Japan
The Bank of Japan has surprised global investors by widening the band of interest rates for its benchmark 10-year bond — something that hadn’t been expected until next year’s departure of its governor, Haruhiko Kuroda. The adjustment itself was slight, but it has outsized significance, because it suggests that the next change on deck will be the abandonment of Japan’s negative interest-rate policy.
That, in turn, suggests the disruption of a huge and globally influential “carry trade” that has been going on for many years, in which investors and speculators borrow in yen and use the proceeds to buy financial assets outside Japan denominated in other currencies. Those who make such a trade can profit handsomely from the return differentials e.g. between Japanese and foreign fixed-income securities. Of course, the stability and predictability of this trade are undermined once permanently easy Japanese monetary policy comes into question as it now has. Investors should watch what Japanese officials and policymakers do, rather than what they merely say.
Some significant portion of the trillions of dollars of Japanese wealth held in U.S., European, and Asian government and non-government stocks and bonds may return to Japan.
We suspect that the yen’s 2022 weakness was largely due to the distortions engendered by that country’s swimming against the tide of rising global interest rates, and that even a tentative reversal of those easy policies can lead to further yen appreciation. The return of wealth to Japan prompted by that interest-rate rise could add further impetus to this process.
On a speculative basis, we like yen exposure, and because of the many cross-currents and complexities involved in such globally systemic currencies, we would rather have it directly through owning the currency than proximately through Japanese stocks or bonds. Markets will judge whether current Japanese policy statements represent an enduring shift.
Commodities
The outlook for commodities in 2023 is the most positive of any sectors we cover, including currencies, stocks, and bonds on a global level, with many factors combining to make commodities likely to be the best investment area of the coming year. A recession in the developed world would appear to diminish the demand for commodities in 2023. However, positives include: the opening up of China; the reversal of the strong dollar trend and the correction of the U.S dollar; the fact that much of Asia may avoid a recession in 2023 — with China, India and other Asian countries well situated to grow throughout the year
The supply of commodities is widely influenced by numerous complex factors, which vary by the part of the commodity complex — energy-related, industrial raw materials and metals, precious metals, and food. Geopolitics; the creation and mothballing of commodity capacity in response to commodity producers’ perceptions of demand and regulatory trends; and global economic growth trends and trends in specific major commodity-importing countries such as China — all are relevant factors.
Energy: Supply of U.S. Oil and Natural Gas In 2023
We anticipate costs of production will rise by about 8% in 2023. This will be due to a higher cost of capital for production, deriving from higher interest rates; double-digit oilfield services inflation; and less available capital for production because of national and local government restrictions, including taxes and regulatory requirements. In addition, banks are increasingly unwilling to lend for oil and gas production at rates that make it profitable — suggesting flat or lower production from the U.S. oil and gas industry in 2023.
Demand for natural gas should grow as reasonable liquified and conventional natural gas substitution for coal continues in Europe and the U.S. Europe and Japan will continue to buy U.S. LNG; China will get supplies of oil, natural gas, and other carbon-based fuels from middle-eastern sources, and will use a great deal of domestic coal for their new power plants. We should realize that China and India both use large amounts of coal to produce electricity and heat, and that use is expanding, not contracting.
In sum, we believe that in 2023, U.S. oil (WTI) will go to $90/barrel or more from current levels (about $75 as of this writing). U.S. natural gas will likely be close to current price levels when December 2023 arrives. Natural gas prices of course fluctuate with seasonal demand. The end of the war in Ukraine would change the supply picture, and we have no insight about the likelihood of that eventuality.
Uranium
Anti-nuclear psychology, bracketed by the nuclear accidents in Chernobyl and Fukushima, has begun to reverse in the last year. Globally, utilities are adding nuclear capacity. One reason is that new technology and smaller plants have genuinely reduced the risk of catastrophic accidents. A second reason for reduced anxiety about nuclear power is greater public appreciation of pragmatic realities about energy needs and options.
Over the years, many uranium mines have been closed, and many producers of uranium have been reduced to storing and selling uranium to the few consumers of the fuel. Now, many new facilities will be built, and the demand will begin to increase the actual production of uranium for the first time in many years. There is a long lead time for uranium capacity, even small mines; but the trend is in place, and uranium will likely gain in price for several years to come. We are bullish on uranium miners, and anticipate buying them on declines in coming quarters. There is no need to “panic in” now, but within a year or two, some uranium-related stocks could do quite well.
Battery Materials (Lithium, Copper, Nickel) and Aluminum
China’s reopening can drive demand for copper and for aluminum. The new China policy will open up manufacturing and likely lead to restock purchases of copper, nickel, and aluminum in expectation of higher economic growth after March when China is fully reopened. Chinese inventories of these key metals, and lithium for batteries, will need to grow now that Chinese economic growth is back on the agenda.
General Investment Outlook
The overall performance of global investment markets in the first half of 2023 will depend primarily on the U.S. dollar and the performance of China as it goes from a zero covid policy to a “let’s get herd immunity s soon as possible” policy. We anticipate that a recession in industrial countries will begin in early 2023, and end in the second half of the year. After the recession reaches its most pessimistic point in terms of economic data, stocks will start to rally as they usually do before the recession has ended. Stocks will bottom months before the economy.
Inflation Trends
Markets look at the rate of change of the economic outlook, so a change from the maximum recession influence (i.e., “less inflation ahead”) will lead to a stock market rally which will last — provided that inflation actually does come down in late 2023 and 2024. We anticipate that inflation will decline; so we expect a market rally.
However, we are cautious, and will watch carefully to discern whether this decline will last for more than two to three years. There is a chance that it will resurge because wage earners, having suffered under the ravages of inflation, demand ongoing pay increases to compensate for a decline in their standard of living.
This happened in the 1970s. In our view, inflation will not be finally tamed until steps much greater than those taken so far are implemented. As we have often said, we anticipate that inflation will fall but will stay at about 5%, and then resurge.
Oil and the Dollar
A weaker dollar will help foreign stocks and commodities. China may grow more rapidly and recover some of the market share lost from covid lockdowns and the recent developed-world response to Chinese industrial and military espionage, and China’s support of Russia in Ukraine. Commodities would benefit from this growth resurgence, as China is the world’s largest commodity consumer.
Oil prices will depend on (1) how rapidly China grows — we are anticipating 5%, the fastest among major countries; and (2) tailwinds that will apply to the whole commodity complex, as the dollar falls back from its big rise in 2022. There will be some headwinds if the war in Ukraine continues to be hot.
A weaker dollar will also help foreign stock markets where the economies are growing.
Markets of Interest In 2023
We anticipate that along with China, India, Japan, and possibly some other Asian counties such as Vietnam will grow faster than the U.S., which we expect to grow by less than 1% in 2023.
We expect U.S. earnings for the S&P 500 to fall by about 10–15% in 2023, and some industries — particularly consumer-facing industries — will have a tougher time than areas we prefer, such as transportation, precious metals, semiconductors, commodities, defense and aerospace, and growth stocks in general (after the period of maximum pessimism resolves).
Interest-rate sensitive stocks will likely perform well once the market begins to anticipate falling interest rates: banks, brokers, and real estate finance stocks could be good buys as we reach the peak of the recessionary bad news. We like adaptable companies that can generate internal cash flow to finance growth.
Some bonds and commodities could fare pretty well in 2023, and we look for a big rally in the latter part of the year as the recession bites.
Historically, it is usually time to buy stocks into the teeth of the recession before it is receding and an all-clear is sounded. Stocks will start to rally as the worst of the recessionary news is announced, because the market discounts a turnaround several months in advance.
Thanks for listening; we welcome your calls and questions. We look forward to bringing you a video round-up of our views in the first week of January.
