Outlook 2023

See the potential

Weaker growth, stronger markets

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introduction

Most things that could have gone wrong for investors did in 2022. Markets that entered the year with extended valuations buckled under high inflation, an aggressive global rate hiking cycle, and the war in Ukraine.

Unusually, both stocks and bonds suffered big losses in 2022 — one of the worst years ever for a balanced portfolio.

But here’s the good news. Precisely because markets are so battered, lower equity valuations and higher bond yields, in our view, offer investors the most attractive entry point for a traditional portfolio in over a decade.

In this year’s outlook, we consider key economic and market forces — the consequences of monetary policy tightening, weakness across the global economy, market pricing and valuation resets — and discuss what they might mean for your portfolio.

Policy backdrop

The consequences of
global policy tightening

stock

26

out of the 31 central banks that we track are raising rates

Global wave of
higher rates

Almost in unison, central banks around the world raised rates in 2022 to combat inflation. Of the 31 central banks that we track, 26 raised rates, up from just two at the start of 2021.

Countries raising rates

Start 2021
Map2021

Countries raising rates

End 2022
Map2022

Forceful Fed

The U.S. Federal Reserve launched its most aggressive round of interest rate hikes in 40 years, disrupting global markets. By the end of 2022, U.S. policy rates will likely move above 4% for the first time since 2006. The European Central Bank (ECB) has followed suit, recently raising its policy rate by 0.75%, its biggest hike since 1999.

For the first time since 2006, U.S. policy rates will likely move above

4%

home2
house

30-year U.S. mortgage rates breached 7% for the first time since 2001.

More expensive to borrow

Especially after many years of low rates and loose policy, higher rates and tighter policy make it tougher for consumers and companies to borrow. 30-year U.S. mortgage rates breached 7%, up from ~3.5% at the start of 2022.

The end of global tightening

We think the global tightening cycle will likely come to an end in 2023. Among the signs pointing in that direction: Growth is likely to slow, labor markets will likely soften, and inflation seems set to fall.

Historical evidence suggests that the real economy suffers the greatest damage after interest rates have already risen, but markets may have already reacted to higher rates and their consequences.

Economic Backdrop

Weakness across
the global economy

Growing friction

We expect friction in the global economy to continue to build. A recession in the United States and Europe is more likely than not in 2023.

United States

In the United States, activity in rate-sensitive sectors such as real estate and capital markets has collapsed. Economic weakness will likely broaden. However, restrained consumer and corporate debt and the lack of imbalances in the economy could act as buffers against a severe downturn.

For the first time since 2008, home sales fell by

~20%

Global value of initial public offerings fell by more than

$600b

The percentage of CEOs surveyed who are preparing for a recession is

98%

Europe

In Europe, contraction seems imminent. Reliance on Russian energy poses a risk even though natural gas storage levels seem full. Further ECB rate hikes to battle inflation will inevitably depress growth.

China

In China, the continued fallout from overinvestment in the property sector and strict COVID containment policy will likely continue to restrict economic activity.

The global growth outlook seems bleak. Higher interest rates and geopolitical risks will continue to dampen activity.

As investors, we are most positive on two types of assets—those that can help protect portfolios from a material economic downturn and those whose prices are already close to reflecting that outcome.

Investment implications

Valuation resets

Pessimism priced in

It’s quite an array of challenges for the global economy.

For investors, one question is key: Where are you getting compensated for the risk you are taking? With global equities down 16% and the Global Aggregate Bond Index down 10% year-to-date, market prices have absorbed a good deal of risk already.

Lower valuations, higher yields

Along the way, valuations have declined dramatically. The forward price-to-earnings multiple of large-cap stocks has retreated to long-term averages, while bond yields are at their highest levels in over a decade.

Equity valuations are lower

Bond yields are higher

From a valuation standpoint, we believe there has not been a more attractive entry point for a traditional portfolio of stocks and bonds in over a decade.

Here’s how we assess risks and opportunities across asset classes:

Bonds

Treasury, corporate and municipal bond yields are at their highest levels in a decade, suggesting investors could potentially reach their goals by taking less risk. That’s a notable change.

Stocks

We think equity markets will find some stability in 2023 as higher valuations offset lower earnings growth.

We prefer the U.S. stock market and quality companies. Over the medium term, we see potential opportunity in U.S. small- and mid-cap stocks, where valuations have largely reflected potential damage to earnings.

Alternatives

Anemic public market activity means private market investors can earn a premium for providing both debt and equity financing.

We also see potential investment opportunity in areas critical to stability and security: infrastructure, transportation, natural resources and real estate.

Conclusion

Putting capital to work

2022 tested the resolve of many investors.

But better days are likely ahead. We believe markets could stabilize even as the economy worsens in 2023. The global reset in valuations is presenting investors with a broader range of viable options to help achieve their goals.

Most importantly, we encourage you to focus on your process: Define and revisit financial goals; then design investment portfolios that may provide the highest probabilities of reaching them.

2022 tested the resolve of many investors.

But better days are likely ahead. We believe markets could stabilize even as the economy worsens in 2023. The global reset in valuations is presenting investors with a broader range of viable options to help achieve their goals.

Most importantly, we encourage you to focus on your process: Define and revisit financial goals; then design investment portfolios that provide the highest probabilities of reaching them.

With your financial goals as our guide, we’re here to help you navigate both the uncertainties and the opportunities.

Contact us to discuss how we can help you experience the full possibility of your wealth.

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Past performance is no guarantee of future results. Indices are not investment products and may not be considered for investment.

The Bloomberg Global Aggregate Index provides a broad-based measure of the global investment grade fixed-rate debt markets. The Global Aggregate Index contains three major components: the U.S. Aggregate (USD 300mn), the Pan-European Aggregate (EUR 300mn), and the Asian-Pacific Aggregate Index (JPY 35bn). In addition to securities from these three benchmarks (94.1% of the overall Global Aggregate market value as of December 31, 2009), the Global Aggregate Index includes Global Treasury, Eurodollar (USD 300mn), Euro-Yen (JPY 25bn), Canadian (USD 300mn equivalent), and Investment Grade 144A (USD 300mn) index-eligible securities not already in the three regional aggregate indices. The Global Aggregate Index family includes a wide range of standard and customized subindices by liquidity constraint, sector, quality, and maturity. A component of the Multiverse Index, the Global Aggregate Index was created in 1999, with index history backfilled to January 1, 1990. All indices are denominated in U.S. dollars.

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