Mark Lister, 16 December 2022

It’s been a difficult year for financial markets, with high inflation, rising interest rates and the war in Ukraine all causing severe disruption.

Pleasingly, signs of moderating cost pressures are emerging, which points to a peak in interest rates during 2023.

While we haven’t yet seen the full impact of this year’s moves, such clarity could still provide markets with some much-needed stability.

Shares have endured their worst year since 2008, with the New Zealand market down 11.4 per cent in 2022 and world shares 17.5 per cent lower.

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Meanwhile, New Zealand house prices (according to the Real Estate Institute) have fallen 13.7 per cent since the November 2021 peak, the biggest 12-month decline in at least 40 years.

Fixed income has proved more resilient (although not immune), with New Zealand corporate bonds down 4.0 per cent in 2022.

Inflation remains the epicentre of financial market worries, with headline measures in all major economies tracking well above central bank targets. That means interest rates have a little higher to go.

More encouraging, measures of supply chain pressure have eased, firms pricing intentions are well down from their highs, and the heat has come out of commodity prices.

In early 2023, its likely to become clear the inflation peak is behind us. That will be followed by an end to the tightening cycle from the world’s central banks.

Policy rates in the US and New Zealand are expected to peak in about May, at between 5.0 and 5.5 per cent.

Markets will welcome this, as they will finally have some clarity about just how much borrowing costs will rise.

However, the rhetoric will quickly shift to the lagged effect of this monetary policy tightening on economic activity, as well as corporate earnings.

We’ll see a slowdown in the global economy and upward pressure on unemployment, which will crimp sales, margins and profits in many sectors.

To a degree, this is “in the price", although it remains to be seen whether investors have been appropriately conservative.

The answer probably hinges on whether places like the US, not to mention New Zealand, fall into recession or not.

The 50 or so economists surveyed by Bloomberg see a 60 per cent likelihood of recession in the US (on average). There’s no guarantee they’ll be right, but that’s a particularly high result.

While financial markets look forward, it’s rare for US shares to bottom before a recession starts.

There have only been two exceptions in the last 100 years.

The first was in 1923 when the S&P 500 bottomed a few months before the recession of 1923 and 1924, and the second was during the recession of 1945, which the market sailed through without a major decline.

In the other 14 recessions since then, the market has typically reached its nadir during the first half of the recession, before rebounding strongly.

The average US recession lasts 13 months, so historically the best time to back the truck up is during those first six months of the downturn.

As we take stock and look ahead to 2023, there could be more market volatility to come, especially if the economic outlook darkens.

On a brighter note, if you believe the narrative that a recession is imminent in 2023, history suggests the point of maximum opportunity isn’t far away.

Be cautious, patient, and sensible with your finances in the new year, but also be willing to take calculated chances when they present themselves.

While 2023 could be another challenging one for the global economy, it could also prove to be a prosperous one for long-term investors, as well as prospective homeowners.