Monthly Market Update- January 2023January 04, 2023
2022 was a wild ride for the markets, with interest hikes, supply chain movement, inflation, volatility and geopolitical risk. Will this impact momentum in 2023? Should investors maintain a defensive posture? We explore here.
New year, new asset allocations? It was a year to forget for the markets, but there were many lessons learned and healthy developments created along the way. We remain cautiously optimistic in a normalizing, yet sometimes confusing investment environment.
What a wild 2022 it was for the global markets, economy, and the world in general, topping even the craziness of the prior two years. The incredible amount of interest rate hikes, supply chain movement, inflation, volatility, and geopolitical risk in such a short period of time was exhausting. We all need a vacation - maybe a week or two, or even the whole year after enduring that. Of course, if we all did the latter, it would cause its own issues. Let’s just wish for a very boring new year.
Despite all of the ups and downs, it may actually turn out to be more of a “normal” year – at least in reference to the broad economy and the markets. Why so? There is quite a bit to unpack here, but much of the foundation for normalcy was built in ’22, even with all of the theatrics.
After the decade-plus bull market and incredible performance over the pandemic shutdown, the equity markets around the world buckled under the pressure of persistent headwinds. The era of ultra-easy money finally concluded, and fundamentals mattered again. This meant the collapse of much of the crypto world, meme stocks, negative interest rates, debt riddled zombie companies, and other corners of the investment universe we have not been particularly fond of.
The S&P 500 index of the top US Large Cap companies finished the year down over 19% despite repeated bear market rallies including a positive 7.1% performance in the 4th quarter. It was the 4th worst yearly decline since its inception. The DJIA fared better down close to 9%, while the tech laden NASDAQ index was crushed, losing 33% on the year.* Value-leaning stalwart companies that make tangible goods or deliver essential services, particularly energy and industrial products, significantly outperformed growth, communication services, technology, and Covid era firms.
Overall, it was the worst year for stocks since 2008 – a reset of sorts. Yet, US stocks are still trading above the long run average relative to earnings and significantly higher than pre-pandemic levels. It will pay to stay defensive as wage and cost inflation – albeit at a slower pace – continues to eat away at margins.
There was no doubt that some air needed to be sucked out of the balloon of risky US based assets and we did get that. The issue is stock analysts and investors alike are not pricing in even a mild recession, which would prove to be problematic, even if a so called “soft landing” is accomplished. It all adds up to a very interesting situation for the equities market outlook in 2023. This may be a time where active portfolio management can thrive and add diversification, with opportunities in more esoteric asset classes such as alternatives, private markets, and stocks overseas.
Weaker US dollar ahead?
The US dollar rose by the largest amount against global currencies in 7 years, despite a weak December. This of course did not help the cause for international markets dealing in dollar denominated debt, with a war-torn Europe and China’s Covid shutdowns fanning the flames of inflation. With a Fed that eventually slows down hawkish monetary policy and foreign countries beginning to do business in non-US dollar denominated goods, it could provide some reprieve to foreign currencies.
If demand for US dollars continues to wane, it would be a boon for certain emerging markets in 2023. Commodity prices, overall, should stay level or may even increase as inflationary pressures persist boosting bottom lines for EM firms.
Stability and income for less risk
What about getting back to some resemblance of normalcy? Where do we go for that? As almost every bond sector was trounced in 2022 via rising interest rates, the future looks much brighter as the Fed moves closer to a 5% base policy rate. The “income” gods are providing opportunities aplenty after the decades long bond bull market was crushed. Even the most credit worthy issuers were not spared.
The clear downside last year was that bonds did a terrible job of cushioning the loss for stocks in your portfolio. The upside now is that higher interest rates should not only provide a key component of total bond return, but with attractive yields for much less risk than the stock market.
This is an opportunity for price appreciation.
For example, in the municipal bond space, over the last three decades, each of the other four times the Bloomberg 10-year Muni Index posted a negative calendar-year return, the following year was meaningfully positive. In other words, we may get the cushion that we wanted last year at a time we need it most – given ongoing stock market volatility from earnings compression and tighter monetary/fiscal policy.
Time to overweight bonds
One need not search very far to find yield. In fact, investors can expect to receive 3% to 5% (5%-8% for tax-equivalent) yields on municipal bonds, 5% to 7% on investment grade corporate debt, 8% to 9% yields on high yield debt, 6% to 7.5% on preferred stock, and over 4% on short-term US Treasuries. Risk free three-month T-bills were yielding over 4.4% as of late December, and the 2-year note was around the same.* Locking in the higher yields at lengthier maturities is becoming an important theme in case of any change in central bank policy.
Stay the course in stocks? Should we favor domestic or international?
Dividend income and low volatility will be key for stock investors domestically and abroad. The quality theme will continue to permeate our investment thesis and portfolio exposure in 2023. US stocks are a mixed bag, but internationally stocks are still cheap and for good reason. China’s producer and manufacturing indexes have been falling even after they re-opened from Covid shutdowns.
The main risk now is China's fragile healthcare system. With low medical supplies and vaccination rates, the country is exposed to any large wave of infection. This could trigger more changes in consumer sentiment and trends while exacerbating labor and supply chain shortages. Europe is still reeling from inflation, tighter central bank policy, and the war in Ukraine. There should be opportunities across Asia for countries with a better outlook for labor demographics.
No love for labor
Back home, the labor market here is tight enough to keep the economy from collapsing. Yet, without enough workers or quick enough increases in productivity from say, robots or automatic processes, there will be a tight lid on how much the economy can grow in the short term.
Comments made by Home Depot Inc. co-founder Bernie Marcus quickly circulated in the media, highlighting the issue stating that “nobody works, nobody gives a damn,” implying a troublesome trend in demographics and capitalism. Automation will be a key input to watch in the economic growth formula going forward.
Income and caution will be key in 2023
As we move through the first stanza of the new year’s storyline, we maintain our defensive posture and look to enjoy yield in safety. On a macro level, the money supply is shrinking but still higher than pre-pandemic levels. This means credit conditions are tightening, but still very large relative to historical norms.
The same logic applies for the equity markets as discussed. On a positive note, equity in property values and consumer net worth are still healthy and intact. The jobless rate does not signal an immediate recession and goods inflations is certainly slowing, despite the bond market’s warning signs.
There will be much to follow in the coming year, but we are optimistic regarding our opportunities. Stay warm and know that your questions and concerns are always welcome at KLR Wealth! Contact us.
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Generally, among asset classes, stocks are more volatile than bonds or short-term instruments. Government bonds and corporate bonds have more moderate short-term price fluctuations than stocks, but provide lower potential long-term returns. U.S. Treasury Bills maintain a stable value if held to maturity, but returns are generally only slightly above the inflation rate.
Diversification does not ensure a profit or guarantee against loss.
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