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Are we back to normal yet? Our economic outlook for 2023 and unique opportunities for investors
After the chaos and highly volatile markets of 2022, economic trends in 2023 suggest a year of transition and a gradual return to normal. But are we already back to normal?
By way of an answer, we suggest taking a step back to look at the long-term trends and asking the following questions: what is the outlook for the world’s major economies in the face of persistent inflation? What impact is monetary tightening having?
How are geopolitical shifts, demographic trends and climate change affecting longer-term economic variables?
Climate transition is also opening up new investment opportunities, most notably the mass electrification of the world economy, which is creating unprecedented sources of return. This edition of Rethink Perspectives, led by Frédéric Rochat, Managing Partner of Lombard Odier, offers a chance to take a step back, to consider the long-term economic trends and to seize cyclical opportunities. The panel for this edition consists of Gérard Felley, Partner and Head of Swiss Private Clients, Samy Chaar, Chief Economist, and Michael Urban, Chief Sustainability Strategist for the Lombard Odier Group; they will answer questions raised and present their analyses.
Economic outlook for the second half of 2023: back to normal?
2023 marks a year of transition, while economies absorb the shocks of the previous year: “the shock to value chains as the Chinese economy closed down and the energy shock from the war in Ukraine, as well as their inflationary impact, and the shock from interest rates as central banks responded very swiftly and sharply,” explains Samy Chaar.
Even so, since the start of the year we have seen the first signs of weakening price pressures, with the prospect of inflation of “around 3% in December 2023 in the United States” and “in Europe soon after that,” he says.
The return to normal economic and financial conditions is apparent on several levels: first, in supply chains, with signs of a clear improvement in lead times for deliveries from manufacturers to consumers. Second, as regards energy prices, which have stabilised. The sharp fall in costs shows that the world energy market is returning to normal; Brent crude is trading at around USD 751 per barrel and gas prices in Europe are back down to EUR 30/MWh.
Disinflation driven by two competing economic forces
There are two economic forces pulling in different directions: on the negative side, central banks have raised their key rates to slam the brakes on inflation. This “puts every rate-sensitive sector under pressure – real estate, manufacturing and trade,” notes Samy. And a positive force which translates into substantial savings in our societies, “allowing households and firms to absorb the shock from higher interest rates.”
The upshot is that the economic slowdown remains weak, so disinflation is modest. Consequently, it will be some time before things get back to normal, although the current path could be viewed with optimism if one condition is met: “Central banks need to keep interest rates high to slow the economic engine,” explains Samy.
What do these economic and financial pressures imply for positioning in our portfolios? “We want to be relatively neutral in terms of portfolio risk,” he comments. Over this transitional period until 2024 prudence is the order of the day.
Geopolitical fragmentation: a new world order?
Looking forward, we are also analysing the long-term fundamentals, with a firm conviction, shared by Samy: “The next ten years are going to be disruptive, and very different from the last ten,” and will offer unprecedented investment opportunities. The years ahead are going to be shaped by three major system changes: a geopolitical transition, an evolving demographic situation and climate change. These will all be a factor in the mass electrification of the economy.
On the first point, we are already seeing the emergence of economic blocs, pitting the USA against China. There are several lessons to draw from this. First, “although trading relations between the two blocs are tending to weaken, within the blocs they are strengthening.” The result is “a growth in trade that is still healthy, but is being rearranged,” as low-cost manufacturing alternatives to China emerge in countries such as Indonesia, India, Poland and Mexico.
The second lesson is that competition is a key factor driving the emergence of these blocs. Basically, the world’s two leading economic powers both want to show that “their economic and social model is better.”
Read also: A great “forward leap”: seizing the Sustainability Revolution
On the one hand, China is asserting its position as the world’s top producer of electric batteries and the leading manufacturer of electric vehicles at a time when growth in electric mobility is exploding. Today, one car in seven sold is powered by a battery, compared to one in 80 in 2017. By 2030 the ratio is likely to be one to 1.6, or 63% of the market. A real Sustainability Revolution is underway.
On the other hand, the US has a substantial lead over their rival in artificial intelligence, having invested nearly USD 250 billion in ten years, compared with USD 95 billion for China. This dominant US position in AI allows it to team up with service companies and give them a major competitive edge.
All this leads Samy Chaar to conclude that “the US bloc is a step ahead of China due to its demand capacity and to its currency; the dollar is a global reserve currency that the Chinese will find it hard to compete with. The leadership of the US bloc should continue in the next ten years, and this will be reflected in the way its assets are valued.”
Overall, Samy feels that “we are going to remain in a low and contained real interest rate environment thanks to the race for investment. This means that we can anticipate attractive asset valuations over the next decade” as the world economy undergoes electrification. What are the investment opportunities that this massive systemic shift is opening up?
Read also: Ten Investment Convictions for H2 2023
Electrifying the economy: a new paradigm creating a unique investment opportunity
Between now and 2050 the degree of electrification of the world economy will rise from 20% to 70%. This major system change will bring about a deep and fundamental transformation of the world economy. What lens should we look through to view and understand the global electrification of the economy?
For Michael Urban, Chief Sustainability Strategist at Lombard Odier, “we are talking about the prospect of final demand for energy (in the form of electricity) moving from some 20% today to around 70% by 2050.” The growing place occupied by renewable energies, such as solar and wind, in the electricity mix today will also inevitably lead to a “steep decline for the technologies associated with fossil fuels.”
Read also: Building the economy of tomorrow: clean energy brings exponential growth
The transition from an economic model that is Wasteful, Idle, Lopsided and Dirty (WILD) to one that is Circular, Lean, Inclusive and Clean (CLIC®) is following a clearly identified pattern. “All the innovations underlying this transformation have now passed the concept stage and the technologies are viable,” comments Michael.
This technical viability brings with it a “reinforcement mechanism that works through support measures from governments”, as was the case with the 2015 Paris Agreement and, more recently, through “economic and financial assistance to accelerate the transition.”
The direct impact of these measures “reduces the risk, for both companies and capital market investors, of deploying private-sector capital,” effectively increasing investments that make it possible to “boost manufacturing capacity, capture economies of scale and significantly reduce costs for consumers and companies,” Michael explains.
Electrification at the tipping point
As a consequence of all these measures, we are already at a tipping point for electrification, which is dependent on three interconnected issues.
First; affordability, i.e. a major fall in costs. As Michael points out: “Over the last ten years the costs of technologies such as solar, wind and batteries have fallen by some 60-90%. These are truly dramatic declines.” Second: effectiveness. Compared with internal combustion engines, technologies such as heat pumps and electric motors “allow efficiency gains of 300% over fossil fuel technologies.” Finally: accessibility. This is the outcome of the first two issues, which lower costs and increase efficiency.
Read also: ‘Prosumer’ power: the rapid rise of decentralised energy
The unprecedented support public authorities have lent to environmental transition sends a strong signal that a new industrial revolution is under way in the shape of the total electrification of the world economy, and it is spreading at the speed of the digital revolution.
If you add together direct and indirect spending by public authorities through measures such as the Green Deal in Europe, the Inflation Reduction Act in the US and private and public investment in China, we are talking about “USD 1 trillion invested annually out to 2030,” remarks Michael. In our view, this long-term trend represents one of the greatest investment opportunities of our time, as is clearly indicated by the “substantial deployment of public capital – much higher than has been seen in recent years.”
1 19 June 2023
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This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier.
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