Through every high and low, all the challenges and newfound opportunities we have experienced during the last couple of years, it’s no surprise why we might be striving for more balance. In 2022, both stock and bond markets were down around the world. The worldwide challenges included pandemic shutdowns in China, the Ukraine war, and inflation hitting a 40-year high. Still, the U.S. and global economies showed impressive resilience despite multiple disruptions.
So, what lies ahead?
First, we’ll see the same disruptors as we did in 2022. While supply chains have primarily recovered from the pandemic shutdowns, manufacturing remains hostage as China struggles to stay open despite medical and geopolitical complications. The war in Ukraine will continue to disrupt global food and energy markets, and the divided nature of the U.S. government following the midterm elections is likely to amplify the political conflict. The Federal Reserve (Fed) will likely keep tightening monetary policy until inflation drops significantly, and depending on how high rates hike, we could see a recession in 2023. But if we do, we anticipate it to be shallow, much like the one we saw in the first and second quarters of 2022 - limiting the damage in severity and duration.
But there’s good news, too. Just as 2022 had a surprisingly positive economic outcome, 2023 is likely to fare better than the headlines say. Job growth should continue to show strength. Healthy levels of employment and wage growth will support consumer confidence and spending. The labor shortage will keep businesses investing, paid for by consumer spending. For the private economy, the signs suggest healthy growth.
Breaking it down further.
Markets - we expect continued volatility in the short term, but our outlook for the coming year is cautiously optimistic. Economic growth is likely to resume, and interest rates should stabilize. With market valuations at the lower end of the recent range, these factors should provide a substantial cushion to limit further short-term declines and support gains by year-end. We continue to believe the best way to navigate a market with this much uncertainty is to cultivate a mix of styles, market caps, and geographies within a portfolio. Owning a little of this and a little of that will help provide balance as we wait for clarity from the economy, inflation, and the Fed.
Bonds - the last year was one of the most volatile periods for fixed income in four decades. Bond prices (which move inversely to yield) collapsed across the board as investors reacted to inflationary pressures and an uncertain economic outlook. As a result of the 2022 sell-off, fixed-income asset classes may offer some of the most attractive valuations we’ve seen in decades.
- U.S. Treasuries - While the consensus favors short-term Treasuries, there may be opportunities further out on the Treasury curve for longer-term investors.
- High-Yield Bonds - Effectively, investors are being paid to wait for bonds to reach their maturity value. This area deserves some attention as investors consider their fixed-income outlook and allocations.
- Municipal Bonds - The lower-credit-quality, high-yield municipal space yields look attractive.
- Corporate Bonds - Another investment-grade sector presenting alluring value as of late is the corporate space, specifically A-rated securities. In tax-free and tax-deferred accounts, we believe the current yield can be attractive for investors willing to accept some level of volatility.
- Emerging Markets - For investors with a high-risk tolerance, emerging market debt offers some of the most attractive yields in the fixed-income space; however, we caution investors to allocate prudently.
Global equities - the greatest headwind for investors with allocations to foreign stocks has been the unrelenting strength of the U.S. dollar. The Fed's aggressive campaign against inflation via an unprecedented series of interest rate hikes over the past 12 months has caused a spike in the real effective exchange rate for the U.S. dollar. And when the dollar is strong, returns on foreign assets translate into less money when exchanged back into U.S. currency. It's reasonable to believe the U.S. dollar will remain strong. Still, our current expectation is that the greenback will not cause as many headwinds for international equity allocations as it did in 2022.
We must also acknowledge the bearish case for foreign equities as we head into 2023. The geopolitical landscape is always a risk factor that investors must consider, especially during the current period of elevated global tensions. Our outlook for international developed and emerging markets remains cautious. Foreign equities will eventually have their moment in the limelight, but our near-term outlook is weighted toward the ongoing risks and relatively underwhelming fundamentals.
Please do not hesitate to contact our office if you want to check-in. We are happy to walk you through our approach and explain what we are doing to keep you on track to meet your financial goals and needs.
During this season, we are reflecting upon the good things we have, like our partnership with you! THANK YOU for your continued support, trust, and collaboration. We appreciate working with you and hope the coming year brings you and everyone you love good health, happiness, and success.
Charles D. Dodds, Jr., CFP®, CLU®, ChFC®, CIMA®
President, Sr. Portfolio Manager
Adrian F. Dodds, CFP®
Managing Partner, Sr. Financial Advisor