On January 3, 2022, the S&P 500 index peaked at nearly 4,800. As a result, it would end the year with a loss of 20 percent, which is due, among other things, to high inflation, Fed tightening, the consequences of the Ukraine war and a flagging China. The International Monetary Fund now assumes that a third of the global economy will fall into recession this year.
Will 2023 be another sad year for stock markets and will the global economy actually suffer a severe setback?
The US remains the world’s largest economy, Washington is the most important political player, the Fed is by far the most influential central bank, and US financial markets are crucial to what happens around the world. It therefore makes sense to focus first on the US political outlook.
Washington will be divided for at least the next two years in the sense that the House of Representatives has passed into the hands of the Republicans – albeit by a very small majority – and the Democrats still control the Senate, having somewhat less minimally exercised their superiority did the last midterm elections. The excitement surrounding the election of the Speaker of the House of Representatives immediately made it clear that the radical wing of the Republican Party would not be deterred by last November’s disappointing result and Donald Trump’s problems.
Disagreements in Washington are generally viewed as positive for equities, as when this happens many laws are less likely to be enforced and less political interference in the economy and markets is generally viewed as a positive for growth prospects. But the question is whether this is still the case now, because falling productivity, rising inequality, the Chinese challenge and climate change call for a strong government.
The 2022 Inflation Reduction Act could therefore prove to be the last major economic law President Biden signed into law until the end of his first term in January 2025. This law aims to reduce carbon emissions, lower health care costs, fund the Internal Revenue Service, and improve taxpayer compliance. According to the independent Congressional Budget Office, if fully implemented, the law would reduce US budget deficits by more than $200 billion. The Anti-Inflation Act is one of three laws passed in recent years — along with the bipartisan Infrastructure Investment and Employment Act and the CHIPS and Science Act — that collectively resulted in about $2 trillion in new federal investment and spending over a period of time of a decade .
If the above laws are indeed successfully implemented, the US will take a massive step towards sustainability (and rightly so, as the country lags behind Europe) and the US will produce more high-quality technology domestically, clearly demonstrating China’s rise as China slows down high-tech country.
That brings us to one of the areas where President Biden will have the most influence over the next two years with a divided Congress: foreign policy. America has become as protectionist under Biden as it was under Trump, if not more so, with the primary goal of weakening China.
Financial Times commentator Gideon Rachman recently wrote: “It’s crucial for the US and the US [European Union] make it clear that their goal is not to prevent China from getting richer. It is designed to prevent China’s growing wealth from being used to threaten its own [neighbors] or intimidate its trading partners.”
However, it is no coincidence that Beijing considers the first target to be the US’s main target. Washington, in all likelihood, will stick to its line of the last few years and could be even tougher in the military, economic, technological and diplomatic fields. In fact, a zero-sum mentality rather than a win-win mentality prevails in both Beijing and Washington.
This will (further) complicate global trade flows, slow technological advances (as countries increasingly build walls around themselves, want to keep prying eyes away and refuse to share knowledge), increase geopolitical tensions (e.g. around Taiwan) and thwart cooperation on problems that can only be solved internationally (e.g. climate change).
The Ukraine war has shown that many countries are reluctant to side too clearly with the West. Also, if not already made clear by the sanctions against Iran, it has become clear how risky it is to be (too) dependent on the dollar and the US capital markets; Hundreds of billions of Russian funds have been frozen. This makes autocratic states in particular more cautious when investing in US government bonds. If tensions between the US and China continue to rise, countries will likely continue to try not to get too biased towards one camp and seek to spread risk even more. Reduced demand for Treasuries and the dollar could therefore put upward pressure on US long-term interest rates and downward pressure on the dollar.
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Incidentally, these forces may be partially offset by the fact that the dollar and US Treasuries are still considered safe havens par excellence in uncertain times and the US is playing an increasingly important role as an energy exporter.
In this uncertain economic and geopolitical environment, the S&P 500 is unlikely to move back towards 4,800 by the end of this year. It has to be said that stock prices are usually well ahead of profits. In other words, if corporate earnings bottom this year, stocks may have moved forward in anticipation of better times.
Andy Langenkamp is Senior Political Analyst at ECR Research, which provides independent research on asset allocation, global financial markets, politics, and FX and interest rates.
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