2023 Strategist Outlook: Turn The Page

After a surprisingly robust first half in which big tech rallied from last year’s lows, yields on US Treasurys reached a 15-year high, and the S&P 500^® Index and the Nikkei Index produced double digit returns, investors may be anticipating more of the same through year end.

But market strategists and economists within the Natixis Investment Managers family warn the headwinds are intensifying and investors should be prepared to turn the page on a new chapter in the next six months.

Surveyed at the end of June for their assessment on the investment landscape for the second half of 2023, these 32 investment professionals in the US and Europe warn that risks are growing on all fronts.

Looking ahead, they paint an uncertain picture for the second half of 2023, yet see clear winners and losers in the end:

• Inflation: While inflation is easing, 69% of those surveyed still rate it as either a high (22%) or moderate (47%) risk in the second half of the year. Overall, consensus estimates it will take the better part of 12 to 18 months before central bank target rates are met.
• Fixed Income: While it may take a long while to meet inflation targets, sentiment suggests higher interest rates are likely to give way to rate cuts later in the year as inflation cools. This, coupled with moderate recession concerns, has 56% convinced that long duration bonds will outperform short duration bonds.
• Equities: Despite the early run up, strategists anticipate headwinds will cool performance and 63% project that the tech rally will fade by year end. Overall, they project that central bank policy (72%) and geopolitics (72%), will provide the stiffest challenges for markets.
• Recession: While some market watchers may anticipate that the natural conclusion to this inflationary period will be a recession, Natixis strategists are less concerned with 50% rating recession a low risk in H2, while 31% see it as a moderate risk.

When it comes down to it, they see an uncertain world, but not one without opportunity. To capitalize, investors will need to effectively navigate a more challenging and riskier macro environment than most have experienced since January.

Inflation: From high anxiety to easing prices

After a painful run of increased costs for oil, food, automobiles, and everyday essentials, consumers caught a break in H1 2023 as central bank efforts to ease the pressure began to produce results.

In June, US inflation shrank to 3% from the 6.5% it registered in 2022. The news was almost as encouraging in the Eurozone as inflation there dropped from 9.2% to 5.5%. The UK failed to keep pace as inflation has been stickier, dropping from 10.5% at year end to 7.9% in June.¹

Despite the progress, 69% of market strategists in the Natixis Investment Managers family classify inflation as a moderate (47%) or high risk (22%) over the next six months. While that leaves 31% who see significant progress to date and rate inflation as a low risk, there is a big difference between seeing little risk and anticipating that inflation is fully under control.

Market strategists anticipate a long wait to achieve inflation targets
In fact, most of those surveyed think inflation targets won’t be met until 2025 (38%) or at least the second half of next year (28%). Even with that long-range outlook, 72% still worry that inflation may linger longer than anticipated.

How long will it take to reach Central Bank inflation targets?

By year end	6%
First half of 2024	19%
Second half of 2024	28%
2025	38%
2026 or later	9%

Although they expect to wait 18 to 24 months or longer for inflation rates to reach targets, those surveyed anticipate many smaller victories along the way. In H2, they anticipate a number of factors will contribute to decreased inflation.

With last year’s sharp declines in rental costs now registering in shelter inflation data, 63% of strategists believe housing will contribute to decreased inflation numbers in H2.

Lower energy prices are another bright spot. Half of those surveyed believe lower costs will contribute to improvements on inflation. Oil had been a key driver of rampant inflation, especially as West Texas Intermediate (WTI) crude reached a peak price of $130.50 on March 7, 2022. Five quarters later, prices have declined by 39% to $74.65 per barrel.²

A year into this long, slow price decline, the majority of Natixis strategists forecast that lower prices will either remain in place or moderate even more in H2. Overall, 50% forecast WTI to be in the $65-$75 per barrel range in H2. Few (6%) see prices dropping below $65, while only 28% see prices inching into the $75-$85 range. Fewer still (16%) see prices reaching the $85-$95 range. Not one among those surveyed anticipate that the price for WTI will come in above $95 at year’s end.

Projected price of WTI at year end

Less than $65/brl	6%
$65/brl to less than $75/brl	50%
$75/brl to less than $85/brl	28%
$85/brl to less than $95/brl	16%
$95/brl or more	--

As for other indicators, 47% of Natixis strategists will look for lower costs in services, an area that the Fed and other central banks see as the final front in the fight to tame inflation. Finally, after a prolonged bout of food inflation across the developed world, 38% say lower food and beverage costs are likely to contribute to lower levels of inflation in H2.

Fixed Income: From higher yields to longer durations

Fixed income delivered what may be the most significant headline for bonds in more than a decade during the first half of 2023 as, after a 15-year drought, investors could finally say, “Yield is back.”

Thanks to aggressive central bank moves to squelch inflation, investors took advantage of the highest rates they’d see since the months before the Global Financial Crisis. At the front of the pack was the US Federal Reserve. After Fed target rates increased by 500 basis points over 12 months, yields on 10-year Treasurys had pushed to 3.84% as of June 30.³

At the same point in time, efforts by the European Central Bank (ECB) have raised policy rates to 3.5%, driving 10-year yields to 2.39% - a far cry from the negative rates of 2020.⁴

Progress on inflation has been strong and, based on how Natixis strategists see policy shifting, it’s likely the headline on fixed income for H2 may just be “it’s time to extend duration” – at least in the US.

Asked for their outlook on the next six months, our strategists anticipate that rates will be range bound, with 47% looking for Treasurys to come in at 3.5% to less than 4.0%. Another 41% even see rates receding in H2, with 28% anticipating 10-year Treasurys to drop to the 3% to 3.5% range, and another 13% looking for rates to drop to somewhere between 2.5% and below 3.0%.

Despite consensus expecting more rate hikes coming down the pike, few see 10-year yields pushing aggressively higher, with just 13% projecting that rates will clear 4% in H2.

Interest Rate outlook for H2

Where will interest rates end the year?
10-year US Treasurys		ECB Rate
Below 2.5%	0%	Below 3.0%	3%
2.5% to less than 3.0%	13%	3.0% to less than 3.5%	9%
3.0% to less than 3.5%	28%	3.5% to less than 4.0%	44%
3.5% to less than 4.0%	47%	4.0% to less than 4.5%	31%
4.0% or above	13%	4.5% to less than 5.0%	13%

Inflation has also improved to 5.5% in Europe as of June 2023, and yields on the 10-year Eurozone Central Bonds stood at 3.22% as of June 30.⁵ Natixis strategists project that ECB rates will be range-bound between 3.5% to 4% (44%) or 4% to 4.5% (31%). Few (13%) anticipate rates to cross the 4.5% line in H2, and even fewer (3%) forecast rates dropping below 3%.

Long duration fixed income favored over short in H2 2023
With the overall inflation picture improving, recession concerns brewing, and central banks, like the Fed, taking a breather on additional cuts, 56% of those surveyed project that long duration will look to outperform short duration investments in H2.

But the picture isn’t all rosy and strategists express some concerns about fixed income in the coming months. Topping the list are the 72% who worry that inflation could linger longer than anticipated. Another 38% also worry that interest rates could go higher than anticipated. While the same number worry that rates could stay higher longer than expected – which could account for the 44% who think short duration will outperform.

Fixed-income concerns for H2

Inflation lingers longer than anticipated	72%
Rates go higher than anticipated	38%
Rates stay high for longer than anticipated	38%
Corporate defaults and downgrades	38%
Recession	28%
Bond market volatility returns	22%
Consumer credit / Housing market	13%

Credit worthiness is on the minds of some as 38% worry about corporate defaults and downgrades. Only 28% are concerned about how a recession could have an adverse effect on bond markets. Fewer still (22%) are worried that 2022’s volatility will return to the bond markets. Overall, strategists were least likely to worry about consumer credit and housing (13%). Given the critical role policy plays in fixed income markets, 69% see a central bank mistake as either a medium (53%) or high (16%) risk in H2.

Equities: Tech cools from red-hot to lukewarm

After a disappointing 2022, driven in large part by losses in Big Tech, markets experienced an impressive turnaround in H1, thanks in large part to the reemergence of tech. Most notably, the tech heavy NASDAQ Composite Index delivered 39.35%, it’s best first half in the index’s 52-year history. Big tech wins also led the S&P 500^® Index to a 16.88% gain.⁶

In Japan, a renewed focus on sustainable growth and enhanced shareholder value led the Nikkei Index to come in at 28.65% on June 30 – it’s biggest gain in 33 years. In Europe, the Euro Stoxx 600 came in at 11.50%. While in the UK, the FTSE 100 was not able to live up to its peers, coming it at only 3.11% for H1.⁷

US favored to outperform other markets in H2

US	34%
Japan	22%
EMs ex China	22%
Europe	16%
China	6%

While the early results generally represent an impressive turnaround, sentiment among Natixis strategists suggest it’s best not to set second half return expectations too high or too low.

Only (28%) anticipate the rally will continue, and fewer still (3%) think the markets will achieve new highs. The largest number of strategists (50%) believe that after a high-flying first half, markets will cool from current highs and prices will dip to reflect the fundamentals. Strategists are less worried about a severe downturn with one in five (19%) forecasting an abrupt end to the rally as a result of recession.

How will the tech rally play out in 2023?

The rally will intensify	--
The rally will continue steadily	31%
The rally will fade	63%
The bubble will burst	6%

Central bank policy, geopolitics top expansive list of market headwinds
Even though they’re not worried about a recession in H2, Natixis strategists anticipate headwinds on almost every front.

Central bank policy (72%) and geopolitics (72%) draw the strongest consensus as headwinds. Bank policy concerns center around the question of how high and how long rates will remain restrictive before bankers declare victory over inflation.

Not all view it as a negative, and 22% go so far as to say policy may be a catalyst for markets as they may be looking at banks pausing hikes and ultimately cutting rates, which could spur growth.

Russia’s war with Ukraine continues to raise questions on the geopolitical front, especially following Turkey’s surprise decision to support membership for Sweden at NATO’s July meeting.

US-China tensions have been another concern in H1, but as 69% forecast, dialogue reopened in earnest in early July. Just how much progress will be made remains to be seen as it has been revealed that China hacked email within US Commerce Department prior to the resumption of talks.

Even as events unfold, one-quarter of those surveyed (25%) aren’t convinced that they will have a market impact, calling the geopolitical issues noise.

Employment (66%) ranks third among headwinds. This can be viewed in two ways: First, they may see labor scarcity as an impediment to growth; or second, they could be looking at slow growth and hear recession concerns and anticipate layoffs down the road.

Corporate earnings are also a concern as 66% of strategists see headwinds as earnings slow and the rally fades. One-quarter (25%) are more optimistic and project that earnings may actually serve as a catalyst.

Similarly, strategists are split on consumer spending. Half worry a slowdown in consumer spending will serve as a headwind, but 28% think consumers will continue to carry the market on their backs and provide a catalyst for continued growth.

While 41% believe that housing will be a headwind for markets in the second half, almost the same number (38%) believe concerns over a housing bubble are just noise. Another 22% take the opposite side of the argument and think there’s more room to run as they believe it will be a catalyst in H2.

Another 41% believe that US GDP, which OECD projects at 1.3%, will be a headwind. Despite the large number who are concerned, even more (44%) think GDP concerns are merely market noise.

Strategists call for US equity markets to lead, large caps to beat small caps
The headwinds are strong, but the largest number of market strategists (34%) believe the US is best positioned for what comes next and project markets there to come out on top at year end. Coming in far behind are the 22% that believe either Japan or Emerging Markets (Ex-China) will be the ultimate winner in H2. Fewer, 16%, think Europe will be the leader and only 6% believe it will be China.

Given the current dominance of big tech in market returns, strategists are calling for large caps (81%) to outperform small caps (19%). Adding to the odds against small caps are the tighter credit standards set in the wake of Q1’s banking crisis. Though there is no consensus on which of those stocks will be the ultimate winner, strategists are split 50/50 as to whether growth or value will outperform.

All tech. All the time.
While big tech has been a key driver of double digit returns in H1, no Natixis strategist anticipates that the rally will gain momentum in the next half, and only 6% think the rally will be a bubble that bursts. Instead, most (63%) anticipate the rally will fade by year end. A little less than one-third (31%) think the rally will continue to deliver steady results.

Much of the tech rally has been driven with the market’s fascination with the commercial implications of recent gains in artificial intelligence. Overall, Natixis strategists believe these advancements will be a net positive in the next 2 to 5 years, especially for investors and investment managers:

• 88% believe AI will unlock investment opportunities that were otherwise undetectable
• Three-quarters also believe AI will help them discover risks they did not previously know about
• Almost seven in ten (66%) think AI will alter traditional market patterns
• While they anticipate AI will change how they invest, only 19% think AI will take their jobs in the next 2 to 5 years

Despite the positives, those surveyed identified the negative implications of AI in markets. Much like the concern that AI can be used to manipulate political sentiment and voter behavior, strategists worry that investor behavior and market sentiment could be manipulated by bad actors, and 100% of strategists say AI will increase the potential for fraud and scams. Another 69% warn that AI will also accelerate day trading.

When it comes down to it, strategists are split on the investment opportunities presented by AI itself. Half think it will drive long-term growth, but the same number are looking at the build up and think it’s a bubble.

Recession: The headline that wasn’t … and still isn’t.

Of all the headlines that broke through in the first half of 2023, there is one that is notable because it never materialized: Recession.

Inflation, rising rates, and slowing growth have had market followers concerned about a potential recession for well over a year. In fact, in a survey conducted in November 2022, 59% of institutional investors believed “recession in 2023 was inevitable.” For some, the signal was so strong that 54% went so far as to say a recession was “absolutely necessary” to curb inflation.⁸

Recession concerns now cooler than institutions felt in Q4 2022
But here we are now: Markets have delivered solid to outstanding returns. Bonds are generating attractive yields. Inflation in the US has declined to just 3% and other countries are moving along the path to lower inflation.⁹ And Fitch Ratings raised its estimates for global GDP growth in 2023 from 2.0% to 2.4%.¹⁰

Given all these new developments, Natixis strategists express a cooler perspective on recession than their institutional peers did just seven months ago, and 78% of those surveyed project a soft landing for the economy versus a hard landing.

Rating the risk of recession in H2

No risk	--
Low risk	50%
Medium risk	31%
High risk	19%

In reality, a little less than one in five (19%) assign a high level of risk to recession in the next six months. Current sentiment is much more likely to rate recession as a low risk (50%) or a moderate risk (31%) in the same time frame.

Asked directly about the chances of recession occurring in the rest of 2023, only 6% say it is inevitable. Instead, the answer is more along the lines of “never say never,” as 53% see it as a distinct possibility. More significantly, close to one third of those surveyed (31%) are doubtful of a recession in the second half, and 9% go so far as to say it’s highly unlikely.

Turn the page

The first half of 2023 provided a dramatic contrast to the reality of last year’s losses for both stocks and bonds. But sentiment among market strategists and economists within the Natixis Investment Managers family suggests the biggest risk may be complacency.

Inflation has gone from an all-consuming concern to a manageable situation in most developed countries, but it could be a long while until the aggressive targets of central banks are met.

Yields reached some of the most attractive levels in 15 years, but an improving economic outlook could signal rate cuts on the horizon and many call for longer durations to outperform.

Big tech helped equities come roaring back in the first half, but, while few foresee a dramatic downturn, 66% are concerned about corporate earnings and 63% project that rather than burning out, the rally will fade away.

Recession concerns for H2 may not be running high, but there are enough lingering questions that more than half say it is still a distinct possibility.

In the end, even if the early success of 2023 tails off, the 32 market strategists and economists within the Natixis family surveyed suggest that the opportunities are still out there. All investors need to do is turn the page and reset their expectations for the rest of 2023.