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10 BIG INVESTMENT TRENDS FOR 2023


BMO GAM’S MONTHLY HOUSE VIEW - SPECIAL EDITION

January 2023
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FRED DEMERS


DIRECTOR, MULTI-ASSET SOLUTIONS

INTRODUCTION


10 BIG INVESTMENT TRENDS FOR 2023

This is a special issue of BMO GAM’s Monthly House View. Our usual format will
return in February.

2022 has been a challenging year for markets, with interest rates rising,
inflation hitting record highs, the Russian war in Ukraine causing geopolitical
turmoil, and a recession now likely on the horizon. As we look ahead to 2023,
questions on these and other issues remain, and new questions will surely
present themselves. What forces will shape markets and economies over the next
12 months? And how will they affect investment portfolios.

This represents our best insights into what the coming year may hold—based on
extensive research, hard data, and our team’s experience and expertise. With
topics ranging from purchasing power and corporate profits to Energy and
cryptocurrency, these are 10 big investment trends to look out for in 2023.

#1: INFLATION


LOSS OF PURCHASING POWER IS TRANSITORY

In 2022, wage growth fell behind inflation, eroding consumers’ purchasing power.

Not only was this development taxing for households, but it also increased the
odds of labour conflict and social unrest in the year ahead—especially in
Europe, which has underperformed relative to its peers, and in developing
economies.

But as 2022 came to a close, inflation numbers cooled somewhat. This decline
means that wage growth will likely outpace inflation in 2023, potentially
creating a tailwind for the economy into 2024.

A repeat of the historic inflation pain of 2022 would be devastating.
Thankfully, we don’t see it happening.

Negative Real Wage Growth Erodes Purchasing Power


Source: Bloomberg, BMO Global Asset Management, as of Q3 2022.

#2: CORPORATE PROFITS


CORPORATE PRICING POWER IS IN HIGH GEAR

Pricing power—companies’ ability to increase the price of its products or
services without a proportionate reduction in demand—is one of the key
attributes of equities that amplifies the compounding of returns.

To put it simply: if a company can successfully exercise its pricing power, it’s
good news for Wall Street and not as good for Main Street, as consumers’
pocketbooks have to bear the burden of rising costs.
Corporate profit margins have been exceptionally strong during the COVID-19
pandemic, and as we enter 2023, we expect some cyclical moderation of those
numbers. But overall, pricing power remains strong, and this is likely to
prevent a repeat of the “Volcker Crunch” of the early 1980s—a reference to
former U.S. Federal Reserve chairman Paul Volcker, who tamed inflation with high
interest rates but “crunched” the economy (and corporate profits) in the
process.

U.S. Aggregate Corporate Profits as Share of GDP (%)


Source: Bloomberg, BMO Global Asset Management, as of Q3 2022.

#3: BALANCED PORTFOLIO


ARE WE IN A NEW REGIME OF MONETARY POLICY?

Predictions of regime change in monetary policy are frequent, but they are
extremely rare.

In recent years, the economy has experienced an intense cycle characterized by
unanticipated headwinds, including COVID-19 and the Russian invasion of Ukraine.
This has some analysts asking the question—have we entered a new regime?

Our short answer is ‘no’. While imperfect, the benefits of the current
inflation- targeting regime are widely accepted by policymakers. Typically,
central banks play the role of ‘banker-of-last-resort’, acting contra-cyclically
to moderate economic ups and downs—lowering interest rates when the economy is
slowing down and raising them when the economy is revving up. But in 2022, they
acted pro-cyclically, hiking into an economic slowdown and thereby hurting both
stocks and bonds simultaneously. This is a historical rarity, as the chart below
demonstrates. In 2023, we expect central banks to return to their role of
leaning against the economic cycle.

S&P 500 & U.S. Treasuries Annual Performance Since 1928


Source: Bloomberg, BMO Global Asset Management, as of October 2022.


THE FUTURE OF THE BALANCED PORTFOLIO

To paraphrase Mark Twain: Rumours of its death have been greatly exaggerated.

The normalization of interest rates— meaning their increase from a low of less
than 1% during the pandemic—has strengthened the future of the traditional 60%
stocks/40% bonds balanced portfolio. We expect that a return by central banks to
their counter-cyclical approach to monetary policy will help government bonds
regain their safe-haven status, as they did after previous economic downturns.

If History Is Any Guide, Government Bonds Should Regain Their Safe-Haven Status


Source: U.S. Federal Reserve, Bloomberg, BMO Global Asset Management, as of
November 2022.

#4: INTEREST RATES


RISING DEBT SERVICING COSTS WILL CAP INTEREST RATES

The public finances of major economies cannot endure sustained high interest
rates.

As the chart below shows, public debt is already on the rise in major economies,
and the increasing cost of servicing that debt is likely to put the brakes on
excessive fiscal deficits. Governments’ elevated debt loads should put a ceiling
on interest rates and prevent a regime shift in monetary policy.

Public Debt on the Rise Across Major Economies


Source: Bloomberg, BMO Global Asset Management, as of September 2022.

Rising interest rates are likely to send debt-servicing costs back to the highs
of the early 2000s. Private debt loads are also much higher now than before the
Global Financial Crisis of 2007-08. Debt service is like a tax—money spent on
servicing the debt is money not spent on goods and services. We expect greater
scrutiny over public finances as the burden of interest rates is revealed in
government budgets.

Debt Service Ratio: Private Non-Financial Sector



Debt Service Ratio: Households


Source: Bloomberg, BMO Global Asset Management, as of September 2022.


NEGATIVE INTEREST RATES ARE GONE. WILL THEY COME BACK?

Ideally, the world is past the regime of negative interest rates; as the chart
below shows, the market value of negative yield debt has been declining steeply
since a peak in 2020-21.

But elevated debt loads and policy makers’ eagerness to steer the economy means
that we cannot rule out the return of unorthodox monetary policies of negative
interest rates or quantitative easing— especially given central’s banks
‘whatever-it-takes’ approach to taming inflation. Going forward, central banks
might support raising inflation targets to 3% from the standard 2% in order to
reduce the odds of hitting interest rates’ zero-bound (i.e., 0% interest rates,
from which point they can’t go any lower) too quickly during an economic
downturn.

Bloomberg Global Aggregate Negative Yield Debt Market Value in USD


Source: Bloomberg, BMO Global Asset Management, as of November 2022.

#5: QUALITY


NAVIGATING TURBULENT MARKETS WITH QUALITY

Quality is the foundation of a portfolio’s strong equity core, and this is
especially true for 2023.

Quality sectors and companies are characterized by high and stable profit
margins, as demonstrated by the sectors at the top-left of the chart below.
Resilience to fluctuations of the business cycle is also key during periods of
elevated uncertainty, like the one we’ve experienced recently. With interest
rates rising and the end of the era of free money over, we expect markets to
refocus on the role of strong fundamentals as a driver of long-term performance.

Industry/Sectors Pricing Power


Source: Bloomberg, BMO Global Asset Management, as of October 2022.

#6: CRYPTOCURRENCY


THE BEGINNING OF THE END OF THE WILD WEST ERA

Recent cryptocurrency-related debacles, including the collapse of crypto
exchange FTX in November, mean that crypto will likely be subject to increased
scrutiny and additional regulations in coming months.

Crypto is already banned in China, and as more instances of fraud become public,
the likelihood of broader restrictions—in North America and around the
world—increases.

The events of 2022 have proven that cryptocurrencies have failed at providing
investors with a store-of-value. As the market froth around crypto evaporates,
we expect hard assets—meaning tangible assets with intrinsic value—to continue
to regain popularity.


#7: GEOPOLITICS


ELEVATED TENSIONS ARE THE NEW NORMAL

The war in Ukraine and rising geopolitical tensions around the globe have shone
a new spotlight on conflicts’ potential effect on portfolios.

The relevant question for investors, however, is not whether geopolitical
instability can impact risk assets, but whether pre-emptive portfolio tilts or
hedges are beneficial for long-term investors. The opportunity cost of portfolio
hedges is rarely cheap, and to successfully pull off such a strategy requires
superior timing—and luck. For many investors, day-to-day conversations about
geopolitical risk can be a drain, fuelling fear with no realizable benefit to
their portfolios. While elevated tensions do appear to be the new status quo,
historically—and even more recently, in the case of U.S./Russia
tensions—conflict between superpowers has largely been limited to proxy wars,
rhetoric, and commercial or political posturing. For investors, there’s little
reason to lose sleep.


#8: ENERGY


PEAK OIL PRODUCTION, NEW OIL CYCLE?

The Energy outlook, now highly influenced by geopolitics, remains a vulnerable
factor for the global economy.

Decarbonization efforts are accelerating, but conventional energy demand remains
elevated. The reality is clear: replacing fossil fuels will be a huge,
generational task. We suspect that the energy transition will be slower than
expected, and the scarcity of oil supply leaves energy prices exposed to
persistent tailwinds.

U.S. Oil Production and Outlook


Source: U.S. Energy Information Administration (EIA), BMO Global Asset
Management, as of October 2022.

#9: CHINA


GETTING OLD MEANS GETTING SLOW

China’s population is expected to peak in 2023, with Beijing’s well-publicized
one-child policy leaving the country vulnerable to aging demographics and a
distorted distribution of population by age.

As a result, China’s long-term fundamentals look increasingly challenging. In
2022, we strategically trimmed our exposure to Emerging Market equities because
of our negative outlook on these fundamentals—and at this juncture, we see no
reason to change our minds, despite the country’s likely economic reopening
post-COVID in 2023.

China Population: Historical, Projections


Source: United Nations – World Population Prospects, BMO Global Asset
Management, as of October 2022.

#10: MACRO OUTLOOK


A RETURN OF ‘THE GREAT MODERATION’

A key benefit to the low levels of inflation developed economies have
experienced since the early 1980s has been a reduction in macroeconomic
uncertainty—what economists have coined ‘The Great Moderation’.

The pandemic brought an end to this period of relative calm, as rising inflation
brought about increased economic turbulence. But will the Great Moderation
return? Our answer is yes. In 2023, as central banks stick to their inflation
targets, we expect macroeconomic uncertainty to return to pre-pandemic levels.

Macro Uncertainty is Set to Moderate Once Again


Source: Bloomberg, BMO Global Asset Management, as of Q3 2022.


DISCLOSURES

The viewpoints expressed by the individuals represents their assessment of the
markets at the time of publication. Those views are subject to change without
notice at any time without any kind of notice. The information provided herein
does not constitute a solicitation of an offer to buy, or an offer to sell
securities nor should the information be relied upon as investment advice. Past
performance is no guarantee of future results. This communication is intended
for informational purposes only.


Any statement that necessarily depends on future events may be a forward-looking
statement. Forward-looking statements are not guarantees of performance. They
involve risks, uncertainties and assumptions. Although such statements are based
on assumptions that are believed to be reasonable, there can be no assurance
that actual results will not differ materially from expectations. Investors are
cautioned not to rely unduly on any forward-looking statements. In connection
with any forward-looking statements, investors should carefully consider the
areas of risk described in the most recent simplified prospectus.


BMO Global Asset Management is a brand name under which BMO Asset Management
Inc. and BMO Investments Inc. operate


This article is for information purposes. The information contained herein is
not, and should not be construed as, investment, tax or legal advice to any
party. Investments should be evaluated relative to the individual’s investment
objectives and professional advice should be obtained with respect to any
circumstance.


®/™Registered trademarks/trademark of Bank of Montreal, used under licence.


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