NZAC - Cumberland Advisors Market Commentary - International Equities Q4 2022

Summary

• There were ample causes for this global downdraft in equity markets.
• Global equity markets look likely to face a global recession in 2023, which appears to have already begun in the final quarter of 2022.
• Equity markets will face a tough global environment in 2023, particularly in the first half.

By William H. Witherell

Global equity markets are in the final days of a challenging year. The iShares MSCI All Country World Index ETF, ACWI , tumbled downward until October and recovered some before dropping again in December, with a year-to-date December 23 decline of 19.6%. International stocks in markets outside the US declined almost as much, with the iShares MSCI All Country ex US ETF, ACWX , down 18%. There were ample causes for this global downdraft in equity markets.

Surging inflation led most central banks to tighten monetary policies, those of China and Japan being exceptions. A bloody and expensive war broke out in Europe when Russia invaded Ukraine. The Chinese economy, the second largest globally and the leader in global trade, slowed dramatically as a result of the constraining effects of its zero-Covid policy together with a protracted correction in its important real estate sector. The growth rate of the global economy declined sharply this year from last year’s 6% pace to an estimated 3.1 %.

Advanced economy markets grew by just 2.6%. The pace of growth in emerging market economies was somewhat higher at an estimated 3.7% rate, but well below the 6.6% advance in 2021. Returns from US-listed international ETFs faced an additional headwind, the strong US dollar, which gained some 9% this year. The dollar value of foreign currency earnings is reduced when their currencies depreciate versus the dollar.

Among the national market ETFs we follow, the only ones that have been able to yield a positive year-to-date return are located in Latin America: Chile, Brazil, and Mexico. Most Asian emerging-market ETFs, in contrast, suffered steep declines, with the decline in China being a major cause of the region’s underperformance. Emerging-market equities, as a whole, lost more than advanced-economy markets did, -22.6% versus -16.3%.

In the coming year, the above pattern may be reversed. Emerging markets, where valuations are extremely depressed, may outperform advanced-economy markets. Global equity markets look likely to face a global recession in 2023, which appears to have already begun in the final quarter of 2022. The severity of the recession will depend, to a significant degree, on what happens in China.

Responding to unprecedented protests, the Chinese authorities started easing their zero-Covid restrictions in December, and they did so at a surprising pace, with little preparation. They did not wait to make up for the serious deficiencies in their vaccination programs, nor to import the more-effective vaccines used in most other countries. The predictable result has been a huge wave of Covid cases, with some 250 million people, 18 percent of the population, becoming infected during just the first 20 days of December, according to Chinese officials.

Hospital and medical staff resources are being overwhelmed as this Covid wave of the highly transmissible omicron variants surges through the population like a forest fire. This wave will likely continue through much of the first half of 2023. No adequate estimates are being provided of Covid-caused deaths, but the toll is expected to be heavy, particularly among the inadequately vaccinated and vulnerable elderly population.

While the Covid restrictions that limited economic activity have largely been dismantled, the Covid wave and the attempts of the population to avoid being infected (e.g., voluntary social distancing) are now a significant new drag on the economy. The widely anticipated reopening of the Chinese economy is likely to be constrained by weak consumer and business confidence in the first half of the year. There will be little help from external demand.

Macro policy stimulus is likely to be front-loaded to the first half, setting the stage for stronger economic reopening in the second half.

In Europe, high-frequency indicators show a broad-based fall in economic activity that implies a decline in economic growth in the final quarter of 2022. The negative growth will likely continue through the first quarter of 2023. This said, the European economy has shown remarkable resilience in the face of elevated inflation, an energy crisis as Russia has cut gas supplies, and all the other negative effects of the Ukraine-Russia war.

Unfortunately, that war shows no sign of easing. European central banks are tightening monetary policies to combat the high inflation, while fiscal policies will continue to support growth. Although there are downside risks, including winter weather and the course of the war, it looks like the recession in Europe will be relatively shallow, followed by a recovery that may gain momentum in the second half of the year as the reopening of China fuels global growth.

Both the euro area and the UK economies may register very modest advances for the year of about 0.5%. Japan, Canada, Australia, and South Korea will likely experience stronger annual growth rates ranging from 1 to 2%.

Emerging-market economies as a group are expected to outperform advanced economies in 2023, growing at a 3.7% rate, which is well below trend but far stronger than the average growth of 1.1% for advanced economies, most of which will experience a recession. Many of the emerging markets have ahead-of-the-curve monetary policies, and there are some signs of inflation easing. Major Latin America central banks may begin to reduce interest rates well before those in the US and Europe do.

India looks likely to be the growth leader, with GDP advancing at a 6% pace. China’s recovery, particularly in the second half, should lead to a 4.5% growth rate for the year.

Equity markets will face a tough global environment in 2023, particularly in the first half. Nevertheless, the combination of generally stronger growth prospects, receding inflation but continued elevated commodity prices, and very attractive valuations lead us to expect emerging-market equity returns to outperform those of advanced-country stock markets, reversing the relative performance in 2022. There will likely be considerable variations in the performance of individual national markets, a situation which calls for diversified portfolios and close monitoring of developments.

We will be giving special attention both to the situation in China and the war in Europe, for which there are significant downside and upside risks.

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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