No single catch-phrase epitomises the 2023 global macro outlook, but here are ten predictions:

1. 2023 will be a year like no other. Investors should not rely heavily on traditional models of previous economic and financial market recoveries, especially ones that worked best since the mid-1990s, as we are entering a unique era; rather, they should maintain a somewhat cautious and balanced perspective, with targeted risk-taking in select countries, sectors and stocks, as described in our other 2023 outlook pieces. Indeed, active stock selection, in particular, will be more important than ever in 2023, so special attention is required in selecting managers who have excelled in the last several challenging years.

2. Re-balancing and China's positive pivots: China, after a hesitant start, will likely see much improved economic growth in 2023 while most of the rest of the world will be sluggish. Its recent surge in the financing of property development was a major pivot in policy that will greatly support economic growth, although the previous mania for purchasing property and the economy's reliance on such will continue to be diminished. This should help keep global commodity prices fairly stable. Also, the sudden pivot towards détente in foreign policy in mid-November has considerably brightened the 2023 global outlook. There will be, however, many challenges to this détente, and as it is not firmly rooted yet. Especially with the likely visit to Taiwan by the new US House Republican leadership and continued trade restrictions, there is a chance that any rapprochement may prove short-lived. Clearly, both "sides" will benefit from a respite in economic and political tensions. For its part, China will likely resume purchases of US Treasuries after major sales in 2022. It also desires a more stable backdrop as it addresses the weakness in its housing sector and parts of its financial markets, while also improving the troubling situation for ordinary citizens and local governments. Meanwhile, US and other countries' corporations, especially Apple, hope that their factories there can keep producing despite various restrictions, that China will remain an important client and that the entire global supply chain will continue healing.

3. COVID will remain a factor, especially China's citizens' fear of such. We have predicted that China would open up the country sooner than expected, though gradually and somewhat furtively, but such has been accelerated by the recent protests and the increasing weakness in the economy. While cases and casualties will likely rise, the government clearly wishes to promote economic growth now and springtime will likely witness a near full opening in China, especially after the National People's Congress in March. We expect that the fears of such there, and globally, will abate in healthy, sustainable fashion.

4. Central banks, excluding that of Japan, will keep rates high to hamper "second-round effects." These "effects" will be the key factor in how inflation evolves. Labour's wage demands, coupled with the strikes and harmful supply shocks usually affiliated with such, obviously stand out, but the perceived "pricing power" of corporations and landlords will also be key, and they all will be watching how determined central banks will be to maintain high rates given the increasing political pressure as economies weaken further. This is most true in Europe, where inflation is the highest in the developed world and where labour is very powerful, especially in key political, infrastructure and economic channels. The media is not widely covering the strike actions, so investors should often screen the news themselves for such. Conversely, countries with low labour demands should have an advantage, especially Japan and much of Asia excluding Korea.

5. Countries with too much concentration in the tech hardware sector may not flourish, as industry fundamentals will remain challenged, including the upcoming oversupply of semiconductors over the intermediate term as countries around the world rush to build their own fabs for national security and other reasons. Due to this, semiconductor production equipment manufacturers, however, should see improved orders after their recent cutbacks.

6. For overall global risk markets, one should expect neither "Doom and Gloom" ahead, nor a Goldilocks scenario. The US equity market is not cheap, so a strong rally seems unjustified from December levels, but most other countries are quite inexpensive and could perform reasonably well. Europe, however, is suffering from unique difficulties, so it may remain inexpensive. Within this backdrop, stock and sector selection will clearly be the most important key to achieve positive returns.

7. Avoiding Short-term scares; many macro-economic, corporate earnings and credit shocks likely lie ahead in the short-term, as the global economy descends further into a semi-stagflationary period in which former excesses are "cured;" however, this is part of the healing process in which the intermediate-term outlook is actually improving, so investors should not panic in the short-term. Indeed, as for corporate earning shocks, as long as such are not far below analysts' estimates, investors may forgive such, especially if the outlook remains positive.

8. The global crypto infrastructure and some other ultra-growth industries are likely to continue to encounter troubles. The recently exposed lack of due diligence by many institutional investors is shockingly disappointing, as were the attitudes and practices of many industry leaders. Partly because of this, most "growth at any price" companies and industries will now be heavily scrutinized by venture capitalists, public-market investors, banks and regulators. This is bound to expose other problems that could spread. Indeed, ultra-growth companies will likely need to show a clear path to profitability on a GAAP basis in order to entice funding; however, such companies definitely exist and should benefit as they will likely attract much more investor interest.

9. Geopolitics will continue to be a factor: the "Clash of Systems and Philosophy" will clearly continue, especially with Russia, Iran and China pursuing their own path. The Russia-Ukraine war will continue through 2023, but possibly in much less bloody way, so this may calm risk markets. One also needs to keep a careful eye on the Middle East, especially Iran, as tensions remain greatly elevated given its internal problems and an even more assertive new Israeli government. As mentioned above, it will be important to watch Taiwan as well. One hesitates to mention North Korea, as it is a perennial, unpredictable worry, but hopefully China will restrain it from its increasingly provocative actions so that both "sides" can reduce the tension.

10. Troublesome domestic politics will be important; fiscal stimulus globally is already greatly constrained due to fears of its inflationary effects and as interest expenses surge, but even the normal functioning of fiscal affairs may encounter significant turbulence. In the US, the Republican control of the House of Representatives is bound to cause major disputes in 2023 and if a financial market or economic accident somehow occurs, action will need to be taken. If it is not taken, much like the initial stages of the Global Financial Crisis, financial markets could revolt. House investigations of various political matters are also likely to cause great discord in 2023, as well. In Europe, political dissent beyond strikes is likely to be intense especially as energy subsidies wane due to the need for fiscal restraint. Asia, however, looks much calmer on the political front.

Conclusion

We greatly hope that these comments, as well as the other outlook pieces, will prove useful to our investors and we are always willing to address their thoughts and questions. We could all use a bit of good luck in the year ahead after the tumult of the last few years.

Author: John Vail, Chief Global Strategist

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Christmas fever was running high with beautifully decorated trees and colourful lights cheering us on every corner. The tone was however a lot less cheery when Amazon recently reported their 3Q22 results and downgraded their 4Q22 revenue guidance.

Similar sentiments were reflected across a large range of consumer names noting pricing pressure and a lack of holiday shopping visibility.  There is also clear evidence that inventories have been building across US retailers with supply chain constraints lifting and post covid "revenge spending" tapering off.

We maintain our preference for companies with strong pricing power, exposure to the more resilient high-end consumer and companies with global reach that can also benefit from a China reopening.

LVMH, MercadoLibre and Starbucks are three diverse consumer names that we believe can withstand a less cheery Festive Season.

Why Amazon's revenue downgrade is a concern

Amazon is a behemoth e-commerce platform with tentacles across most consumer channels and verticals.  They have access to extensive supporting data that can paint a clear picture of the general consumer outlook.

Historically we have seen Amazon downgrade earnings expectations, but this is the first time in many years that they've downgraded revenue expectations.  The fourth quarter outlook is specifically prevalent given that it includes big spending days in the US, such as Black Friday, Cyber Monday, and Christmas.  Amazon cited slowing consumer trends particularly in the US and Europe and a lack of holiday season visibility.

Whilst there were several consumer companies that reported relatively good 3Q22 results, outlook statements echoed Amazon's concerns and remained cautious around peak season sales and beyond.

Consumers are still nervous and hunting for bargains

Softer economic data points are now becoming more frequent following the flurry of central bank interest rate hikes year to date.  The US composite PMI slipped to just 44.6 in December, US housing continues to cool down, layoffs are surging, and consumer sentiment remains at levels last seen in 2009 despite a recent recovery.

US consumer spending has remained relatively resilient during 2022 as households continued to draw on excess savings accumulated during the pandemic. Post COVID pent up demand have been driving a revenge spending cycle focused on travel, leisure, occasion-based spending (for example weddings), beauty, entertainment and more.  Recent data points however suggest a softening in these trends with consumer wallets facing more constraints (softer macro/inflationary pressures).

According to Evercore ISI's December company surveys, current holiday sales remain focused on consumer staples products while discretionary category sales are slow, and consumers are focused on discounted goods.  More broadly pricing power continues to soften across industries from elevated levels as global growth slows.

Pricing power continues to soften across industries

Source:  Evercore ISI, December 2022

Signs of inventory build are intensifying  

Many companies across a range of sectors reported higher inventory levels during the 3Q22 results season. A result of continued supply chain disruption improvement and softer demand.  Target (US general merchandise discount store) and Nvidia (inventor of graphics processing units) were two examples of big bellwethers that guided to big inventory build, - adjustments, and/or write-offs.

Our detailed analysis of inventory levels for a sample of 30 global consumer stocks across retailing, food, and apparel, suggest a sobering level of inventory build across the consumer landscape.  We looked at the change in inventory as a % of sales and inventory days (average number of days a company holds its inventory before selling it) between the latest reported quarterly numbers (3Q22) and the same quarter last 2021 heading into the Festive Season (3Q21).

The results showed that there are only 3 stocks with lower inventory days and only 5 stocks with lower inventory as a % of sales in our sample.  There is specifically a clear inventory build in sportswear with Adidas, Puma, and Lululemon the worst offenders. For example, Adidas's inventory to sales is now almost 30% up from c17% at 3Q21 and Lululemon's inventory days are up from 126 days to 150 days (see chart below for the change in Inventory Days) over the same period.

Increased inventories a concern across many consumer names

Source:  Alphinity, Bloomberg, December 2022

Positioning in companies with strong inventory management and pricing power

Alphinity invests in quality companies that are in an earnings upgrade cycle that trade at a reasonable valuation.  In our view, excellent inventory management skills and strong pricing power will be critical in determining the winners vs losers in the 2023 consumer race.  Companies that can withstand margin pressures in an environment where business offload excess inventory and consumers hunt for bargains.

Investing in quality companies at the right time in their earnings cycles

Source:  Alphinity, December 2022.  Note: Alphinity currently owns LVMH, MELI & SBUX, but not AMZN & TGT.

Pricing power remains critical:  LVMH, the world's largest luxury group, is currently our biggest position in our Global Equity Fund as we head into 2023.  Demand for their luxury products have remained resilient despite slowing macro trends, with the company able to pass through inflation given their very price insensitive customer base.

LVMH has been in an impressive earnings upgrade cycle since 2020, delivering earnings growth across sub-segments, brands and increasingly across geographies.  Management also remains confident in a demand recovery in China once restrictions have lifted.

Despite the relative strong performance of the last 12 months, the company still trades at an undemanding 22x 12-month forward Price to Earnings, which is at the bottom of its 5-year trading range (20-35x)

LVMH - Strong pricing power & resilient demand drive an impressive earnings upgrade cycle

Source:  Alphinity, Bloomberg, December 2022

The US consumer is not the global consumer.  Certain emerging market countries, such as Brazil, are ahead in the business cycle vs major developed markets, where inflation, interest rates and unemployment are already past peak levels.

MercadoLibre (MELI), is the largest e-commerce and fintech company in Latin America, with over 88 million subscribers and exposure across 15 countries.  MELI has a unique eco-system model with their marketplace, payments, credit, logistics and other services all reinforcing each other, driving strong top line growth.

MELI's reported very strong 3Q22 results well above their peer group, with accelerating sales growth and margin expansion reflective of their core strengths, including their broad category base, continued logistics improvements and a step change in marketing.  Management noted they continue to "manage for growth and market share leadership"

MELI consistently delivering strong Revenue growth and Operating margin expansion

Source:  Bloomberg, December 2022

China reopening will be an important earnings driver of 2023 earnings for multi-national companies: Starbucks (SBUX), is the leading specialty coffee retailer in the world, operating across more than 80 markets through company-operated and franchised stores. SBUX experienced a tough time during COVID, with many store closures resulting in a big drop off in sales and margins across all markets.

Looking ahead, we expect their new strategy to drive a strong recovering in same store sales growth across their international markets and a return to profitability.  SBUX is also well positioned to benefit from a China reopening, where they continued to open new stores during the pandemic (going from 4123 stores at the end of 2019 to 6000), that can return to profitability.

China Same Store Sales Growth - Potential to rebound on reopening

Source:  Bloomberg, December 2022

We will only know during the first quarter of 2023 if Amazon did indeed cancel Christmas and if general market jitters were justified.  Regardless, good inventory management, strong pricing power and the right geographical exposures will remain critical elements for consumer companies as they navigate yet another tough macro year ahead.

At Alphinity we will continue to do bottom-up analysis and global company visits to find the highest quality companies that have these attributes and can deliver higher than expected earnings.

Author: Elfreda Jonker (Client Portfolio Manager)

This information is for advisers & wholesale investors only.

By now, people whose eyes don't immediately glaze over once discussions of personal or national budget are broached are well aware of an upcoming spike in their electricity and gas bills. However, for the majority of the Australian citizenry the 'sticker shock' from the increase in utility bills will still be felt in real time. Tim Toohey, Head of Macro and Strategy, details why for many Australians this will merely compound an already dire cashflow situation.

For context, the Australian Treasury has assumed that electricity prices will rise 20% (y/y) by late 2022 and a further 30% in 2022-23. This will take utilities to an unprecedented share of wallet in 2023, some 2.6% of household income by Dec 2023 (refer Chart 1). While that may not sound like a particularly scary figure, it's 25% above the 10-year average and 49% above the long run average dating back to 1960. It will also represent the biggest one year rise in utility bills in the post-War period.

The cause for the spike has been well documented. A surge in global coal and energy prices in reflex to the invasion of the Ukraine was the dominate force, some unfortunate timing of coal-fired power station maintenance and some less than transparent behaviour by market participants all played a role. Yet the cause of the trend rise in utility costs is less well understood at the household level; the rapid transition to renewables is unravelling the economics of running coal and gas-fired generation at an even more rapid rate.

This is not to say that decarbonising the grid in an expeditious manner is not necessary or desirable. It merely means that the cost of the transition will be felt well beyond well-heeled investors asked to dig deep into their pockets to finance the capital cost of the transition. Indeed, it is the consumer that will invariably be forced to pay for the potholes in the road to decarbonisation as firms seek to recover the cashflow hit from declining economics of traditional generation via higher power bills.

Utility companies know this. Politicians should know this. Households largely have no idea that they are ultimately on the hook if best intentions of a smooth energy transition turn to custard somewhere along the journey.

To overwork the analogy, we have barely gotten the car out of the driveway with a long journey ahead to a known destination but without a clear map of how to get there. We don't have enough cash in our wallet to complete the journey, some of the roads have not yet been built, and the kids who have been fighting politically for years before getting in the car are continuing to do battle in the backseat.

For those of us scarred from family car trip holidays at this time of year, we are collectively at the point where optimism and excitement at the start of a trip are about to be overwhelmed by the reality of a long-haul car trip in the Australian heat. The feeling of sizzling hot car seats, the taste of Aerogard inadvertently sprayed into a protesting mouth and the injustice as youthful back seat rebellion is brutally supressed by the front seat elites.

Yes, it's going to be a long and painful journey. But to get a sense of who will bear more of the cost, we can look at the average quarterly electricity bill across different dimensions.
Geographically, households in WA on average have lower power bills and for any 50% national price increase will be roughly $240 p.a. better off than their SA cousins (refer Table 1).

By household size (refer Table 2), the more children you have the greater the power bill increase (and the more time the parent spends wandering around the house turning off lights left on by their children).

By age, it's the young that will feel the pain more acutely (refer Table 3). Indeed, Gen Z (18-24yo) power bills will swamp the bills of Baby boomers (60+) by $150 p.a. Yes, despite the moral superiority of youth, it seems it takes more power to fuel video gaming sessions in the wee hours and to charge the armoury of devices required to keep your social media presence tip top!

From the perspective of a top-down economist, the addition increment to inflation from rising power and gas bills could add 1.75% to inflation by the end of 2023 in first round impacts and potentially a further 0.35% in second round effects (Refer Table 4). That's a lot, but that's an average estimate. From the perspective of young households with multiple children living in the Eastern States, the impact will be larger and more painful.

Worst still, this is the slice of the population that are most at risk of rising education, health, insurance and housing costs. We all know that the interest payments on the stock of existing total household debt are set to rise incredibly sharply in 2023, compounded by the roll off of fixed rate mortgages (refer Chart 2).

In conjunction with principal payments, debt servicing for the average household is set to breach the prior record during 2023 (refer Chart 3). Again, this is for the average household. The situation for young mortgaged households is far more dire, not to mention a rising proportion of the recent new homeowners who are now entering negative equity scenarios for their homes.

This will place an enormous impost on a large section of society. Nobody likes having their discretionary income squeezed and nobody likes an unexpected spike in their gearing ratio via falling asset prices. Even if we assume the ongoing robust growth in wages and employment in 2023 the impost of higher interest costs, utility costs, insurance costs and rents will be sufficient to see average discretionary cashflow fall by 15% by mid-2023 (refer Chart 4), and much more for young households with large families and large mortgages.

Given, retail sales growth normally closely tracks our measure of discretionary cashflow, we expect that retail sales will slow from the rapid rate of close to 20%(y/y) to zero growth by mid-2023. Note, this is likely the best-case scenario. It could easily be worse if sub-trend economic growth reveals labour market weakness with a lag, as observable in all prior downturns.

The argument that Australians have accumulated 'buffers' via $260bn in 'excess savings' since the pandemic and via pre-payments on mortgages will exceed additional interest payments - for most borrowers at least - is illusionary.

While this might be true in an accounting sense, the RBA is likely asking itself the wrong question. It is not a question of how big a 'buffer' is before tightening policy will hurt, it is why did households accumulate such a buffer in the first place? And is the economic outlook improving or deteriorating?

Excess fiscal stimulus obviously contributed to the initial saving spike, but what if the ongoing accumulation of savings was more about de-risking asset exposure in an uncertain time or because a large cohort of the population is simultaneously entering retirement (COVID may have expedited this decision for many Baby Boomers).

If this is the case, then the 'excess saving' is not suggestive that a consumption boom lies ahead that threatens future inflation. Quite the opposite: in times of rising economic uncertainty households tend to initially lift their saving rate. They do not decrease it.

There has been ongoing debate whether the government has a role to play in capping utility costs. And, if so, whether that should be at the company level or the consumer level. Given the recent history of firms profiteering through the crisis by lifting prices rather than absorbing margin pressure and the impending cashflow hit for households, the answer should be obvious.

More importantly, if the government wants to keep everyone in the car playing nicely during the initial phase of the energy transition, then the answer is very much yes: utility costs need to be controlled. Let's just hope that there are enough fiscal resources and goodwill to get us to that new energy destination as quickly and efficiently as possible.

Author: Tim Toohey, Head of Macro and Strategy

The RBA delivered an eighth-straight rate hike to hit a 10-year high to round out a tumultuous 2022. 
 
In the final episode of The Rate Debate for the year, Darren and Chris discuss their thoughts on further tightening next year, whether a global recession could solve the inflation problem and the impact of the fixed-rate mortgage cliff on Australian homeowners and the domestic economy.

Speakers: Darren Langer and Chris Rands, seasoned fixed-income specialists 

WaveStone Capital's Henry Hill and Kirsty Mackay-Fisher travelled to the Northern Hemisphere, visiting a large number of companies and gaining insights on the impacts of inflation and a slowing consumer. Hear their insights and observations of the outlook for the Australian share market.

The RBA hiked rates for the seventh consecutive month as it seeks to stifle inflation. Global central banks continue aggressive monetary tightening despite early signs of moderating inflation and weaker forward growth indicators.

With the consumer bearing the brunt of high inflation and tighter financial conditions, the RBA has backed away from aggressive rate hikes for now. Will other central banks follow, or is this a temporary reprieve?

Speakers: 
Darren Langer, Co-Head of Australian Fixed Income &
Chris Rands, Senior Portfolio Manager

From Stockholm to Zurich, then a week in the UK at a European Industrials Conference. Chris Willcocks details his time spent overseas visiting companies, seeing their assets and operations and meeting management teams.

Speakers: Chris Willcocks, Portfolio Manager & Elfreda Jonker, Client Portfolio Manager

This information is for advisers & wholesale investors only.