The new year can’t get here soon enough. Twenty twenty-two will go down in history as one of the toughest markets ever. The famed 60/40 portfolio consisting of 60 percent stocks and 40 percent bonds had its worst year on record giving up around 19%, which is not far off from the 20% drawdown of the S&P 500. Usually, bonds offer a hedge against falling stock markets as interest rates are cut to spur demand. There were simply very few places to hide as interest rates suddenly shot up in efforts to tame soaring inflation causing both stocks and bonds to fall simultaneously.
Rising interest rates can be a powerful tool to reduce high prices by making money more expensive, jobs more scarce, and hampering demand for goods and services. The problem is that it can take months to work, so it’s difficult for the Fed to know when to stop hiking rates and how much the economy will suffer. In 2023 we believe the Fed will push rates up several more times before topping out around 6% mid-year. Hopefully, this will be just enough to slow inflation but not enough to severely damage the economy. There is a chance the Fed can pull a rabbit out of the hat and do just that, something that has not been easily accomplished during previous rate hiking cycles. The job market might be strong enough to allow this to happen. Deep recessions coincide with massive job losses, yet it’s unlikely we’ll see mass unemployment this time around as most businesses’ main complaint is the struggle to find and keep quality workers. The tight labor market is one of the reasons we are seeing such strong and persistent inflation. It’s still better than the alternative. No jobs and lower prices. Related to this is another reason to be hopeful we won’t see a bad recession in 2023. Namely, business and household balance sheets are surprisingly healthy. The US is a consumer driven economy and so far the consumers have remained resilient, continuing to buy goods and services at a brisk pace, propping up the economy. Rising wages from the tight labor market and the $2 trillion savings built up during the pandemic have greatly bolstered balance sheets and allowed for continued and increased spending.
Driven by the strong consumer and the dollar’s status as the global reserve currency, we remain optimistic for the US relative to the global markets. It is likely that Europe will fall into recession, if not already in one, and the rest of the world will see only modest GDP growth of roughly 2.5%. Tailwinds from Federal, state, and local fiscal stimulus enacted in the past two years should support US GDP growth. However, we don’t expect to see quite the same returns this coming decade as we saw during the last decade. Now that 4% can be made on cash, stocks suddenly have some competition. Interest rates will likely remain elevated for some time due to the inflationary pressures of an aging workforce and increased protectionism around the globe. As countries close borders it makes it more difficult for businesses to find cheaper labor elsewhere. Additionally, the movement and availability of goods is hindered adding to business overhead and putting upward pressure on prices. In this economic environment, businesses with established supply chains, robust market share, and reliable cash flows will likely be more desired by the investment community than their fast-growing, capital-intensive peers.
Some predictions for 2023. It is likely to be volatile (although much less so than 2022), with dividend paying stocks outperforming non-dividend payers, and domestic stocks outperforming international stocks. Corporate earnings will grow 5-10% and instead of retracting, equities will advance by year-end in the high single digits with some areas of the market seeing massive returns as investors realize fears were overblown. Energy companies will underperform relative to other sectors such as healthcare, and housing will continue to drag as mortgage rates climb, destroying purchasing power. Technology companies will remain under pressure, but we will start to see the leaders of the next decade rise from the heap. Bonds will also continue to struggle as longer-dated maturities quickly lose value with each increase in interest rate, but short-term notes and cash will offer attractive alternatives to stocks for risk-averse investors for the first time in two decades.