The Path Towards Stability
Submitted by ClearBridge Wealth Management on July 14th, 2023July 13, 2023
Our 2023 investing outlook started with a theme of returning to normalcy. Considering 2022’s market volatility and the aftereffects of the pandemic, the idea of finding balance was certainly a welcomed change. It’s a theme we could all embrace six months ago and what we will continue to rally around through year-end.
That’s not to say that 2023 hasn’t come with its own set of challenges. We saw two regional banks fail in rapid-fire succession in March—and another closed its doors in May. Collectively representing over $530 billion in assets, the trio ranks as the second, third, and fourth largest bank failures to date.
We also held our breath as a last-minute deal to raise the debt limit came together as the clock ticked closer to default. Despite the market gyrations these events caused and a banking sector still on tenterhooks, the overall financial system seems stable. Counterbalancing the challenges, some bright spots include:
- Inflation is under 5% at home, significantly lower than its 8.3% level this time last year
- The fed funds rate is approaching its apex as the Federal Reserve grapples with the unknown impacts yet to emerge from its aggressive tightening cycle
- Global inflation has ticked down from its 8.7% high in 2022, and is following a slow descent to a projected 6.5% for 2023
By and large, these are things we know, definitively or directionally, a guiding force that shapes our perspective on the next six months or so. Like anything, they come with some potential opportunities for investors—opportunities that may present themselves in international equities, core bonds (particularly if the Fed is indeed done raising rates), and industrials to name a few.
On the flip side, there are uncertainties out there. Recession is probably the biggest unknown, with some of the biggest questions around when it might hit, how long it might last, and how significant it could it be. That said, any recession that occurs would appear to be more in the mild range at this point. Perhaps recession is the largest unknown, but we should also factor in the possibility for interest-rate volatility. For example, rates could move higher if inflation remains stubbornly high. Or, they could see a fairly sizable move lower in the event of recession.
The Path Forward:
Economy Overview
The baseline forecast is the domestic economy may slide into narrow recession in the late half of 2023 as consumer demand cools, especially for services. If job growth cools and the unemployment rate rises, consumers will likely experience declining disposable income, which could be the impetus for a short recession as consumers pull back on spending. But in the near term, consumers are still unleashing pent-up demand for services. We expect the Fed to end its rate hiking campaign in the latter half of this year and introduce the possibility of a cut in rates as economic conditions weaken. But as inflation convincingly cools, markets will likely respond favorably to the slight pivot in Fed policy. So far, an improving Chinese economy has not had a material impact on global inflation.
Stocks Overview
In the first half of 2023, progress was made toward better balance as inflation fell and interest rates stabilized. However, macroeconomic risks remain top of mind as a potential recession looms. Earnings are likely to decline this year, but solid revenue growth and stable profit margins may help limit the magnitude of any decline. An improved inflation outlook by year-end may enable market participants to see through the economic malaise and toward recovery in 2024. Against this backdrop, we sees modest second-half gains for stocks, though with the potential for elevated volatility, until investors get more clarity on the likely depth and duration of a potential recession.
Bonds Overview
After the most aggressive rate-hiking campaign in decades from the Fed, short-term interest rates are at levels last seen in the early 2000s. At the currently elevated levels, the risk is that these rates won’t last, and upon maturity, investors will have to reinvest proceeds at lower rates. So, unless investors have short-term income needs, they may be better served by reducing some of their excess cash holdings and extending the maturity profile of their fixed income portfolio to lock in these higher yields for longer. If the Fed is finished raising interest rates, we could start to see lower yields on intermediate-term securities before the Fed actually cuts rates. Historically, core bonds, as proxied by the Bloomberg Aggregate Bond Index, have performed well during Fed rate hike pauses.
Geopolitics Overview
The global dynamic has shifted as 2023 has progressed. An attempt to forge a negotiated settlement to end the Russia-Ukraine conflict was thwarted by an unflinching determination by both sides to win at all costs. Chinese President Xi Jinping is the latest world leader to offer a framework for ending the fighting. This framework also helps underpin China’s unrelenting determination to establish a global leadership position, as it seeks to broaden its trade and political relationships and undermine the economic power that the U.S. commands. Regarding U.S. and China bilateral relations, the backdrop has become increasingly fraught with concerns that China has intensified its efforts to secure technology that enhances its military buildup.
Alternative Investments Overview
Given the economic backdrop of the last six months, globally and at home, we’re constructive on alternative investments, which can offer portfolio diversification and performance that exceeds traditional benchmarks. It’s important to note that against our economic backdrop, we may see a wider range of performance among fund managers—depending on things like their trading style or geographic focus. This means that it will be more important than ever to understand the opportunities, risks, and overall strategy of any given alternative investment.
As always, please do not hesitate to contact me if you have any questions or concerns.