What are the top investment trends for 2023?

Emerging markets, small cap stocks and bonds could outperform the market, experts say

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The past 12 months have been grim for investors who weren’t even treated a last-minute pre-Christmas Santa rally to alleviate the gloom enveloping global markets.

Shares sold off in a final flurry of panic as investors anticipated a tough start to 2023 and central banks continue to raise interest rates to combat inflation.

There is little hope of a quick solution to the war in Ukraine, with the US pledging another $1.85 billion of military aid and Russian President Vladimir Putin ramping up his war drive, says Joshua Mahony, senior market analyst at trading platform IG.

The energy shock is not over, either, “as a drawn-out conflict could put pressure on prices and stifle efforts to fill EU gas stocks for next winter”, he says.

The battle against inflation has forced the US Federal Reserve to lift its funds rate from 0.50 per cent to 4.5 per cent since March, and Mr Mahony warns of more to come.

“The bears are back in charge amid growing concern that the Fed will continue pushing rates upwards.”

2023 is likely to divide into two distinct phases, says Stéphane Monier, chief investment officer at Swiss private bank Lombard Odier.

“Tighter monetary policy, high inflation and slowing growth will carry into 2023, demanding prudent portfolio positioning. However, once real interest rates peak, the economic cycle will pivot, creating opportunities in risk assets.”

The Fed will only “pivot” and start easing once inflation peaks, most probably after the US falls into recession early in 2023, Mr Monier says.

“The resilience of the American job market will be key to the shifting pace of monetary policy.”

While US inflation fell to 7.1 per cent in November, it was still at 11.1 per cent in the EU, driven by rising energy prices as the continent decouples from Russian sources.

“Much now depends on the severity of the Northern Hemisphere’s winter, but gas inventories have been replenished,” Mr Monier says.

“Any further delay in reopening the Chinese economy would also weigh on global growth, and we cannot rule out further geopolitical tensions over Taiwan.”

Lombard Odier is cautious today, investing in high-quality companies with low earnings volatility that can maintain margins, while favouring safe-haven currencies such as the US dollar and Swiss franc.

“We are overweight cash, which enables us to stay nimble and seize investment opportunities as conditions improve,” Mr Monier says.

Now may be a good time for private investors to start building up their ammunition to go shopping for shares and other assets ahead of the recovery.

Hawkish central banks mean we are not there yet, says Rupert Thompson, chief economist at wealth managers Kingswood.

“Markets face a few more months of volatility before the improving outlook becomes clear enough to engender a sustained recovery in equity markets.”

Yet, investors who survey the gloomy headlines and decide it is time to run for cover could regret selling at today’s lows.

The US S&P 500 is down about 20 per cent this year, with the Nasdaq technology index falling by a third and other markets performing poorly, too.

Selling today will only crystallise what are otherwise simply paper losses and lock investors out of the recovery when it comes, as it ultimately will.

Markets are forward-looking and history shows they typically pick up while the economy is still in recession. Those who leave it too late risk missing the early stages of the recovery, which tends to be when the biggest gains are made.

Quilter Cheviot’s head of fund research Nick Wood says there were few hiding places in 2022, but the future is brighter.

“Wherever volatility rears its head, opportunity comes calling quickly afterwards and investors need to position their portfolios for a changing environment in 2023.”

Mr Wood tips emerging markets to outperform the developed world when investor sentiment revives, “as wealth increases and industries become more mature”.

Smaller companies often lead the charge in a recovery, says James Cullen, chief executive at Schafer Cullen Capital Management.

“History shows that when small cap stocks do well, they tend to outperform everything else.”

Small caps have been oversold in recent years and the recovery could be “dramatic”, he says.

A 40-year bull market in bonds came to a crashing end in 2022, but they now look cheap, says Tom Stevenson, investment director for personal investing at Fidelity International.

“As the inflation and interest rate storm blows through the financial markets, they could be the biggest winners in 2023.”

Commodities were the top-performing asset class of 2022, but may find the going harder next year despite the war in Ukraine, says Yves Bonzon, group chief investment officer at Julius Baer.

“We do not expect a generalised commodity super-cycle to materialise this decade, even if some key commodities necessary for the energy transition may see upward price pressure, as supply struggles to catch up with demand.”

While US technology companies such as Amazon, Netflix, Meta Platforms and Tesla struggle, the digital revolution could create new growth champions for long-term investors, Mr Bonzon says.

“The field is quite large, from robotics and automation to supply-chain optimisation, but our preferred theme remains disruptions in the life-science space, including digital health care and biotechnology.”

As for Bitcoin, 2022 was desperate and Myron Jobson, a senior personal finance analyst at Interactive Investor, says do not assume it will bounce back.

“Crypto has typically rebounded from steep falls in the past, but the environment is very different as the industry appears set for a regulatory crackdown.”

The one thing investors can expect in 2023 is the unexpected, says Charlie Huggins, head of equities at advisers the Wealth Club.

“At the start of 2020, no one predicted a global pandemic while 18 months ago, nobody could foresee today’s double-digit inflation or war in Ukraine.”

Investors should protect themselves from a world of uncertainty by holding some cash back for emergencies and making sure the rest of their portfolio is well diversified.

“Don’t make one-way bets on how the economy or stock market might pan out in 2023,” Mr Huggins says.

Everybody likes to make predictions at this time of year but the truth is that nobody knows what is going to happen.