For professional investors and qualified investors only

GLOBAL OUTLOOKS 2023

No more bad news
shouldbeESG
VIEWPOINT
good news in 2023

William Davies
Global Chief
Investment Officer

Issued December 2022

After a dismal year for markets, William Davies gives histhoughts on risks and opportunities in the market as we head
into 2023. While there is plenty to be cautious about, a repeatof 2022 seems unlikely
Going into 2022 the market repriced for bad news – and there was certainly noshortage of that. We have seen deteriorating US-China relations and associatedtariffs and trade wars; the Covid pandemic and subsequent supply-chain problems;
the Russian invasion of Ukraine and intensified pressure on energy resources; andthe great resignation and a reduction in the participation rate of workers. In addition,
we have seen stickier headline inflation and rising interest rates, expectations fora recession, and in the UK a period of intense volatility as the government and its
policies see-sawed.

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Global Outlooks 2023

For 2023 we may see many of these macro conditions continue,
but in the US in particular we don’t necessarily expect theseto result in an extended deep recession, and as long as things
don’t deteriorate significantly investors may begin to feel more
optimistic and we might see market conditions improve. We
believe the recession in Europe will be deeper than the US, but theunpredictability of the situation around Russia and Ukraine makes it
difficult to factor this into a central case. In each instance, however,no more bad news could end up being good news for investors.

Interest rates in the UK, meanwhile, remain a little bit unpredictablefollowing a change in government and a reversal in policy.
Overall, although I don’t expect global rates to come down in 2023,
an end to the guessing game about how high they go has thepotential to be a positive catalyst (Figure 1).

Figure 1: The majority of developed market central banks (inyellow) expect to reach terminal rate in 2023

A different story on inflation and interest rates
Headline inflation should come down in the US unless energy
prices increase substantially. Core inflation is likely to be stickier,but stable or lower readings mean that the US Federal Reservemight pause interest rate rises in early 2023. We would not expect
a looser monetary environment as rates come down, but with somestabilisation 2023 should be a different year.
In terms of raising rates, in our view the European Central Bank
(ECB) has more work to do than the Fed. The ECB only began tohike in July 2022, so although it is unlikely to raise rates as high as
in the US it may have to do so for longer. However, there is a little
less clarity on inflation in Europe given both the war and the relianceon imports in the region, particularly of energy. Whereas the US isconsiderably more self-sufficient, Europe has worked to build up
energy inventories1, but a particularly cold winter could see rationing
and additional contribution to an economic slowdown.
1

Source: Bloomberg, November 2022

An end to the guessing game about
how high interest rates go has thepotential to be a positive catalyst

Reuters, Mission accomplished? Europe fills gas storage ahead of schedule, 4 October 2022

Issued December 2022

2Global Outlooks 2023

A recession playbook with a twist
So, it seems inevitable that Europe will see recession, and in theUS we will have to watch the Fed and assess how much economic
pain it deems necessary to beat inflation. Although I don’t think
we will see a recession along the lines of 2020 or 2008, given therisks I believe focusing on quality will be essential for success –across asset classes and regions – because there are going to becompanies that are able to survive a recession much better, andthose that are going to be less well prepared.
In fixed income, credit quality is likely to be a much greater
determinant of success in 2023 relative to 2022 when duration
was the key driver. There are a lot of companies which built up
strong balance sheets during the periods of low interest rates, but
the almost indiscriminate fall in valuations has created pockets ofopportunity in markets.
In equities it is a similar story with quality of earnings andbalance sheets the likely requisites for success. Although wehave seemingly emerged from Covid-19 in the west, we are notquite “normal” in terms of activity. We are, however, seeing more
spending on services than goods, and areas of recovery that aredifferent to those areas of strength we saw in 2020/21. Usually ina recession you would avoid economically sensitive sectors, andIssued December 2022

investors should be cautious, but this “return to normal” does
create opportunities even with the prospect of recession.
In both equities and fixed income, however, you need a reallythorough analysis capability to find the winners with strong balance
sheets that can survive a recession, and we pride ourselves on thatat Columbia Threadneedle.
We must also be aware that this is a different environment to thepast few decades: low inflation goes back to the 1970s and 1980s,
so we must be careful about extrapolating from those periods
which companies and sectors will do well over the next few years.
In a time of cheap money, weaker companies perhaps survived for
longer than they would in an environment where money is morenormally priced, and they are about to be tested in ways they
haven’t previously experienced.

In fixed income, credit quality is likely
to be a much greater determinant of
success in 2023 relative to 2022

3Global Outlooks 2023

The same focus on quality applies to relative opportunities
across regions. Europe is cheaply valued compared to the US
but is facing greater headwinds; emerging markets, dominatedby China, are also relatively cheap but are experiencing uneasy
geopolitical relationships and trade restrictions; while theUS looks pretty reasonable in terms of valuations and is thebroadest market. Again, research and analysis will be key infinding the right opportunities.

Trials for the energy transition
Turning to renewables, the Russian invasion of Ukraine hascreated a dichotomous outcome in Europe. The increase infossil fuel energy prices will accelerate the energy transition,with a desire to be self-sufficient paramount. However, theenergy crisis has also seen the extended use of coal andnuclear plants that were scheduled to close2. So on the one
hand we are taking a step back in terms of carbon reduction
policies – out of necessity – but on the other we are seeing
increased investment in renewable projects3. This also brings
2IEA, Global energy crisis, June 2022

a sensitivity we must be aware of from an ESG (environmental,social and governance) point of view. This crisis has highlighted
that if we reduce the supply of fossil fuels, it drives theirprice higher. Environmentally that may be good, with lessenergy being consumed because it is expensive. Socially,
however, it is problematic because those that are less welloff spend a greater proportion of their income on energy.
So we have a huge social negative for what environmentally
is a positive.
I do believe, however, that rather than this reversing theopportunities in ESG because fossil fuel production keeps taking
place, it will actually increase the opportunity for renewables
because the increased investment should accelerate
future growth.

The Russian invasion of Ukraine
has created a dichotomous
outcome in Europe	IEA, Record clean energy spending is set to help global energy investment grow by 8% in
2022, June 2022

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Issued December 2022

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Global Outlooks 2023

Higher inflation and interest
rates will remain part of theeconomic backdrop in 2023,
but stability on thesemeasures should provide
some supportConclusion
It is difficult to recall a year in which news has been sosustainably negative as 2022. Looking forward and seeking
to make a central case is challenging given the difficulty incalibrating the risk of escalation of the war in Ukraine andits impacts on Europe, or even regime change in Russia.
Meanwhile, rising tensions between China and the US haveintroduced heightened risks for emerging markets and added
caution. We believe higher inflation and interest rates will remainpart of the economic backdrop in 2023, but stability on thesemeasures should provide some support. The markets did
not anticipate the Russian invasion as we entered 2022; it’spossible a similar blind spot occurs heading in to 2023.

4In our view we are well-placed to navigate this uncertainty.
At Columbia Threadneedle we are globally connectedwith more than 650 investment professionals
based in Europe, North America and Asia4 sharing
perspectives across all major asset classes andmarkets. We look to continuously improve ouranalysis and research, and our investment approachis underpinned by a culture that is dynamic andinteractive, and by processes that are team-based,performance-driven and risk aware. This has allowed
us to perform well over the long term, and as we head
into 2023 we believe this will continue.

As at September 2022

Issued December 2022

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Global Outlooks 2023

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