Colin Graham

Investors are looking forward to a new year that has one redeeming quality – it doesn’t mirror the annus horribilis of 2022. 2023 is likely to see recession, and that investors need to wait for inflation, interest rates and US dollar strength all to peak before the good times resume. 

The current consensus isn’t that rosy, but if history tells us anything, it’s that nothing is ever set in stone. So, what are the possible events  – good and bad – that could derail these central scenarios? Here are the ten potential black swans, and what the consequences may be.

1. Goldilocks revenge

The first is ‘Goldilocks’ revenge’ – the economic porridge won’t be too hot or too cold but just right. Here, US inflation peaks without a recession, the dollar drops, and the US Federal Reserve (Fed) can rest easy but remain vigilant. The post-Covid fiscal expansion slows, acting as the brake on excess demand. The result for multi-asset investors is that high yield bonds become very attractive as default rate expectations fall. 

2. Panic stations

Alternatively, the Fed could tire of low long-term rates and review its inflation target, citing a structural break with the previous regime that had largely been in place since the global financial crisis. It could claim that the two per cent target is far too close to zero, saying the next recession could tip the economy into outright deflation. The result would be panic, and bonds denominated in US dollars would see negative returns for the third year in a row.

3. Deflation disaster

Even worse is the prospect of deflation. While falling prices sounds great, it means consumers would not buy anything as they expect goods to become cheaper in the short term, leading to outright recession. Here, if deflation has a higher number of hits than inflation according to news-flow data from Wall street and Main Street, it means that central banks are driving the economy using the rear view mirror, causing a major bust.

4. Greenwashing and now impact washing

The drive to improve the environmental, social and governance (ESG) characteristics of companies has enormously gained in importance, and is the bedrock of investments at Robeco. The problem is that it has also led to a rise in greenwashing, where companies and investors make ESG claims that cannot be substantiated, often for PR and marketing reasons.

Another growing problem is impact washing, where companies or investors claim to be making an impact on the ground, when proving or even measuring it is doubtful. We see the potential for sustainability claims to be more strongly scrutinised by regulators, media and investors, and as a result, large financial institutions will struggle to evidence their sustainability credentials across facets of their businesses. Rather than focussing on improving their ESG and delivering shareholder value, companies could end up selling or divesting businesses that don’t meet ESG criteria and withdraw from markets where regulators demand higher sustainability credentials. 

5.Rewards for risk

One lesser-known issue concerns risk appetite, where multi-asset investors are asked to state the level of risk that they can tolerate. These risk profile funds are usually labelled as ‘cautious’ – i.e. low risk, focusing on safer government bonds; ‘balanced’ funds that offer more of a mix of bonds and equities; or ‘aggressive’ funds that may well allocate to much riskier stocks. The problem here is that in 2022, there was little difference between any of them. The performance of these profiles was within 20 basis points (in euro terms) by the end of December. If this happens again in 2023, the implication would be we would see a second year of negative returns in balanced funds, similar to the experience following the tech bubble burst of 2001-2002.

6. Give peace a chance

But it’s not all bad news. Much of the consensus opinion assumes that the war in Ukraine which caused so much volatility in markets in 2022 and sparked major inflation across the world will continue. If peace breaks out, a more welcome disruption would occur.

We could see a peace dividend in which Ukraine secures its borders with European ‘aid’ and the flow of wheat, oil and gas resumes, ending the bottlenecks. Other countries would then relax their travel and trade restrictions, allowing inflation to fall and supply chains to re-shore faster. There would be an energy costs windfall for global economies, especially in Europe.

7. Anti-social media

Social media is another battleground, albeit where the participants are armed with words rather than weapons. Stricter regulation against the tech titans that fuelled growth stocks could benefit value stocks instead.

We could see another backlash against social media and more regulation on large technology and social media platforms as data protection issues come to the fore again. The result would be a change in equity market leadership – value companies with capital discipline and quality earnings would be more highly rewarded on a relative basis.

8. Shock regime change

Then there is the possibility of a ‘shock regime change’, as witnessed when the UK which went through three prime ministers in 2022. This is the first year this century without an election in a G7 country. However, we could see a major shift in policy as a ‘major’ regime topples, as witnessed with Boris Johnson and then Liz Truss a month later, resulting in major volatility spikes.

9. Upsetting the applecart

Truss’s brief prime ministership and a disastrous mini-Budget which forced the Bank of England to take emergency measures to protect the pensions industry showed just how fragile certain financial systems can still be. In this scenario, private assets see a liquidity drain, liability-driven investment (LDI) structures are questioned, and there is increased scrutiny on banks following a crypto bust. This would expose investments that were only funded because cash was ‘free’ at the time.

10. Net-zero upside

Finally, the commitment to moving to a net-zero economy could surprise on the upside. There can be no backtracking on climate: the evidence about climate change continues to mount, and COP27 highlighted that political will is key to shaping the balance between climate ambition and implementation. In the long run, achieving energy security means investing more in green technologies and climate solutions to close the gap between ambition and implementation. We could see a multinational ‘super fund’ set up to facilitate the net zero transition, backed by several governments.

By Colin Graham, head of multi-asset strategies

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Rachel Whittaker

In its annual outlook, Robeco expects a considerable brightening of the return outlook for major asset classes during 2023, but not before inflation, interest rates and the US dollar hit major peaks first. While these peaks are in sight, they have yet to be reached. Central banks are still battling to bring inflation back and their second-to-last hike of the tightening cycle is pending. Short-term sovereign bond yields remain above official rates and the dollar continues to reign supreme. The last leg of a steep climb implies short-term pain as exhaustion and capitulation take hold across the multi-asset spectrum.

As we enter 2023, Robeco expects an earnings per share drop of 20-30 per cent, making high yield valuations look more attractive than those of equities. Yet, as real rates are expected to come down, and the earnings recession gets fully priced into 2023, a major inflection point in risky asset valuations is to be expected towards 2024. Robeco believes that mid-2023, when unemployment surges towards five per cent and disinflation accelerates, will likely create good entry points for long duration in fixed income, followed by decent troughs in risky fixed income and equity markets. It could be an especially good year for emerging market equities, excluding China. Not only do they typically outperform their developed counterparts in a dollar bear market, the downturn in the earnings cycle in emerging markets is also more mature because its central banks have pre-empted developed markets central banks in combating inflation.

In addressing the energy crisis in 2023, Europe will face a trade-off between efficiency and economic security. Increasing energy efficiency will not be enough for the region to wean itself off Russian gas. Price caps to ensure energy security for lower-income households may also increase demand, intensifying the energy crisis. On the other hand, necessity is the mother of invention, and we expect to see energy transition goals lining up with accelerated energy security and reduced carbon footprints.

Robeco expects to see sustainable investing strategies again grow as a proportion of assets under management in 2023 as investors continue to seek solutions to the multiple challenges facing humanity, including climate change, the cost of living crisis and income inequality.

Colin Graham, head of multi-asset solutions: “We think the belief in central bankers’ ability to prevent cyclical downturn and engineer a soft landing in 2023 is flawed. Instead, we expect a hard landing. Moreover, as recessions tend to be highly disinflationary, we believe this will take the sting out of inflation. Once the three peaks in inflation, rates and the US dollar have been reached, 2023 will ultimately contribute to significantly better returns across all major asset classes.”

Rachel Whittaker, head of SI research: “We believe there are several reasons why sustainable investing will grow AuM faster than the industry – one is that there is evidence that integrating ESG considerations alongside financial analysis can support financial returns over the long term, for example through reducing unanticipated environmental or social risks, or identifying new growth opportunities. Additionally, greater societal awareness of sustainability challenges is leading more investors to align their portfolios with their values, while the growing range of sustainable strategies available is making it possible for more investors to target both sustainable and financial goals.”

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