2022 Review & 2023 Market Outlook
A lot can happen in one year! The Federal Reserve was forecasting that real GDP would grow a strong 4.0% in 2022, that PCE prices would be up a relatively moderate 2.6%, and we should expect a grand total of three 0.25% Fed rate hikes by the end of the year. Instead, it looks like real GDP will be up around 0.5%, while PCE prices will be up 5.6%. What’s even more shocking that we had the equivalent of seventeen 0.25% Fed rate hikes, finishing the year between 4.25% - 4.50%. Even the Fed has a difficult time predicting the future! Aside from the Fed curveball, the global economy has been plagued with persistently high inflation and geopolitical issues. All these factors contributed to a perfect storm of asset repricing in both the Stock and Bond Market. Unless you are a highly concentrated investor that picked the correct parts of the market, there have been very few places to hide. Year-to-Date, many of the major market indices have struggled. As of December 22, 2022:
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S&P 500 TR Index = -18.50%*
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Nasdaq 100 TR Index = -32.29%*
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Bloomberg US Aggregate Bond TR Index = -12.13%*
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Bloomberg US Treasury 7-10 Yr TR Index = -13.97%*
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Bloomberg US Treasury 10-20 Yr TR Index = -23.47%*
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DJ Moderate TR Index = -14.79%*
If this wasn’t harsh enough on investors, we currently have a Macro setup that is forecasting a recession in the next 6-12 months. The Treasury Yield curve is deeply inverted, Leading Economic Indicators are declining, personal savings rates have plummeted, and credit card debt is on the rise. In addition, investors have not seen revisions lower in corporate profit forecasts, something that is likely to take place in 2023. So, what does this mean for 2023?
Equities
We generally prefer to invest in the high-quality parts of the Equity Markets, with a persistent overweight to Domestic Large Cap Stocks. We maintain this preference going into 2023 balanced between Growth and Value, with one small caveat. Domestic Mid & Small Cap stocks look attractive on a relative basis compared to their Large Cap counterparts. If we do happen to fall into a recession in 2023, there could be a buying opportunity for us to strategically overweight the Mid & Small cap space, as those parts of the market have historically outperformed coming out of a recession.
Fixed Income
Coming into 2022, the majority of our fixed income allocations focused on two themes, limiting interest rate sensitivity and increasing credit quality. This served our investors well, but since then we have made changes to our fixed income allocations. We still maintain our bias for high quality investment grade fixed income but have become more comfortable taking on a bit more interest rate risk. Historically, when the Fed is coming close to the end of a rate hike cycle, it has been logical to have a neutral or slight overweight to interest rate sensitive fixed income. We are finding good opportunities in tax-free and taxable municipal bonds, US treasury bonds, and to a lesser extent, corporate bonds. We have very little exposure to any below investment grade credit at this juncture, but that could change if an opportunity presents itself in 2023.
While we believe that there are opportunities good enough to act on, this does not change the fact that we may see more turbulent times ahead, which brings us to our last comment on asset allocation: 2022 has taught us that sometimes investors need diversification beyond Stocks and Bonds. At Main Street, we manage a suite of portfolios that include Alternative investments. The investments that we use are daily liquid and come in the form of a mutual fund or exchange traded fund. A diversified basket of Alternative investments can reduce volatility and correlation risk from traditional asset classes such as Stocks or Bonds. It is our preference going forward that investors consider adopting Alternative investments as part of their overall asset allocation to diversify away some of the risk from traditional parts of the financial markets.
As always, sound financial advice can be as important as ever to help steer you through the environment and bring you closer to meeting your short, intermediate, and long-term financial goals. If you have any questions or comments, never hesitate to reach out to your financial professional at Main Street.
