Fidelity: Forecasting is a difficult business

Henk-Jan Rikkerink told FTAdviser that although the start of the Ukraine war will be the first entry under 2022 when history books are written, for markets, the Fed was the only game in town.

“Financial history, indeed all of history, is littered with bombastic claims about the significance of recent events that are exposed as naïve or foolish with the benefit of hindsight,” he said. 

One asset class that we believe will play an important role in 2023 is government bondsHenk-Jan Rikkerink, Fidelity International

Rikkerink quoted former Fed chair Ben Bernanke, who said in 2007 that “we do not expect any significant spillovers from the subprime market to the rest of the economy or the financial system” to illustrate this point.

“However, even with this in mind, we believe 2022 will mark a significant shift in how a generation of investors, policy makers and consumers will think about inflation and interest rates,” he said. 

“Not only is the post-financial crisis era of cheap money and quantitative easing definitively over, but also the era of low inflation and ever-decreasing rates that investors had grown accustomed to since the early 1980s.

“Forecasting is a difficult business.”

The year ahead

“The global economy is facing multiple moving parts in 2023,” Rikkerink said, outlining the recession facing the west, which will be felt stronger.

Meanwhile, he said, China’s future appears to be in the hands of policy makers. 

The Fed will slow the pace of its rate hikesHenk-Jan Rikkerink, Fidelity International

“Deciding if and when to relax zero-Covid rules or provide more support to the property sector will have a significant impact on economic growth and market sentiment, which means volatility will be high and based on news that is difficult to predict.”

Asset allocators’ primary focus in 2023 will be protecting portfolios from further downsides to risk assets. 

“To that end, we are underweight equities…we believe that earnings estimates are still too high given the macro outlook, while equity valuations are not yet particularly cheap considering how high bond yields are now,” Rikkerink said. 

“One asset class that we believe will play an important role in 2023 is government bonds.”

Bonds have had a torrid year, Rikkerink said, with central banks chasing runaway inflation with aggressive rate hikes, causing bond prices to plummet.

There are pockets of real value emerging in many asset classesHenk-Jan Rikkerink, Fidelity International

However, as we begin 2023, he said, inflation in the US, and possibly Europe too, appears to have peaked. 

“This should reduce uncertainty about the path of interest rates and the terminal policy rate, which should in turn lower bond market volatility and improve investor sentiment. 

“And the likelihood that the Fed will slow the pace of its rate hikes and possibly even reduce rates at some point in 2023 will put a cap on yields and support government bonds.”

In addition, he added, the outlook of slowing growth will be beneficial to government bonds. 

If the recession ahead is more severe, high quality fixed income will be in demand as a safe place to park money. 

The changing inflation dynamics should also mean the reinstatement of the negative correlation between equities and bonds, which was broken in 2022. 

“[This] will enhance bonds’ credentials as a diversifier in multi asset portfolios, especially important at a time when we believe equities could come under renewed pressure,” Rikkerink said.

Although the start of 2023 might look challenging, Rikkerink is optimistic about the prospects for risk assets over a longer-time horizon.

“Inflation will come down and central banks will eventually become more accommodative. 

“While still not yet cheap, equity valuations have come down a long way from their frothy post-pandemic highs,” he said, adding positive news is expected from China on zero-Covid rules at some point.

“And there are pockets of real value emerging in many asset classes, such as investment grade bonds.”

sally.hickey@ft.com