Market Outlook 2023: A Golden Age for Alternatives?
When closing out the year in 2021, few anticipated the kind of geopolitical, economic, and social environment we experienced in 2022. As the COVID pandemic seemed to recede into history, many of us expected 2022 to be a year of strength for the global economy, and a return to normalcy in the world of politics and economics. What we got, however, was anything but. Instead, we experienced unprecedented inflation not seen in nearly two generations; the Fed dramatically tightened monetary policy in the United States, in line with a number of the world’s central banks; political strife in many areas across the globe; and ultimately, the biggest war seen in Europe since World War II with the Russian invasion of Ukraine. As a result, the trends we have seen in the markets have been unsurprising: high and accelerating inflation, low growth in the face of rising rates, widening credit spreads, and a sell-off across equities markets.
As we kick off the new year, where are markets today, and what is the market outlook for the future? While we do not have a crystal ball, it seems a safe bet to expect that many of the geopolitical and macroeconomic headwinds we faced in 2022 will still persist as we enter 2023. One of the items on top of this list is likely the Ukraine War. As Russia continues to reportedly falter in the South and East of Ukraine, the potential for unknown and unknowable fallout for investors remains high. Likewise, the path of both domestic and global inflation remains unclear from a market outlook point of view: U.S. inflation is showing initial signs of slowing, however, the lessons from the 70’s and 80’s show that while we may be experiencing a secular return to low and stable inflation, it could also mean that we are returning to an accelerating pace of rising prices. Regardless of how inflation responds though, it can be difficult in a monetary tightening environment to see strong economic growth. As a result, while certainly not the only outcome we could see in 2023, it would be prudent to expect persistent turbulence across asset classes, strategies, and markets.
While 2022 was a dismal year for equity-focused hedge funds, there were certain managers and strategies that navigated the tumult and generated strong returns for investors. These types of managers and strategies that thrived in the 2022 environment may be similarly positioned to capitalize on global uncertainly if such trends continue in 2023: global macro, equity market neutral, multi-strategy on the hedge fund side; and private credit, LBO, and some venture on the private markets side.1, 4, 5
So, as the market outlook looks more uncertain from a political, social, and economic point of view, could this be the start of a golden age for alternative assets?
To understand where markets may go this year, let’s first reflect on what happened last year. On the macroeconomic side, while we saw a lot of volatility with respect to prices, the year started and ended with almost identical rates of inflation (7.04% on Dec 31, 2021; and 7.11% Nov 30, 2022):
U.S. Inflation Rate
Source: Y Charts
If you remember the Fed’s repeated use of the phrase “transitory”, then you may also remember just how quickly that phrase was dropped once the Fed decided to turn off the monetary taps. While the Federal Reserve initially was cautious and measured with its rate hikes, moving 50bps or less for the first couple rounds of hikes, as inflation remained persistent and elevated, they quickly turned more aggressive, raising the Federal Funds rate 75 bps at its July meeting, and still continued its large hikes throughout the year.
U.S. Fed Funds Rate
Source: Trading Economics
And as monetary policy tightened, we saw a commensurate and immediate drop in growth, with two quarters of contraction in the middle of the year, and a significant slowdown in employment.
United States GDP Growth Rate
Source: Trading Economics
United States Non Farm Payrolls
Source: Trading Economics
Paradoxically, consumer confidence and spending, as well as the housing market, remain strong, while at the same time the ISM Purchasing Managers Index, a measure of business confidence, stayed positive for most of the year, only recently turning negative in Nov of 2022. As a recent article in Vox puts it: “the economy just doesn’t make sense anymore.”2
In public asset markets though, data shows that the relevant benchmarks were less equivocal, with nearly all USD-denominated risk assets experiencing a year-over-year selloff. The S&P 500, Dow Jones Industrial Average, U.S. Treasuries, Barclays AGG, and cryptocurrencies all saw double digit drops, with even some energy, agricultural, and industrial commodities prices, after so much turmoil in many of the world’s largest producers of oil, gas, and minerals, experiencing a sell-off in 2022.
Source: Trading Economics
However, some alternative assets saw strong performance throughout 2022. On the Hedge Fund side, nearly every HFRI index outperformed the S&P and AGG in 2022. In particular, we saw strong returns in strategies that traditionally capitalize on high volatility and market uncertainty: Global Macro, with the HFRI Total Macro Index returning +9% over the last year, and the HFRI Equity Market Neutral Index seeing returns of nearly 2%.3
On the private market side, while overall performance with private equity has remained muted, private credit has seen enormous growth, driven by a handful of factors. First, as rates have risen and risk appetite dropped, the primary market for syndicated and leveraged loans has nearly evaporated, with a transition from banks being the primary source of funding to the direct lender ecosystem within private credit. At the same time, a great share of investors’ allocations to private credit have gone to a smaller pool of funds, as, much like many other strategies within the alternative asset space, the private credit markets have started to mature, with investors finding themselves more selective when choosing a manager as the importance of diversification, track record, experience, and independent service providers rises to the forefront of investors’ minds as recession fears loom.4, 5
While it is impossible to accurately predict a market outlook for 2023, many of the overall factors that affect markets in 2022 are becoming more apparent. On the geopolitical front, the war in Ukraine, continued tensions in the Taiwan Strait and the South China Sea, and even potentially a further escalation of the sociopolitical tumult Iran has experienced for the last several months, may continue to play a prominent role in the public’s mind as we enter 2023.
In addition, COVID is likely to still play a factor in overall markets. As China shifts from its zero-COVID approach to a more open economy, much like with the initial lockdowns and reopenings in America, we can likely expect some degree of social strife as society readjusts. Moreover, as China, a huge source of global aggregate demand in addition to being a key element of the global supply chain, is likely to see the same resurgence in purchasing power experienced after the initial lull from Covid in late 2020. As a result, it is possible that as regional demand in China recovers, we could see additional supply chain bottlenecks that spill over across the world. At the same time, it is possible that the recent rise in cases and deaths could also lead to a reactionary shutdown across the nation, with over 9,000 deaths per day in the country, China’s highest daily death rate ever, which we can reasonably expect will have some knock-on effects to its economy and industrial capacity.8
Finally, on the macroeconomic front, while it is extremely difficult to forecast how inflation and GDP perform, many investors and analysts are perhaps unsurprisingly anticipating a slowdown and possibly even a mild recession in the US as the Fed reserve continues to restrict monetary policy. However, were inflation to plummet more quickly than expected, rate hikes might decelerate, if not pause or even reverse in 2023, as the effects of 2022’s rate hikes permeate throughout the economy.
Slow Growth in 2023, But Above-Consensus on the US
Note: All forecasts calculated on calendar year basis. 2022-2024 are GS forecasts. Potential growth is the median of GS estimates for 2023-25 for the US, Japan and Canada, our long-run estimate for the European economies and 2023 for EM economies. IMF forecasts used for India 2023 and 2024 consensus when quarters not available in Bloomberg. The global growth aggregates use market FX country weights
Source: Bloomberg. Goldman Sachs Global Investment Research.
Source: Goldman Sachs
With so much uncertainty in our society, economy, and the political sphere, 2023 may end up with just as many surprises for the world as the last few years have. While it is impossible to predict which asset classes will definitively outperform, those expecting a continuation of the same volatility we saw in 2022 into this year may be well placed to take a deeper look into alternative investments. As noted above, global macro, a strategy in which hedge fund managers nimbly play across marketplaces, countries, and asset classes, to capitalize on dislocations in the market. Moreover, in a slow growth environment, equity market neutral may be effective at avoiding overall equity market beta. As credit spreads and rates remain high though, with the Fed indicating it is likely to continue raising rates, we would expect to see outperformance in Private Credit, owing to continued issues with regulatory treatment of private debt for banks removing available supply of credit, credit spreads remaining elevated, and rates continuing to rise, as most private debt are floating rate assets. Finally, while it is hard to predict where venture and private equity will go this year, we continue to see substantially lower valuations for both private and public equities, as well as significant amounts of dry powder, which should lend itself to more transaction volume, lower leverage multiples, and more discounted buying opportunities. In particular, LBO / take-private strategies may benefit from the weakness in public equity markets, while weaker overall economic growth can present opportunities for successful managers to turn underperforming public companies around and effectively identify synergies and rectify inefficiencies within target companies. As many analysts have predicted and alluded to, rather than increased price to earnings multiples driving growth, transaction entry levels may be far more important in determining the success of private market deals and managers, at least in a low growth / high inflation market.
As investors look back to 2022 to help decide where to allocate in 2023, we recognize that 2022 was visited by global events that had not been experienced in over a generation: hyperinflation; widespread protests in Iran, China, and more; War in Europe, and more. While many of these issues are likely to persist and continue to affect the economy and markets in 2023, this year may also bring a host of new concerns, issues, and conflicts. Rather than worry about the dynamics of individual assets and markets, it may be most effective for advisors to guide investors towards alternative assets that can capitalize on global uncertainty. Many of the same strategies that performed well in 2022 may be likely to continue outperforming the public markets, which may lead markets into a golden age of alternatives as the 60/40 portfolio remains weak and investors continue to look high and low for alpha. Now more than ever though, it is critical that that any investor in alternatives identify managers with a long track record through multiple market cycles, diversified portfolios, skin in the game, and independent service providers. While many managers will reap great gains in 2023, those with interests aligned with their investors and proper risk mitigation approaches are more likely to weather drawdowns, and capitalize on market dislocations.
- Reuters. Jan, 2023. “Hedge funds in 2022 post worst performance since 2018, dragged down by equities -HFR data.”
- Vox. Dec, 2022. “The economy just doesn’t make sense anymore.”
- HFRI | HFR®
- Bloomberg. Dec, 2022. “Blackstone, Goldman Among Top Funds Dominating Private Credit.”
- Yahoo Finance. Jan, 2023. “2023 European Private Credit Outlook: Direct lenders retain optimism.”
- Morgan Stanley Investment Management. Dec, 2022. “2023 Investment Outlook.”
- JP Morgan. Nov, 2022. “Investment Outlook 2023.”
- The Economist. Jan, 2023. “How China’s reopening will disrupt the world economy.”