Turning the page and awaiting the consequences of 2022’s historic tightening cycle
Introduction by Jonathan Dane, CFA
To say markets were challenged in ’22 is an understatement. The combination of inflation, the Fed’s unwavering constitution to keep raising rates, the war in Ukraine, and uncertainty over the trajectory of the global economy all weighed on markets. And unlike during previous market declines, traditional diversification benefits failed investors, leading to a historically bad year for diversified portfolios.
As we enter 2023 the economic foundation investors have been waiting for is within reach – inflation is softening, Fed hawkishness appears to be lessening, COVID restrictions are gone, and robust labor markets support consumer confidence. However, the Fed’s battle to control inflation “at any cost” has consequences, and the magnitude of them is about to be felt.
We expect 2023 may be a year of two halves. In the first half, the focus will likely shift from the number of future interest rate hikes, to how much those interest rate hikes will impact the economy. The second half, and how markets perform, will be determined by the magnitude of slowdown in 1H22. Ultimately we remain optimistic that the US economy can recover from any slowdown and suggest investors maintain a risk-on focus, capitalize on higher rates in fixed income, and be selective in private markets.
Equity Commentary by Stu Strasner, CFA
After thirty-five years of experience as an equity analyst and investment counselor one key lesson I’ve learned is that the fundamentals always matter sooner or later.
There will be significant investment opportunities in commodity-based stocks once the Fed stops raising rates and company earnings estimates approach a trough. This is true across the commodity complex because of significant under investment in production capabilities. This is also true of fossil fuels, metals and agricultural commodities. Industrial firms that make use of technology to lower breakeven points and reduce operating risks will also present opportunities in the late recession stage.
Headed into 2023, as the global economy normalizes this advantage will persist and provide investment opportunities in cyclical stocks.
Five investment themes for 2023
Inflation and central bank policy were the primary drivers of markets in 2022, however in ‘23 we expect economic data and corporate fundamentals to play a larger role in determining the market’s direction. Higher rates will create opportunities in traditional fixed income, while stabilizing inflation should alleviate valuation concerns within equities. Overall we see opportunities in risk assets for investors, but expect to see greater dispersion in returns. The market environment and associated returns are likely to be increasingly selective near-term compared to recent history.
These topics are encapsulated in our five investments themes for 2023 discussed below:
THEME 1: Inflation should finally decline
Headline and core inflation appear to be trending lower after peaking, but remain elevated
THEME 2: Fixed income (finally) offers attractive yield
Traditional fixed income once again provides yield opportunities
THEME 3: Reset in equity valuations creates (selective) opportunity
Equity multiples contracted in ’22, driving equity markets lower
THEME 4: Economic growth likely to slow, but overcome recession headwinds
Economic growth is likely to weaken in ‘23, but overcome recession headwinds and stay positive
THEME 5: Even after the Fed stop hiking, rates remain elevated
After the fastest Fed rate hikes since the ’80s, the yield curve is much higher today
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This commentary reflects the personal opinions, viewpoints and analyses of the author providing such comments, and should not be regarded as a description of advisory services provided by Defiant Capital Group or performance returns of any Defiant Capital Group client. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Defiant Capital Group manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary.
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A word on risk
All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-U.S. investments involve risks such as currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. This report should not be regarded by the recipients as a substitute for the exercise of their own judgment. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.