Main asset classes Equities 32 | 33 2023: A tale of two halves otherwise known as pricing power. In terms of While we believe that the worst of the de-rating is sectors, we like healthcare due to its defensive A tale of two halves behind us, a significant re-rating of equities would characteristics and margin stability. The relative require a shift in central bank rhetoric. We expect a valuation compared to other defensive sectors is turning point in the market to materialize in the also appealing. Furthermore, long-term growth second half of 2023. Until then, we would expect drivers like better healthcare access in emerging volatile but rather muted equity returns and would markets (EM), aging populations and new technolo- focus primarily on defensive sectors/regions offering gies (e.g., mRNA vaccines) remain intact. Our The higher-rates-for-longer theme triggered a significant de-rating (i.e., lower stable margins, resilient earnings and low leverage. preferred market in this challenging environment is valuation multiples) of equities in 2022. This theme will likely continue to Once we get closer to such a pivot, we would rotate Switzerland. Thanks to its defensive characteristics, toward interest rate sensitive sectors with a growth it tends to outperform when growth slows. In dominate during the first half of 2023, leading to muted equity performance. tilt, such as technology. addition, the earnings outlook is relatively bright, Sectors and regions with stable earnings, low leverage and pricing power with double-digit earnings growth expectations for How to position for 2023 2023. In EM, we expect Latin America to outper- should fare better in this environment. In the second half of 2023, we expect Going into 2023, investors should focus on equity form Asia. In equity styles, we currently prefer that the discussion will turn to peak hawkishness, with earnings resilience in sectors and regions that show resilient earnings quality (i.e., companies with high returns on equity, a slowing growth environment in focus. We see the technology sector as growth and an ability to defend their margins, stable earnings growth and low financial leverage). offering the most attractive returns once the US Fed pivots. The past year has been tough for financial markets, our economists do not forecast rate cuts from major including equities. The Ukraine war added to central banks, including the US Federal Reserve post-pandemic supply chain issues and fueled a rise (Fed), in 2023. in inflation to levels last seen in the 1980s. Central banks were initially slow to react but were then Earnings resilience key to watch Headwinds from real yields forced to hike aggressively. Equity valuations came Higher-for-longer policy rates will have a negative The impact of rising real yields on equity valuations under significant pressure as policy rates and real impact on the global economic outlook. Against this yields spiked across the globe. In our view, central backdrop, our economists forecast a recession in -1.5 –1.5% banks and their policies aimed at reducing inflation the Eurozone, the UK and Canada, alongside very 2121 continue to be a key driver of equity returns. This is weak growth in the USA. This will inevitably add -1.0 because higher central bank rates increase funding downside risks to corporate earnings, even more so 2020 –1.0% costs for corporations and increase the discount rate given rising costs (e.g., wages and raw materials). 19 of future earnings, which is a headwind to valuations. Consensus earnings have already been revised 19 materially lower, but the current estimate of 3.7% -0.5 – 0.5% Any signs that inflation is brought under control (i.e., growth for 2023 may still be too optimistic, in our 1818 close to central bank targets on a sustainable basis) view. Ultimately, earnings resilience will depend 0.0 would likely loosen central banks’ restrictive stance heavily on the length and magnitude of the economic 1717 0.0% and could therefore trigger a re-rating in equities slowdown, but we see rising risks of an earnings 16 (i.e., higher valuation multiples). However, we do not recession (i.e., negative earnings growth in 2023). 16 think this will be the case in the first part of 2023 as 0.5 0.5% 1515 1.0 1414 13 1.0% 13 1.5 1.5% 1212 Jan 18 Jan 19 Jan 20 Jan 21 Jan 22 MSCI AC World 12m fwd P/E US 10-year real yield (inverted, rhs) Last data point 07/11/2022 Source Refinitiv, Credit Suisse