The first quarter of 2023 has been a rollercoaster for investors. Daniel Casali, chief investment strategist at UK wealth manager Evelyn Partners, takes a look at the risks and opportunities in the world economy through the rest of the year. 

As the first quarter of 2023 draws to a close, the risks and opportunities in the world economy and financial markets are still finely balanced, Daniel Casali, chief investment strategist at UK wealth manager Evelyn Partners, said this week. 

“Global stock markets have become more volatile, sending investors on a rollercoaster, as central banks have tightened monetary policy with rapid hikes in interest rates,” he added in a statement.

“The direction of interest rates continues to be the subject of considerable debate, along with the outlook for company earnings, the potential for recession and the impact of China’s reopening,” he said. 

The comments come at a time when, after a period of rising interest rates, global volatility amid the Russia-Ukraine war, and adjustment after the pandemic, wealth managers are trying to work out asset allocation to capture developments for the rest of this year and in the medium term. 

Global markets on a rollercoaster  
In balancing these competing forces, his view is that global growth, in terms of real GDP, will emerge a little below trend for the year, at around 1.5 per cent. This assumes that inflation will decelerate, and central banks pause on rates, with the Federal Reserve leading the way. 

China’s reopening will have a moderate stimulus effect for the global economy, creating a ‘soft-ish’ landing, he said. 

Against this backdrop, stock markets can continue to progress, but are likely to see considerable volatility and there is the potential for some deceleration in company earnings’ growth. “As such, we think a defensive strategy is still warranted, with a focus on dividend yield and sound cash flows,” Casali said. 

He believes that any contagion from the banking turmoil has been contained. This was also highlighted by UK-based firm Albion Capital at a media briefing last week. “Levels of bad loans are far lower than during the Global Financial Crisis (GFC). Many banks have mark-to-market losses on their holdings in treasuries and quality bonds, but this is a less intractable problem and would be largely resolved if bond yields drop,” he continued. “In addition, the cost of interbank lending is still low, showing that banks are still willing to lend to each other, unlike during the GFC.” 
 

Headwinds for global markets 
“Nevertheless, there remain a number of clear risks. The first is a global recession. Central banks have a poor track record in engineering a soft landing for their respective economies,” he said. However, the growth picture has notably improved since earlier this year and global recession fears have eased.

“Should the global economy weaken further, there is a risk of earnings' downgrades. This would put pressure on stock markets, but it has not materialised to date,” he said. “It is clear that for the time being, the market doesn’t believe company earnings' downgrades will be severe,” Casali continued. 

Geopolitics remain fragile. He believes that the Ukraine crisis has created greater tension between autocracies, namely Russia and China, and democracies, notably the West. “Russia and China have moved closer to each other. Russia sees China as a key strategic partner in terms of its competition with the West and a lifeline for trade, while China sees Russia as a useful tool in its challenge to the Western-led world order,” he said. “OPEC appears to have sided with the autocracies, cutting oil production at a time when energy prices were high. These tensions are unlikely to dissipate,” he added. 
 
Tailwinds for global markets 
The US dollar has been declining from its highs, as the interest rate spread between the US and elsewhere narrows. International fund flows are also moving away from dollar assets. If risk appetite were to increase, this would also diminish the appeal of the dollar. He believes that momentum is moving away from the dollar, and this should be helpful for growth elsewhere. 

Like many wealth managers, he thinks China’s reopening could also act as a catalyst for global markets. At the same time, the jobs market in the US continues to be relatively robust. These two economic factors are helping drive growth and could help create the soft economic landing Casali expects. 

On earnings, he said corporates have shown stronger-than-expected pricing power. “Even with flat economic growth, companies have been able to raise their prices, often ahead of inflation. It’s been a cost-of-living crisis for individuals, but a cost-of-living boom for corporates,” he continued. “Profit margins remain elevated across, Europe, the UK and the US – and are above pre-pandemic levels." 

“The final element that stock markets have in their favour is their valuation. The price-to-earnings ratio for the MSCI All World Index has moved from 20 times to 15 times over the past two years. This indicates that share prices are now cheaper relative to company earnings than two years ago,” he said. 
 
How does this translate into investment strategy? 
He continued to focus on a number of key themes. The first is to seek out companies with a compelling dividend yield. This led him to defensive areas, backed by solid cash flows and to the UK and Europe over growth-led US markets. 

He sees a more general renaissance in European stocks. With an energy crunch averted, Casali sees consumer and business confidence returning: “Earnings for European corporates have been stronger than their US counterparts.” 

Like other wealth managers, he believes that Asia ex-Japan should also be a beneficiary of a weaker dollar and China’s reopening. “The Chinese market still has relatively low valuations and the Chinese economy continues to beat economists’ expectations. This should galvanise the wider region,” he said. 

“It may also be a moment to look at longer-dated government bonds, with yields high relative to recent history. If the interest rate cycle turns, there could be value in having some interest rate sensitivity in a multi-asset portfolio,” he said.

The world economy and financial markets remain finely balanced, and Casali believes that a recession remains possible in a number of key developed economies in the second half of the year. “However, the picture has undoubtedly improved since the start of the year, which may create less vulnerability for these rollercoaster markets,” he concluded.