FTSE 100 & DAX 40 2023 Outlook: Central Bank Policy Presents the Largest Risk
11:12, 23 December 2022
FTSE 100 2023 Outlook
In a year that has seen the majority of markets fall into bear market territory in the wake of global central banks raising interest rates at the fastest pace in decades. The FTSE 100 has stood out to be the outperformer across major markets and in fact, at the time of writing has eked out marginal gains for the year. A large factor behind this really comes down to the composition of the index, where the largest weighted stocks are made up of energy names, consumer staples and healthcare stocks (shown in the table below). This is important to note given that during risk-off periods, consumer staples and healthcare stocks are more defensive sectors and therefore perform comparatively better than their counterparts. Meanwhile, energy stocks have of course benefitted from the energy price shock, which in turn has seen oil majors report near-record profits. Another point to make is that while sentiment regarding the UK has been crisis after crisis, UK-specific uncertainty is not usually reflected clearly within the FTSE 100 given that two-thirds of the revenue generated among FTSE 100 companies are from overseas. As such, the FTSE 250 and the Pound are better expressions of UK sentiment.
FTSE 100 YTD Performance vs S&P 500, Dow Jones, Nasdaq 100 and DAX 40
Top 10 Largest Weighted Stocks in the FTSE 100
That being said, the FTSE 100 has largely been a range trade where the index struggles to break through to fresh highs above 7700 and finds support around 6800-7000. As we look ahead to 2023, I am of the view that this will likely continue and the rare outperformance relative to its counterparts that we have seen in 2022 is likely to diminish.
What is your sentiment on UK100?
FTSE 100 May Struggle with the Oil Disconnect
A worrying chart for energy names and by extension those with exposure to the FTSE 100 is the disconnect between oil stocks and the price of oil. Despite all the good news for the oil sector throughout 2022 with China reopening, OPEC cuts and a war between Russia and Ukraine, Brent and WTI crude futures are relatively flat for the year. As such, if oil is struggling to rally on good news, that likely presents a red flag for bulls, even more so for energy stocks in the FTSE 100 such as Shell and BP which have yet to reflect the moves in oil and thus offering a potential headwind for the FTSE 100 in the new year.
Royal Dutch Shell vs Brent Crude Oil
How Will Markets React to a Fed Pivot?
Among the key narratives for the beginning of 2023 will be at what point the Federal Reserve officially pivots. While some would argue they have pivoted following the slowdown in the pace of rate hikes, I would disagree as they are still raising interest rates. In the December dot plot projection, the median view among the Fed is that rates will be 5.1% by the end of 2023. This is in contrast to money market pricing where the peak rate is seen being reached in Q1 2023 at 4.75-5%, before falling back down to 4.25-4.5% by the end of the year. The issue here for markets is if the Fed follows the path of its dot plots equity markets are at risk of a hawkish repricing, keep in mind inflation is still elevated and the Fed are unlikely to back down until they are convinced inflation will come close to its target.
Federal Reserve Money Market Pricing in 2023
Elsewhere, looking at prior pauses from the Federal Reserve, the general reaction for equities, including the FTSE 100 is to find a bid when a pause has been confirmed. However, this may well be an H2 2023 narrative, unless inflation prints at the beginning of 2023 post a sizeable drop.
FTSE 100 vs Fed Funds Rate (Vertical line = Fed Pause)
FTSE 100 Technical Analysis
From a technical point of view, as I have mentioned, the FTSE 100 has largely been in a range trade with overhead resistance from 7600-7700 remaining while key support at 7000 and 6800 has rarely seen a significant break below, My bias in the new year remains for this range to persist throughout the first quarter. A change in tactic that could suggest a breakout would be if we see a closing break above 7700, which in turn would open up 7800. On the flip side, what would encourage bears would be a swing high failure above 7700, where you see a break above, but a close back below 7700, which in turn could provide a reversal signal.
FTSE 100 chart: daily time frame
DAX 40 2023 Outlook
The DAX 40 fell in line with the majority of its counterparts, having fallen as much as 25% year to date by the time October hit. However, following a 17% rally in the index throughout the final quarter of the year, the index looks set to show a yearly loss of around 16-18%. As has been highlighted previously, the factors that had weighed on the market had been the Russia/Ukraine war and the subsequent fallout, the stop-and-start Chinese economy amid seemingly neverending covid restrictions for the most part of 2022, as well as the ECB embarking on aggressive rate hikes. As we come out of 2022, the Chinese zero-covid headwind is unwinding as the country opens up its economy and deviates away from its strict covid policy. In turn, this provides an undercurrent of support for the DAX given its elevated exposure to China. But as is the case with most equity benchmarks, risks are aplenty in 2023, most notably central bank policy.
In its final meeting of 2022, the ECB reduced the pace of rate hikes to 50bps (vs 75bps prior). However, while most central banks are heading towards the exit of their tightening cycles, the ECB has suggested that they are not even thinking about exiting having stated that “interest rates still have to rise significantly at a steady pace”. At the same time, President Lagarde offered her most hawkish press conference in recent times, having noted that 50bps rate hikes were appropriate for a period of time, adding that they were in it for the long run. Elsewhere, the ECB also outlined its plan to shrink the balance sheet (quantitative tightening) from March. As such, this hawkish pivot from the ECB does add headwinds to the DAX 40.
DAX 40 Technical Analysis
On the technical front, the outlook is somewhat more encouraging. Moving averages on the shorter time scale (55DMA) are above the longer-term moving averages (200DMA). While holding above the latter moving average offers a more optimistic technical outlook in the short run. However, bulls have thus far failed to eclipse 14700, which coincides with the June highs. On the downside, support sits at 13800, which marks the pre-Covid high, although, it would be a break below the 200DMA that would raise the bearish risks for the index.
DAX 40 chart: daily time frame