This article first appeared in Wealth, The Edge Malaysia Weekly on January 30, 2023 - February 5, 2023

The market is already rife with talk about 2023 being a recession year. Vasu Menon, executive director of investment strategy at OCBC Bank’s Wealth Management unit, has a similar view, but with a touch of optimism.

It will be a year of two halves, Menon tells Wealth in an exclusive interview. The first half of the year will be challenging but by the second half, a rebound in markets could be expected. Amid the volatility, many opportunities will arise for investors to scoop up beaten-down assets.

“Now, because everything is so beaten down, we can actually tell people there are opportunities. We are not suggesting that you jump in and buy right now. But we have greater conviction that in the next two years, some of these things will do well. There’s a silver lining to the very sharp pullback in the markets we saw in 2022,” says Menon.

His view is that the US is headed for a shallow, or technical, recession in the first half of the year. It will be a challenging and volatile market. But once the Federal Reserve turns dovish, the second half of 2023 and 2024 could be a good period for investors.

For a shallow recession to occur, inflation will have to go down, says Menon, which the Fed is currently tackling by raising interest rates. Once that is done, however, it will have to soften its hawkish stance. Recession risks will also have to be properly priced into markets.

“The earnings forecasts are still not forecasting a recession. Analysts are still fairly positive about the earnings outlook. I think we need to see more meaningful earnings downgrades, which will hopefully happen in the next six months,” says Menon.

There could be less shock to the markets when the earnings outlook is more realistic.

One reason Menon thinks a recession, if it happens, would be shallow is due to the strength of consumer spending and corporate balance sheets in the US. 

“Companies and individuals are not over-leveraged and individuals are cashed up. In the US, they have excess savings of US$2 trillion (RM8.65 trillion). That’s a lot of firepower from consumers,” he says. Additionally, there have not been massive job losses and wage growth remains strong.

Once the high inflation has been curtailed, the markets will recover, Menon believes. There is a lot of money parked in money market funds in the US — US$4.7 trillion, which, according to Menon, is a record high — that is waiting to be deployed when the outlook becomes more positive. This will help support the rebound.

The recession will be mostly limited to the Western economies, in Menon’s view. In Europe, this is due to rising interest rates and also the Russia-Ukraine war. But the situation will be more positive in Asia.

China reopened its borders to the world in January after lifting its zero-Covid policy. This will lead to a rebound in China’s markets and spill over to the region, says Menon. It will drive up demand for services, tourism and hospitality and reduce the stress on broken supply chains. The latter factor could drive inflation down.

“The risk is that when Chinese demand comes back, commodity prices could go up and that could fuel inflation. So, the jury is out on whether the reopening of China is going to be good or bad for inflation,” says Menon. 

However, “the recovery will help Asia particularly, so we are positive on Asia”.

Menon has been positive on China since the second half of last year. Since then, the Chinese market has done well despite rising cases of Covid-19 infections. The Shanghai Composite Index, for instance, has increased by 2.53% year to date, although it is still down by at least 9% from a year ago (as of Jan 13).

Herd immunity could be possible if most of the population has been infected, says Menon.

“For instance, in Singapore, when we lifted Covid-19 restrictions, it took about six to eight months before things settled down. China lifted it in two weeks and almost 70% of the population was infected. It creates immunity. Because of that, recovery is going to be faster.”

Meanwhile, he points out that the decline in the equity and bond markets last year was exceptional. According to Menon, there have only been two occasions in the last 25 years when both asset classes were sold off at the same time. This has, in turn, created opportunities for investors.

He is still neutral on equities at the moment due to the expected challenges in the first half of 2023. This might change for the better, however, if factors like declining inflation are realised.

However, Menon is positive on developed market investment-grade bonds because, with an impending recession, investors will seek quality assets. Additionally, if the Fed cuts interest rates in 2024 when inflation has been contained, investment-grade bonds, which are typically longer in duration, will benefit.

“We also see opportunities in emerging market investment-grade bonds and high-yield bonds because valuations have now become attractive with the sell-off,” he says.

The big tech rout was the headline in 2022 as tech counters saw their stock prices plummet after a huge run-up during the pandemic. Menon is still somewhat positive on the sector, especially for tech stocks in China.

“Chinese tech stocks have been badly hammered but have seen a massive rebound of between 70% and 90% in the last few months,” he says. “The prices were previously driven down by regulatory tightening. The government’s stance, however, has changed as the sector is seen as pivotal to job creation. I think things are getting better in China, so the tech sector there is in favour.”

On the flip side, he is neutral on US tech stocks because there could be more volatility ahead. While it has been heavily sold off, the valuations could still be cheaper.

“Right now, the MSCI tech index is trading at a price-earnings ratio of about 20 times. During the first big sell-off [after Covid-19], the valuations sank to a low of 16 times and during the US-China trade war, it went down to 14 times. So, there is still possibly more downside,” says Menon.

“You can’t take your eyes off this sector after such a big sell-off because tech is here to stay. It’s a matter of finding the right level to buy.”

A sector that Menon is overweight on is healthcare, thanks to the greater awareness of disease management due to Covid-19 and the ageing population. Both will benefit the sector. Financial services, meanwhile, will benefit once the recession is over and there is a recovery.

A trickier sector to look at is energy. The reopening of China will boost demand for commodities. But this will be offset in some way by slowing demand from the US and Europe due to the recession, says Menon.

“We think oil prices are going to hover around US$80 to US$90 per barrel. The energy sector is where you want to keep your eye on. Of course, in the longer term, there will be a greater focus on solar and renewable energy. It’s a space you cannot ignore.”

On a related note, the environmental, social and governance (ESG) space will be important because it’s a long-term play, Menon believes. It is something investors will need to keep in their portfolios. “It’s like technology 15 years ago. If you had invested in it then, you would have done extremely well [now].”

This is despite the view that companies will scale back their investments in ESG initiatives because of the recession. 

Menon argues that companies will have to change regardless of the situation because fund managers are embracing ESG, regulations are being introduced and the new generation of consumers see it as a priority.

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