Rising yields and recession risk are likely to abate in 2023, sending the US dollar lower and opening the door for a broad rally in risk assets, particularly non-US equities.
2022 has been an extremely difficult year. Fixed income and equity markets have been hit hard by high yields and rising growth risks, which have largely been attributed to persistently high inflation, a near record-setting pace of monetary tightening, geopolitical uncertainty, and lingering impacts from Covid (particularly in China). Following a decade of strong outperformance, US equity markets have continued to outperform developed markets (DM) and emerging markets (EM) in 2022: The MSCI USA Index has outperformed the MSCI ACWI ex USA Index by 1.5% year-to-date.1
However, despite these challenges, we do see signs of opportunity. A historically strong US dollar (USD) has contributed to this outperformance year-to-date, and since the end of 2020. However, stripping out the impact of the surging USD, the MSCI ACWI ex USA Index actually has outperformed the MSCI USA Index year-to-date in local terms. This is particularly relevant for investors because we see a strong case that the USD should reach its peak and begin to decline in 2023.
The USD has been supercharged by a combination of rising relative yields and its appeal as a safe haven during a tumultuous time. Near term, high yields and rising recession risk are likely to continue to support the dollar and keep us in a defensive stance, i.e., underweight equities. Looking forward to next year, however, we expect a gradual change in this economic regime. A key driver of this change is a transition from inflation to disinflation and a policy shift by central banks to focus on growth. This shift should result in lower yields, helping to build confidence that global growth will stabilize and eventually recover. In other words, rising yields and recession risk, the two key supports for the USD, should abate and send the dollar lower, opening the door for a broad rally in risk assets, particularly non-US equities.
A defining feature of USD strength is its safe-haven appeal during periods of heightened geopolitical risk. Such risks have depressed 2022 economic performance outside of the US, most notably in Europe and China. The “probability of outcomes” favors the creation of an improved environment in which ex-US growth narrows the gap with US growth. In Europe, the Russia-Ukraine War has delivered a full stagflationary energy shock, which we believe will continue to ripple through 2023. However, markets have largely priced-in the war. Going forward, marginal negative shocks are less likely to impact markets than the continuing geopolitical status quo, or even de-escalation. It would be naïve to ignore tail risks — the use of nuclear weapons, new humanitarian disasters, or sabotage of European energy infrastructure — but the probability of additional significant macroeconomic shocks is diminishing. While the perception of increasing tail risks may rise with Ukrainian success on the battlefield, the recapturing of Russian-held territories by Ukraine also serves to bring the conflict closer to an endgame or stabilization scenario.
China’s Zero-Covid Policy has constrained growth throughout 2022. China will almost certainly loosen restrictions over the course of 2023, with the magnitude and speed of economic effects still to be determined. This loosening is certain to lift Chinese growth relative to 2022, and thus will also help narrow the gap versus ex-US growth. We think that increased geopolitical fallout from US-China tensions is only likely once China has fully normalized its economic conditions — so the near-term outlook is encouraging on that front, too.
We view the outlook for equities through the following primary lenses: fundamentals, valuations/discount rates, and positioning.
Fundamentals have been strained globally in 2022, and we expect this to continue into 2023. The global outlook, ex-China, shows deceleration almost everywhere, suggesting that after a rather weak 2022 we will see only a mild rebound for earnings in 2023. Earnings in the US have improved slightly so far in 2022, but are likely to see some significant headwinds with the sharply rising dollar. We do not expect any major equity region to generate better than mid-single-digit earnings-per-share (EPS) growth next year. The clear advantage that the US has had in EPS growth may now be in question.
Valuations of non-US equities are at average levels, while valuations of US assets remain relatively overpriced. It is difficult to say that non-US assets are attractively priced, either in DM ex-US or in EM, which have declined 30% this year. Both EM and DM ex-US are trading fairly close to their long-term averages, but remain relatively inexpensive relative to US stocks. Historically, appealing price levels have not been enough (by themselves) to attract significant flows, given the high profitability differential and innovation advantage of US companies. If valuation levels were very cheap relative to history, some investors would look to pick up exposure and be happy to hold it, awaiting future improvements. However, we are yet not at that point. On the flip side, rising rates are likely to put valuation pressure on long-duration assets, of which the US has multitudes.
Positioning is a critical area where we see an upside to non-US assets. Other global economies are significant long-term investors in USD-denominated assets. Institutional owners have the highest overweight to the US in approximately 25 years (see Figure 1). In contrast, institutional owners have strong underweights to emerging markets across a similar time frame (see Figure 2). Will this trend persist long-term? We think the likely answer is no, and conditions may suggest a reversal. This evolution will require a catalyst of some sort to encourage investors to take positions outside of the US safe-haven currency. Historically, positioning at these levels has not stayed this one-sided for long — something will move. While the timing of a catalyst may be uncertain, we think some level of repositioning makes a great deal of sense over the medium term. The time is now to prepare one’s trades.
1 As of September 30, 2022.
For Professional Investor use only.
All forms of investments carry risks, including the risk of losing all of the invested amount. Such activities may not be suitable for everyone.
Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.
Concentrated investments in a particular sector tend to be more volatile than the overall market and increases risk that events negatively affecting such sectors or industries could reduce returns, potentially causing the value of the Fund’s shares to decrease.
This information should not be considered a recommendation to invest in a particular sector or to buy or sell any security shown. It is not known whether the sectors or securities shown will be profitable in the future.
Investments in emerging or developing markets may be more volatile and less liquid than investments in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems that have less stability than those of more developed countries.
All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
ETFs trade like stocks, are subject to investment risk and will fluctuate in market value. The investment return and principal value of an investment will fluctuate in value, so that when shares are sold or redeemed, they may be worth more or less than when they were purchased. Although shares may be bought or sold on an exchange through any brokerage account, shares are not individually redeemable from the fund. Investors may acquire shares and tender them for redemption through the fund in large aggregations known as “creation units.” Please see the fund’s prospectus for more details.
The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
The information provided does not constitute investment advice as such term is defined under the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell any investment. It does not take into account any investor's or potential investor’s particular investment objectives, strategies, tax status, risk appetite or investment horizon. If you require investment advice you should consult your tax and financial or other professional advisor.
The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.
This document has been issued by State Street Global Advisors Limited (“SSGA”). Authorized and regulated by the Financial Conduct Authority, Registered No.2509928. VAT No. 5776591 81. Registered office: 20 Churchill Place, Canary Wharf, London, E14 5HJ. Telephone: 020 3395 6000. Facsimile: 020 3395 6350Web: www.ssga.com
This document has been issued by State Street Global Advisors Europe Limited (“SSGAEL”), regulated by the Central Bank of Ireland. Registered office address 78 Sir John Rogerson’s Quay, Dublin 2. Registered number 49934. T: +353 (0)1 776 3000. Fax: +353 (0)1 776 3300.. Web: www.ssga.com
SPDR ETFs is the exchange traded funds ("ETF") platform of State Street Global Advisors and is comprised of funds that have been authorised by Central Bank of Ireland as open-ended UCITS investment companies.
SSGA SPDR ETFs Europe I & SPDR ETFs Europe II plc issue SPDR ETFs, and is an open-ended investment company with variable capital having segregated liability between its sub-funds. The Company is organized as an Undertaking for Collective Investments in Transferable Securities (UCITS) under the laws of Ireland and authorized as a UCITS by the Central Bank of Ireland.
Please refer to the Fund’s latest Key Investor Information Document and Prospectus before making any final investment decision. The latest English version of the prospectus and the KIID can be found at www.ssga.com.
A summary of investor rights can be found here: https://www.ssga.com/library-content/products/fund-docs/summary-of-investor-rights/ssga-spdr-investors-rights-summary.pdf
Note that the Management Company may decide to terminate the arrangements made for marketing and proceed with de-notification in compliance with Article 93a of Directive 2009/65/EC
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
For Investors in Austria: The offering of SPDR ETFs by the Company has been notified to the Financial Markets Authority (FMA) in accordance with section 139 of the Austrian Investment Funds Act. Prospective investors may obtain the current sales Prospectus, the articles of incorporation, the KIID as well as the latest annual and semi-annual report free of charge from State Street Global Advisors Europe Limited, Branch in Germany, Brienner Strasse 59, D-80333 Munich. T: +49 (0)89-55878-400.F: +49 (0)89-55878-440.
For Investors in Finland: The offering of funds by the Companies has been notified to the Financial Supervision Authority in accordance with Section 127 of the Act on Common Funds (29.1.1999/48) and by virtue of confirmation from the Financial Supervision Authority the Companies may publicly distribute their Shares in Finland. Certain information and documents that the Companies must publish in Ireland pursuant to applicable Irish law are translated into Finnish and are available for Finnish investors by contacting State Street Custodial Services (Ireland) Limited, 78 Sir John Rogerson’s Quay, Dublin 2, Ireland.
For Investors in France: This document does not constitute an offer or request to purchase shares in the Company. Any subscription for shares shall be made in accordance with the terms and conditions specified in the complete Prospectus, the KIID, the addenda as well as the Company Supplements. These documents are available from the Company centralizing correspondent: State Street Banque S.A., Coeur Défense - Tour A - La Défense 4 33e étage 100, Esplanade du Général de Gaulle 92 931 Paris La Défense cedex France or on the French part of the site ssga.com/etfs. The Company is an undertaking for collective investment in transferable securities (UCITS) governed by Irish law and accredited by the Central Bank of Ireland as a UCITS in accordance with European Regulations. European Directive no. 2014/91/EU dated 23 July 2014 on UCITS, as amended, established common rules pursuant to the cross-border marketing of UCITS with which they duly comply. This common base does not exclude differentiated implementation. This is why a European UCITS can be sold in France even though its activity does not comply with rules identical to those governing the approval of this type of product in France.The offering of these compartments has been notified to the Autorité des Marchés Financiers (AMF) in accordance with article L214-2-2 of the French Monetary and Financial Code.
For Investors in Germany: The offering of SPDR ETFs by the Companies has been notified to the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) in accordance with section 312 of the German Investment Act. Prospective investors may obtain the current sales Prospectuses, the articles of incorporation, the KIIDs as well as the latest annual and semi-annual report free of charge from State Street Global Advisors Europe Limited, Branch in Germany, Brienner Strasse 59, D-80333 Munich. Telephone: +49 (0)89-55878-400. Facsimile: +49 (0)89-55878-440.
For Investors in Italy: State Street Global Advisors Europe Limited, Italy Branch (“State Street Global Advisors Italy”) is a branch of State Street Global Advisors Europe Limited, registered in Ireland with company number 49934, authorised and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2. State Street Global Advisors Italy is registered in Italy with company number 11871450968 - REA: 2628603 and VAT number 11871450968, and its office is located at Via Ferrante Aporti, 10 - 20125 Milan, Italy. T: +39 02 32066 100. F: +39 02 32066 155.
For Investors in Luxemburg: The Companies have been notified to the Commission de Surveillance du Secteur Financier in Luxembourg in order to market its shares for sale to the public in Luxembourg and the Companies are notified Undertakings in Collective Investment for Transferable Securities (UCITS).
For Investors in the Netherlands: This communication is directed at qualified investors within the meaning of Section 2:72 of the Dutch Financial Markets Supervision Act (Wet op het financieel toezicht) as amended. The products and services to which this communication relates are only available to such persons and persons of any other description should not rely on this communication. Distribution of this document does not trigger a licence requirement for the Companies or SSGA in the Netherlands and consequently no prudential and conduct of business supervision will be exercised over the Companies or SSGA by the Dutch Central Bank (De Nederlandsche Bank N.V.) and the Dutch Authority for the Financial Markets (Stichting Autoriteit Financiële Markten). The Companies have completed their notification to the Authority Financial Markets in the Netherlands in order to market their shares for sale to the public in the Netherlands and the Companies are, accordingly, investment institutions (beleggingsinstellingen) according to Section 2:72 Dutch Financial Markets Supervision Act of Investment Institutions.
For Investors in Norway: The offering of SPDR ETFs by the Companies has been notified to the Financial Supervisory Authority of Norway (Finanstilsynet) in accordance with applicable Norwegian Securities Funds legislation. By virtue of a confirmation letter from the Financial Supervisory Authority dated 28 March 2013 (16 October 2013 for umbrella II) the Companies may market and sell their shares in Norway.
For Investors in Spain: State Street Global Advisors SPDR ETFs Europe I and II plc have been authorised for public distribution in Spain and are registered with the Spanish Securities Market Commission (Comisión Nacional del Mercado de Valores) under no.1244 and no.1242. Before investing, investors may obtain a copy of the Prospectus and Key Investor Information Documents, the Marketing Memoranda, the fund rules or instruments of incorporation as well as the annual and semi-annual reports of State Street Global Advisors SPDR ETFs Europe I and II plc from Cecabank, S.A. Alcalá 27, 28014 Madrid (Spain) who is the Spanish Representative, Paying Agent and distributor in Spain or at spdrs.com. The authorised Spanish distributor of State Street Global Advisors SPDR ETFs is available on the website of the Securities Market Commission (Comisión Nacional del Mercado de Valores).
For Investors in United Kingdom: The Funds have been registered for distribution in the UK pursuant to the UK’s temporary permissions regime under regulation 62 of the Collective Investment Schemes (Amendment etc.) (EU Exit) Regulations 2019. The Funds are directed at 'professional clients' in the UK (as defined in rules made under the Financial Services and Markets Act 2000) who are deemed both knowledgeable and experienced in matters relating to investments. The products and services to which this communication relates are only available to such persons and persons of any other description should not rely on this communication. Many of the protections provided by the UK regulatory system do not apply to the operation of the Funds, and compensation will not be available under the UK Financial Services Compensation Scheme.
© 2022 State Street Corporation. All Rights Reserved.
Exp. Date: 11/30/2023