet peaked, and with a recession looming ahead, investment-grade bonds make more sense.

6. Investment Grade Bonds Beat Equities

Given the outlook for lower interest rates, current yields are so promising that even double-digit returns are possible on long-dated investment-grade corporate bonds. Accordingly, barring a soft-landing scenario, equities will have a hard time outperforming bonds. Granted, equities are no longer overvalued after the price declines of 2022, but the big question remains future earnings. In addition to government and corporate bonds, it is worth taking a look at high-quality quasi-governmental agency bonds.

But whether government or corporate bonds, it is important to focus on good credit quality.

7. Corporate Margins and Earnings Fall

The equity markets continue to optimistically price in 3 percent earnings growth for 2023. But another negative correction in earnings forecasts is expected, and downgrades will keep the markets volatile. We see two sources of momentum. Although margins were squeezed slightly in 2022, companies were still able to pass on a large portion of price increases to their customers.

That might be harder to do this year. Cost pressures remain high, particularly from labor costs, while weaker demand is holding back top-line growth. This will put even more pressure on company margins than before and lead to shrinking profits.

8. Value and Dividend Stocks Outperform Growth Stocks

We expect value stocks to maintain their lead structurally over growth stocks in 2023. Value outperformance is likely to continue, albeit less spectacularly. Especially early in the year, high-quality value stocks should perform strongly. Companies with pricing power and solid market share should be overweighted.

Over the course of the year, however, we expect the equity-market environment to swing back towards growth stocks, as central banks mark a pause and markets begin to price in the looming recovery. Even so, value and dividend stocks should come out on top.

9. China Ends its Strict Zero-Covid Policy

The zero-Covid policy triggered a severe economic slowdown in 2022. If the lockdowns are not ended once and for all, they could send the economy and the real estate market in particular into a downward spiral. Economic imperatives are forcing policy-makers in Beijing to begin changing course, and a prompt recovery is therefore expected for the Chinese economy, driven by heavy pent-up demand.

We expect China and the entire region to have stronger growth momentum than industrialized countries next year.

10. Emerging market equities outperform developed market equities

Emerging markets, on the whole, are likely to ride high over the next few months. There have been lots of negative newsflows, especially from China, which dragged down all emerging markets with it. The situation should move back to normal by the summer, and pent-up consumer demand should provide a boost to the markets.

This makes the region attractive from a cyclical point of view, and valuations are also far cheaper than in developed markets. Emerging markets haven’t been this attractively priced for a long time, and a lot of pessimism is being priced in. But political risks in China also merit a higher risk premium.

That’s why China isn’t quite as attractive as it might look at first glance. Nevertheless, we are confident that equities in the region will outperform developed markets over the coming year. If the geopolitical situation eases, the dollar should weaken further, which would be good news for beleaguered investors in emerging markets.

  • The Investment Outlook 2023 can be found here. 

Disclaimer: The Market Insights program provides comprehensive data and commentary on global markets without reference to products. Designed as a tool to help clients understand the markets and support investment decision-making, the program explores the implications of current economic data and changing market conditions.] For the purposes of MiFID II, the JPM Market Insights and Portfolio Insights programs are marketing communications and are not in scope for any MiFID II / MiFIR requirements specifically related to investment research. Furthermore, the J.P. Morgan Asset Management Market Insights and Portfolio Insights programs, as non-independent research, have not been prepared in accordance with legal requirements designed to promote the independence of investment research, nor are they subject to any prohibition on dealing ahead of the dissemination of investment research. This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not a reliable indicator of current and future results. J.P. Morgan Asset Management is the brand name for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. To the extent permitted by applicable law, we may record telephone calls and monitor electronic communications to comply with our legal and regulatory obligations and internal policies. Personal data will be collected, stored and processed by J.P. Morgan Asset Management in accordance with our EMEA Privacy Policy www.jpmorgan.com/emea-privacy-policy. This communication is issued in Europe (excluding the UK) by JPMorgan Asset Management (Europe) S.à r.l., 6 route de Trèves, L-2633 Senningerberg, Grand Duchy of Luxembourg, R.C.S. Luxembourg B27900, corporate capital EUR 10.000.000. Image source: Getty Images. 09hv232501140239