After a terrible 2022 in which nearly every asset class fell, 2023 has seen (almost) everything rally. Across assets, it’s been one of the strongest starts to a year in recent memory.
But behind this broad-based strength, we find three distinct themes across Asia, Europe and the U.S. The narrative in Asia looks most compelling, while that in the U.S. is most uncertain. After a terrible 2022 in which nearly every asset class fell, 2023 has seen (almost) everything rally. Across assets, it’s been one of the strongest starts to a year in recent memory. But behind this broad-based strength, we find three distinct themes across Asia, Europe and the U.S. The narrative in Asia looks most compelling, while that in the U.S. is most uncertain.
#1: The Ripple Effects of China’s Reopening
Until recently, the world's second-largest economy was following a different Covid strategy than almost every other country in the world, imposing restrictive lockdowns that limited economic activity. That policy is now shifting, with surprising aggressiveness, driving large upward revisions to our estimates for China GDP, Asia equity earnings and regional price targets.
A counterpoint to this optimism is that this story is now well-known – for example, hedge fund exposure to China stocks has already jumped. But we think that this stance risks missing the forest for the trees. We’re seeing a major policy shift in a very large economy, impacting markets that trade at reasonable valuations. MSCI Asia may be up 25% from its lows in October of 2022 but is largely unchanged from five years ago. China, Korea and Taiwan remain top regional picks within global equities.
Bottom line: This theme is likely to continue on a positive trajectory.
#2 A Positive Surprise from Lower Energy Prices in Europe
The second theme addresses Europe’s dramatic fall in energy prices: A warm winter and sizable U.S. imports have made it possible that Europe will have more natural gas than storage can hold – a prospect that would have seemed unimaginable even a few months ago. As a result, the price of natural gas is down by more than 80% since late August, driving our forward-looking forecasts for the commodity lower.
This decline is important. Lower energy prices mean less inflation and better growth, which in turn makes Europe “investable” for corporates and others who previously worried about an energy crisis.
Note that this is also distinct from the trend around China’s reopening. While that helps Europe, equities in Europe bottomed a full month before those in China. Energy has been the bigger driver.
Bottom line: We see some of the best opportunities in Europe via a stronger euro, lower EUR yields and banks over cyclicals.
#3 A “Soft Landing” for the U.S. Economy
The forward-looking narrative in the U.S. is less certain than in Asia or Europe. It might be about a soft landing and the idea that U.S. growth will slow enough to moderate inflation and encourage the Federal Reserve to stop hiking rates, but not enough to drive the economy into recession. That’s one way to explain higher equities, lower yields, tighter bond spreads and expectations that the Fed funds rate will be 150 basis points lower than it is today by the end of 2024.
A soft landing has been a key part of Morgan Stanley Research’s year-ahead outlook. But the incoming data remain mixed, with moderating wage growth and a very strong payroll report, alongside weak readings for the U.S. Institute for Supply Management index and the Index of Leading Economic Indicators. The debate around growth seems alive and well.
The story in the U.S. might be about resilient earnings, whatever the growth outlook. But with half the S&P 500 now having reported for the fourth quarter of 2022, earnings per share is falling and only meeting expectations (versus the more typical scenario, which is beating expectations). Our fundamental view remains that U.S. earnings will sharply underperform the economy. Among other factors behind our skepticism about the U.S. story, our sentiment indicators suggest that investors’ outlooks have shifted from fearful to complacent.
Bottom line: Investors may want to take profits on recent upside in U.S. stocks and put that money to work in global markets.