A Long-Range Economic Look at the Year 2023
The U.S. economy is currently in a late-cycle environment. The odds of a recession are elevated and rising as we enter the New Year. Consumer spending remains resilient, boosted by a tight labor market. The consumers’ balance sheet is strong as they have built up a cash reserve over the past couple of years. Inflation is still a concern, but the excess cash should provide a buffer to rising costs.
However, leading economic indicators are pointing to a downturn in 2023. These include a struggling housing market due to the Fed’s rapid monetary tightening and rising mortgage rates which negatively impact housing affordability. Additionally, the manufacturing sector is showing signs of contraction while consumer sentiment levels are near historic lows.
The Chinese restrictive COVID policies and the RussiaUkraine war continue to be a headwind for global economic growth.
In our view, the market may face major headwinds in early 2023 as earnings get downgraded, and economic deterioration shows up in the hard data, such as the lagging indicators of payroll and inflation.
While the labor market remains strong and cash in household bank accounts is high, most of the evidence supports a slowing economy.
We believe there is an opportunity for long-term investors to pick great buying opportunities as the market starts to price in an economic recovery. The timing of this inflection point will depend on the incoming data from the leading economic indicators mentioned above. So, staying nimble, open-minded, and most of all humble is paramount as the uncertainty is unprecedented.
The year 2022 was a very challenging year for fixed-income investments. In fact, it may go down as the worst year for bonds since 1931, and the first-time bonds were down by double-digits in a year. These higher yields and lower prices were due to higher inflation rates and the subsequent reaction by the U.S. Federal Reserve (Fed).
The silver lining is the higher yield investors can get now from fixed-income securities. For the first time in many years, investors can now purchase a one-year T-Bill and earn more than 4.5% at the end of November 2022. This is a much better return than 0.25% last seen at the end of 2021. After a long wait, bonds may be an attractive alternative when compared to the dividend yield on the S&P 500 Index.
Considering the deteriorating economic conditions that we are likely to see in 2023, it is advisable to have a defensive posture in fixed income, favoring Treasury securities with moderate duration and highly rated Municipal bonds. Historically, Treasury instruments do well in challenging economic environments. Municipal bonds have benefited from a sizable cash buffer accumulated from Covid stimulus plans.
― Increased Volatility
― Below Average Earnings Growth
― Continue To Favor Defensive Sectors: Healthcare, Consumer Staples, Utilities
― Begin To Add Selective Small Cap And Cyclical Stocks When Fed Policy Shifts
― Look For Companies with Pricing Power
― Favor High Quality Stocks
― Bonds May Provide Diversification
― Inflation May Have Peaked But May Persist
― Bond Income Now An Alternative To Stocks
― Favor High Quality Treasury & Municipal Bonds
WHAT COULD GO WRONG
― Fed Pivoting In A Major Way
― U.S. Consumer And Corporations More Resilient Than Expected
― China Fully Reopening And Boosting Global Growth
― Europe’s Recession Not As Severe As Forecasted
― Positive Development In The Russia-Ukraine Conflict
― Overall U.S. Economic Growth Holding Up Better Than Leading Indicators Suggest