What are the prospects for asset prices?

If we take the bullish arguments first for assets such as bonds, stocks, and currencies bar the dollar, there is clearly some cause for hope.

>> The FED might sooner end its tightening cycles

This year the bears have clearly been on top as all assets bar commodities and the dollar have plunged. Investors will be hoping that the balance will shift in 2023 but Mr. Steve Barrow, Head of Standard Bank G10 Strategy, tends to think that there will be a sharpening of both the bull and the bear arguments, and this could mean even more volatility than we’ve already seen.

If we take the bullish arguments first for assets such as bonds, stocks, and currencies bar the dollar, there is clearly some cause for hope. For a start, asset prices are much cheaper after this year’s fall. Whether that makes them “cheap” on the various metrics used by analysts, such as P/E ratios for stocks or purchasing power parity for currencies is an open question. But “cheapness” could be a factor that drives investors on in 2023 if the fundamentals seem to be improving.

“On this score inflation looks as if it will decline through next year and, while a difficult economic growth period looms in the near-term, many might look out further and anticipate the rebound that could easily develop in the second half of next year”, said Mr. Steve Barrow.

Another bullish argument is that most central banks seem reasonably close to the end of their tightening cycles. The prospect of rate cuts in 2023 still looks premature but, with assets beaten up so much, the bulls might only need to see an end to rate hikes to step back into the market. In sum, the bullish arguments seem to be much stronger; perhaps not immediately, but certainly if we look out over the next year.

But Mr. Steve Barrow’s view, the problem is that, while the bullish arguments might have sharpened up, so too have some of the bearish developments, and actually for the same reasons. If that sounds like Double Dutch bear with us. Take policy rates. He argued that a bullish factor is that central banks may be close to the end of their tightening cycles. But they are only close to the end of these cycles because most have tightened policy very aggressively and that could have created all sorts of financial tensions that we are yet to see. It is the same with the growth story.

The outlook may appear better when we get into the second half of the year, but probably only because the next 6 months, or so, will be so dire. And this weakness of economic growth too could cause all sorts of financial risks to arise that pummel asset prices much more than we’ve seen already. In short, the bearish arguments are increasing because we are reaching a stage in the tightening cycle where economic conditions and financial market strains will start to cause liquidity and even solvency risks.

We’ve seen that already in the UK gilt market which had a near-death experience during the ill-fated Truss-led UK government and forced the Bank of England to intervene to prevent any liquidity risk turning into a solvency issue. Of course, there’s no such “buyer of last resort” function in the crypto market which is why crypto exchange FTX seems to be going to the wall. Quite clearly many policymakers see crypto as the financial wild west and would argue that liquidity and solvency threats here are not indicative of the rest of the economy, not least because they can offer financial backstops.

>> How will FED's tightening cycle impact USD and risk assets?

If you look at the recent central bank reports on financial stability, including the Fed’s, you will see that concerns do not seem elevated. Yes, the Fed and others identify some problems, such as falling liquidity in the treasury market but, by and large they appear quite optimistic. Investors will have to hope that this confidence is not the same sort of misplaced confidence that marked the ill-fated description of inflation in the US as transitory’ up to a year ago.

In the end, central banks and governments might be right, and we can look forward to the bullish arguments for asset prices taking hold and ending the nightmare of 2022. But Mr. Steve Barrow still thinks that the time to buy is not until well into 2023. In the meantime, he thinks it pays to be defensive in case unanticipated financial strains increase substantially.