Inflation and market outlook

I am optimistic about the outlook for 2023, as I believe, there is a real chance, most of the current inflationary forces will abate over 2023.

This will arguably see interest rates peak during 2023 and there is a real chance that a combination of ‘softer demand’ (due to higher interest rates) with the improving supply of goods and services, will see inflation in most economies ‘normalise’, without the need for a recession. To elaborate;

High energy prices

High energy Prices may well have done their job, at least in Europe, so assuming there is no big freeze event this winter, we may very well have seen the peak in coal, oil and gas prices, at least until the next vulnerability is exposed. Arguably high energy prices achieved three things for the Europeans;

1. They were able to outbid consumers in most other countries, securing and contracting much of the World’s uncontracted supplies of coal, oil and gas (or at least the supplies that could be transported to Europe).
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2. High prices created the incentive for superfunds, sovereign wealth funds and governments in Europe, to invest in mines and other energy infrastructure to support Europe’s move away from Russian supply and support their energy transition policies. To illustrate;
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   • The UK has just approved(1) their first new coal mine in 30 years. (I would note that the UK is, one of the few countries in the OECD, likely to enter a recession during 2023 due to the impact of high energy prices on their economy).
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   • While Germany approved, constructed and commissioned their 1st LNG(2) receival facility in under 10 months, with a further 4 under construction and due for completion before the onset of the 2023/24 Winter. Germany has been able to replace most of its Russian gas supply by switching to other global suppliers, such as the Netherlands, Norway and the USA.
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3. And improve their energy efficiency; for example turning down the internal heating(3) in Government offices and public places as part of a Europe wide goal, to reduce gas consumption by 15%(4) for the Winter.

Covid lockdowns and supply-chain disruptions

Covid lockdowns and supply-chain disruptions may very well be coming to an end, with China abandoning its policy of rolling lockdowns. I am not sure what’s changed or what this means for the Chinese health system but hopefully they are able to navigate the explosion of covid infections.

It has been a difficult challenge for every country to balance the ‘right to life’ versus the ‘right to live’, to choose between being amongst friends and family and risk getting covid, or choosing isolation?

If I assume China is able to manage without rolling lockdowns, then over the next 6 to 12 months, Chinese society should be able to return to much of its pre-covid level of activity. Which will be great news and not just for the Chinese but for the rest of the World, as China is an important trading partner.

If trade with China ‘normalises’, during 2023, it opens up the possibility that the global supply chain will be able to return to its pre covid levels of production, innovation and competition, within the next 12 to 18 months. Without China, this goal would still be several years away.

Labour shortages

Labour shortages are evident in many countries and many industries. Part of this can be attributed to;

1. The disruption to the supply chain. Very few if any cities have sufficient spare capacity to deal with the normal ebb and flow of demand. Typically, the local economy will only have sufficient capacity (be that manufacturing or wholesaling) to meet the ‘predictable’ demand and for everything else there is (was) the global supply chain.
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   Pre-covid if you found that you were short of something important, it could potentially be flown in from anywhere in the world, within a couple of business days but due to covid lockdowns, this has extended to weeks, if not months and in some cases years.
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   All of these delays slow down the delivery of goods and services, so for argument sake, if you still wanted to complete 2 projects in 2 months you may need twice as many people, as each project is taking twice as long.
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2. Covid restrictions have seriously limited the ability of free people to move around their own country, let alone between countries and while this has greatly improved over the last 12 months, it still hasn’t returned to its pre covid levels of affordability and reliability.
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   There are many examples of where the mobility of labour is critical for the efficient and productive functioning of society; be it uni-students taking a gap year to travel and work in cafés, farms, tourist parks etc, a town trying to rebuild after a natural disaster needing plumbers, builders, electricians etc or a new nursing home opening up to meet the needs of an aging population and needing to recruit from outside of the local community (if only because the local community is already constrained by any aging population, having fewer people of working age to do all the things that used to be done when everyone was younger, let alone provide a new service).
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3. A reluctance of baby boomers to remain in the workforce(5).
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   • Maybe the desire was to go to work and share their knowledge and experience with real people, not to stay home and connect through a screen.
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   • Covid lockdowns disrupted many travel plans, and you don’t get any younger, so after two years of restrictions, the freedom to catch up with friends and family and travel to all those places you wanted to see has taken priority.
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   • Arguably the recent property boom provided many, would be retiree’s, with the opportunity to liquidate real estate at healthy prices and provide the liquid funds they needed to be able to do the things they wanted to do.

So oddly enough, as 2023 advances, we could see rising unemployment underpinning a stronger economy. With more people looking for work, more vacancies will be filled faster and more things will get done sooner, be that; fruit picking, home building or running a nursing home (or at least assuming the right people with the right skills are in the right places at the right time).

Unemployment is just like any other economic variable; when it is too low, important things are not getting done (due to a lack of labour), when its too high, people are unable to earn a reasonable income to look after themselves and their family, but when it is just right,(6) people can; change careers, move towns, retire etc, still make a reasonable income and actually buy the goods and services they need.

So arguably 3 of the biggest inflationary forces of 2022 will abate in 2023, without the need for a recession. Of course the share market will remain jittery and there is always the unknown unknown, but I still think it is a good time to revisit some of the ‘expensive growth stocks’ of 2021, given their share prices halved in 2022.

On my radar are companies like; Google (Alphabet), Booking.com (Booking Holding), Realestate.com and Seek.

If you have any questions about your portfolio or strategy please feel free to call 07-3334 4856.

Ken Howard CFA LLB BEcon

Authorised Representative 259290

Morgans Financial

Index

1. https://www.gov.uk/government/publications/called-in-decision-former-marchon-site-pow-beck-valley-and-area-from-the-former-marchon-site-to-st-bees-coast-whitehaven-cumbria-ref-3271069-7
2. https://www.bundesregierung.de/breg-en/search/scholz-wilhelmshaven-2154424
3. https://www.bundesregierung.de/breg-en/search/energy-security-package-2065896
4. https://ec.europa.eu/eurostat/web/products-eurostat-news/w/DDN-20221220-3
5. https://www.philadelphiafed.org/-/media/frbp/assets/economy/articles/economic-insights/2017/q4/eiq4_where-is-everybody.pdf
6. The ‘ideal’ level of unemployment is quiet a theoretical concept, but arguably if there are more jobs advertised than there are people unemployed (as there is right now in Australia and the USA) it is probably fair to say, the level of unemployment is too low and some important things are just not getting done.

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Ken Howard is a Private Client Adviser at Morgans. Ken's passion is in supporting and educating clients so they can attain and sustain financial independence.

If you have any questions about your financial plan or your share portfolio, your strategy, investments or would just like to catch up, please do not hesitate to give me a call on 07 3334 4856.

General Advice warning: This article is made without consideration of any specific client’s investment objectives, financial situation or needs. It is recommended that any persons who wish to act upon this report consult with their investment adviser before doing so. Morgans does not accept any liability for the results of any actions taken or not taken on the basis of information in this report, or for any negligent misstatements, errors or omissions.