Topics they explore include:
Please read important information at the end of this program.
Recorded on 12/06/2022.
Outlook 2023: Back to the (new) future
Hosted by:
Chris Hyzy
Chief Investment Officer
Merrill and Bank of America Private Bank
Featuring:
Michael Hartnett
Chief Investment Strategist
BofA Global Research
Savita Subramanian
Head of U.S. Equity & Quantitative Strategy
And Head of ESG Research
BofA Global Research
Ethan Harris
Head of Global Economics Research
BofA Global Research
Matthew Diczok
Head of Fixed Income Strategy, Chief Investment Office
Merrill and Bank of America Private Bank
Marci McGregor
Senior Investment Strategist, Chief Investment Office
Merrill and Bank of America Private Bank
CHRIS HYZY: Hello. I’m Chris Hyzy, and welcome to this conversation we’re calling Outlook 2023: Back to the (New) Future.
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Chris Hyzy
Chief Investment Officer
Merrill and Bank of America Private Bank
I think we’d all agree, 2022 was a challenging year for investors. We saw inflation reach a 40-year high, along with a sharp hike in interest rates. There was the outbreak of war in Ukraine and other geopolitical tensions. And both stocks and bonds had one of their most volatile and worse performing years on record. During times like these, it could be hard to look beyond the present and plan for the future, but it’s at these moments when it’s perhaps more important than ever.
On this program, I’ll be joined by several experts from Bank of America for their insights on what 2023 might look like for the economy, the markets and your financial life, and we’ll offer ideas you could consider now as we move into a new year.
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Michael Hartnett
Chief Investment Strategist
BofA Global Research
Now, first up, I’m joined by Michael Hartnett, Chief Investment Strategist for BofA Global Research. We’ll survey the forces reshaping the global investing landscape and look at some of the trends, challenges and opportunities he’s watching for in 2023.
CHRIS HYZY: Michael, thanks for joining me today.
MICHAEL HARTNETT: Pleasure, great to be here.
CHRIS HYZY: So, the markets, the economy, geopolitically, the world, it’s been through a lot in 2022. Taking a look back on the year, what’s surprised you the most and, you know, as we’re transitioning into 2023 for the full year, what do you see happening?
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Michael Hartnett
Chief Investment Strategist
BofA Global Research
MICHAEL HARTNETT: Well, I think the big surprises for the year were what I would describe, one an inflation shock which led to a rate shock, which in turn when you’ve got interest rates going up and inflation going up, it’s not going to be good for the markets. So, you had a doozy of a bear market, both in bonds and in equities.
I think what the surprise was, actually, that those things, the inflation, the rates, and the bear market, you didn’t get a recession shock. You know, you didn’t go into recession.
Resiliency of the consumer and strong labor market
were two big surprises in 2022.
So, I think that the resilience of the consumer, you know, was a big surprise, and of course, the labor market being as strong as it is, is still a big surprise and is, you know, we’ll see what that means for 2023. But certainly, so far as 2022 was concerned was probably the biggest surprise.
CHRIS HYZY: You talked a lot about cyclical bear markets and the cycles that they go through. What are you looking for at the beginning of 2023 to suggest that the bottoming process is either over or getting tired?
MICHAEL HARTNETT: Credit. You know, at the end of the day all great bull markets begin with credit, and I think one of the positive developments at the end of ’22, if you remember the middle of ’22, it was just everything was going down. But toward the end of ’22, you’ve started to see a little bit more confidence that the bond market is a safer place to invest in, the corporate bond market may be one of the winning themes of next year. And I think that gives confidence that the losses that we saw in 2022 are not going to be repeated in ’23.
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Credit markets and the labor market could be key
for Wall Street and Main Street in 2023.
So, I think credit is probably the most important Wall Street thing to get right. For Main Street, it’s the labor market, that’s going to be very key going forward.
CHRIS HYZY: So, from your global perch that you look at the emerging markets, the non-U.S. developed markets, the U.S., you talked a lot about over the years of how bull markets are born. There’s a lot of liquidity. Now in 2023, is there some payback as it relates to the areas that were unloved for quite a long period of time?
MICHAEL HARTNETT: Well, I think you are beginning to see that already. Commodities, you know, for various different reasons have done well in 2022. I think small cap, industrials, banks, these all have decent long-term stories, but partly they have decent longer-term stories because for the past 10 years they’ve been completely shunned and ignored because everyone’s been in tech.
So, I think that the rest of the world’s story, I think is good. It’s not to say the U.S. will be bad, but I just think the starting point in terms of valuation, in terms of price, and the potential catalysts that you have, the China reopening story, potentially a dialing down of the war with Russia/Ukraine, improving geopolitics, could be something that actually leads people out of the U.S. for probably the first time in 10 years, into the rest of the world.
CHRIS HYZY: That’s one of the reasons why the outlook for ’23, we call it “Back to the new future.” Can you take us through the immediate new future as it relates to a step-by-step process through the year? You talked about bonds outperforming in the first half, potentially stocks in the second half, take us through the year if you will.
MICHAEL HARTNETT: Well, I wish it was going to be as easy as that.
CHRIS HYZY: That’s right.
MICHAEL HARTNETT: It won’t be, but I think broadly I think the, you know, the transition that you should go through is bonds, credit, stocks. I think you’re beginning to see, as I said, the interest in bonds reemerge. Once that mutates into corporate bonds, which I think will be a sort of spring story, once we’re past the greatest of the recession fears, I think people will feel a lot more confident about going into corporate bonds. And thereafter, I think once people see a turn in earnings, then equities will do well. As I said, it’s not going to be as neat and tidy as that, but that’s basically the timeline we’re looking for.
CHRIS HYZY: And speaking not neat and tidy as it relates to outside the United States geopolitically, any big thoughts there for ’23?
MICHAEL HARTNETT: Well, I think the China reopening story is a genuine story and as we saw in 2020 and 2021, you get a pandemic, you get a lot of stimulus; you get a lot of stimulus, you get a bull market. But if you’re just concentrating on the two things that drive markets, rates, earnings. In China the rates are going to come down, the earnings are going to go up, and as a consequence I think that is a story that will work and there’ll be less fear, I think, of what China can – havoc it can wreak for the rest of the world.
War is not an easy thing. No one predicted it would happen, but certainly there seems to be a ratcheting down, you know, in terms of the Russia/Ukraine situation. Certainly, that’s what the oil price is telling you. So, both of those, for Europe and Asia, and together with the fall in oil price that we’re seeing towards the end of 2022, they all go well so far as ’23 is concerned.
CHRIS HYZY: As it relates to just overall positioning, from a diversification standpoint, asset allocation for 2023, are we back to the way markets should work, as we have seen over the time of history when there wasn’t excessive liquidity or massive tightening to remove what the liquidity created?
MICHAEL HARTNETT: You’re getting there, you’re getting there. I mean certainly one of the best things about 2023 is that it’s not 2022, and in 2022, you just came into the year with zero rates and quantitative easing, and all of these, you know, bull markets, and these were the expectations. It’s why people didn’t want to sell, you know, they wanted to stay. And those expectations obviously have flipped, you know, this year.
I don’t think you can immediately say we’re going back to QE or zero rates, I mean that era’s not coming back, but what you can say is a lot of the assets that were penalized greatly in 2022, there’s been a lot of, if you like, creative destruction, more destruction than creation. But hopefully the valuations now a little bit more settled and these growth themes over the medium term can actually start to -- you can start to sort of action on them.
CHRIS HYZY: So, if you take that and you segue to a new statement that some are using out there as, you know, 2023 being a foundational year again. What does that mean from your perspective about the next few years, as if 2023 is indeed a foundational year for investors again?
MICHAEL HARTNETT: Well, like any year, you start off with a blank sheet of paper and you know, what does the world need, what are the big themes?
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Big investment themes
· Climate change
· Deglobalization
· Inequality to inclusion
Well, the big themes are climate change, the big themes are deglobalization, inequality to inclusion. You know, these are all big themes and if it’s a foundational year, that’s a year where you use the dips, or you use the weakness to build those foundations, because in ’24 or ’25, ’26, those are the themes that are going to work.
CHRIS HYZY: So, as it relates to planning now, thinking about that in both bond and stock markets and then rebalancing at the beginning of the year as you look back and you see what the world needs?
MICHAEL HARTNETT: You always want to have a playbook that you execute on, but I think as an investor, or a good investor, the playbook is not about the first three months of 2023, it’s about the next three years. And again, I think that there are these major themes, I think there is big change taking place in the world, but that presents a lot of opportunities. 2022 was all about threat. 2023, there are still threats, but there’s going to be a lot more in terms of opportunities because the price of those opportunities is a heck of a lot lower today.
CHRIS HYZY: So, final question. You’ve written a lot about deglobalization or re-globalization. We saw during the pandemic how connected the world’s supply chain is. It doesn’t appear like we’re going to find new labor sources anytime soon at this point to fix some of that. But take us through your thoughts quickly on the next movement in the supply chain and deglobalization overall.
MICHAEL HARTNETT: I think the big buzzword is reshoring.
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Reshoring of supply chains should be a key theme as
Europe and U.S. become less dependent on China.
And I think there’ll be European reshoring because they’ve got to become less dependent on China. There’s going to be U.S. reshoring because, again, they’re going to be less dependent on getting the goods from China. China itself, you know, is an economy in transition from being capital spending led to one of consumption led. So, again, there are these big changes, you know, taking place.
But I think that if you have optimism on the U.S. economy going forward, it’s going to be driven by capital spending. You know, the consumer’s done as much as the consumer can be asked to do. So, it’s really about the corporations deciding that we have to re-shore or adjust those supply chains, make them safer, make them closer, and that’s going to cause capital spending on the industrial sector, I think part of the tech sector, I think the small-cap sector, these are areas that will win out from that.
CHRIS HYZY: I think that’s a great place to end. Michael, always appreciate your insights.
That makes the perfect segue for my next guests.
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Ethan Harris
Head of Global Economics Research
BofA Global Research
Savita Subramanian
Head of U.S. Equity & Quantitative Strategy and Head of ESG Research
BofA Global Research
They are Savita Subramanian, Head of U.S. Equity and Quantitative Strategy and Head of ESG Research, and Ethan Harris, Head of Global Economics Research. We’ll explore what they think the coming year could bring for the US markets and the economy.
CHRIS HYZY: Ethan, Savita, thanks for joining me. Ethan, the surprise of last year, for some, was inflation. The sharpness of it, where it came from, how it developed. What’s your thoughts on that as we sit here today looking back, and then now for 2023, what’s your – what are your thoughts overall on inflation?
ETHAN HARRIS: Well, I think some of this was expected. I mean, we had a very hot economy going into last year.
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Ethan Harris
Head of Global Economics Research
BofA Global Research
You had tight labor markets, you had a very easy monetary and fiscal policy, so some of this wasn’t a total surprise.
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Commodity shocks and supply chain problems
helped create high inflation in 2022.
What was a surprise is we had also big commodity shocks, we had big supply chain problems, and so all of these things kind of combined to create this very high inflation. Now we’re at a new point in time where things are starting to cool a little bit, it’s going to be a long process, but the worst is probably over.
CHRIS HYZY: When you think about the first part of 2023, with inflation coming down, the Federal Reserve remaining tight overall, what’s the outlook in terms of growth on a real basis for the U.S. economy, and with everyone talking about the R word, recession, what type of recession?
ETHAN HARRIS: Well, first of all, I think some of the inflation will come down without the Fed really hitting the brakes here.
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In 2023, inflation should start coming down and
supply chains are already reengaging.
Supply chains are already reengaging, commodity markets are really determined by geopolitics and global growth, so you don’t really need the Fed to solve those problems. The problem is that you have a red-hot labor market and you have rising inflation expectations. People are beginning to expect inflation and imbed it in their decisions, and that’s where the Fed comes in. Unfortunately, I think it’s too late to avoid a recession. There’s too much inflation, it’s become too imbedded, the Fed will keep hitting the brakes until we get a mild recession. So, I hate to say it but, yeah, it’s going to be the R word next year.
CHRIS HYZY: So, let’s tap into the last point of that as it relates to just the labor force. What surprises you about the resiliency of it, or is this a big shift from goods-based labor spending into a pent-up demand situation in the service economy?
ETHAN HARRIS: I mean there’s a lot of things going on here. One of the stories here is a shift over to service demand on air travel and hotel and recreation, all that stuff. Those are labor intensive sectors and that’s where the demand is, and therefore, that’s where the jobs are. But the other thing going on here is the last couple years has left a legacy of massive excess demand for workers.
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U.S. job openings are close to record levels,
preventing a “normal” weakening of the labor market.
The number of job openings across the whole economy is almost record levels. So, as the Fed cools the economy down, while some companies are slowing their job growth and doing layoffs, a lot of others are just still trying to fill all those missing slots. And so, it’s really prevented us from getting a normal weakening of the job market. It doesn’t mean it’s not going to weaken a lot going forward, it just means the whole process is taking much longer than normal.
CHRIS HYZY: And this is – this kind of speaks to the health of the consumer, generally speaking, and you know, the consumer doesn’t get a lot of credit, but their balance sheets are relatively healthy this time around. What about the corporations, Savita, let’s talk about the corporation itself heading into 2023, and corporate earnings in general.
SAVITA SUBRAMANIAN: Yeah, I mean I think corporates are equally healthy. If you look at leverage of the S&P 500 companies, they have basically locked in long-dated fixed rate debt at incredibly low rates.
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Savita Subramanian
Head of U.S. Equity & Quantitative Strategy and Head of ESG Research
BofA Global Research
I think where it becomes interesting is, you know, corporates have inherited a lot of cash from fiscal stimulus, from Fed policy. We’ve been a world awash with capital, and as that starts to be removed from the system, I think that’s where you start to see the wheat separate from the chafe, and I think that’s the type of market we’re in. It’s not going to be easy for everyone to get access to capital like it has been for the last 10-plus years. So, now things get a little bit more complicated.
CHRIS HYZY: And the story of protecting margins is still there. A corporation will always try to protect margins.
SAVITA SUBRAMANIAN: Absolutely.
CHRIS HYZY: But there’s certain environments where you have 40-year high inflation or so, even though it’s coming down, where the pressure is still very large. So, they’re still going to do that, but how far into that do you think we are?
SAVITA SUBRAMANIAN: So, I think we’re a ways into that cycle. I mean, one of the things we’ve seen is that with the labor markets as tight as they are,
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Companies are spending more on automation,
which should lead to increased productivity.
companies are actually spending more on automation, which is a bullish theme for productivity, it’s a bullish theme for efficiency gains. Industrial companies are benefiting from this, semiconductor companies are benefiting, but it takes a while to put that type of tech into place, and along the way, companies are spending rather than making money. And we think that this is going to be another draw on cash in the near term.
CHRIS HYZY: What are some of the big surprises for 2023 as you sit here and you look across all of the equity markets, whether it’s in size and style, in sectors, the market itself. Give us your like outlook right now for some of the bigger surprises you think might unfold in ’23.
SAVITA SUBRAMANIAN: One of the surprises we could see next year is that the wealth effect of financial asset losses has actually been broadened out pretty significantly over the last 12 to 24 months. I mean, if you look at the number of individual investors in the world today, it’s a much higher number than it was a few years ago. And that democratization of the investor base might create an even more amplified impact on consumption as those losses are felt. So, that’s one surprise.
I think the other surprise is the idea that, you know, what we’re seeing right now in the labor market is actually very healthy for the consumer. Consumer confidence is still relatively strong, and if that continues, we could get through this recession with less of an impact on earnings and consumption than we’ve seen in prior cycles.
So, our view is, we’re going to get through this okay. Leverage is a little bit better than it has been in prior cycles, consumers are still healthy, gainfully employed, so there’s a lot of good things happening in the macro backdrop.
CHRIS HYZY: That’s a nice segue back to you, Ethan. You touched on some of the surprises of 2022 and a little bit on ’23. Give us your view as it relates to what is the yield curve telling us right now?
ETHAN HARRIS: Yeah, I mean the yield curve historically has been a great predictor of recessions. The yield curve’s extremely inverted right now. That means short rates are much higher than long rates. That’s consistent with the markets expecting a weak economy in the future.
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Recession in 2023 should be mild, given the healthy
balance sheets of consumers and corporations.
Now our assumption, partly for the reason Savita suggested, is a mild recession. You’ve got good balance sheets for both the consumer and the corporate sector, and really, you’ve got only one problem, and that’s in high inflation. So, the Fed needs to get the inflation genie back in the bottle, hopefully that means a pretty mild recession.
CHRIS HYZY: So, if inflation does come down, what’s the impact overall on the sector part of the overall U.S. equity market in your opinion, Savita?
SAVITA SUBRAMANIAN: Yeah, I mean when I look at sectors, I think we’re still in an environment where investors will pay for quality, they’ll pay for cashflow, they will pay for companies that have visible earning streams and companies where you’re getting your cash quickly rather than, you know, pushing out your growth prospects. Because we’re still in an environment where the cost of capital for equities is likely to increase, and I think that’s one of the most important drivers of stocks over the long term.
So, I think in the coming year, the sectors that are going to do well are kind of a continuation of 2022.
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Favorite sectors for 2023:
· Energy
Source: BofA Global Research
We’ve seen energy companies that are still generating free cashflow, have gotten some capital discipline, I think those companies could continue to outperform, especially given our fairly bullish view on oil prices that our strategists are penciling in for 2023.
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Favored sectors for 2023:
· Energy
· Financials
Source: BofA Global Research
I think that financials could be a sector that surprises. You know, typically you don’t want to own financials in a recession, but this is not the financials of 2007, 2008. It is a well-capitalized, healthy sector with actually fairly stable earnings growth. So, I like financials and energy on the cyclical side.
And then I think it’s also time to get a little more defensive. And if you listen to our global team, and Michael Hartnett, his view is that bonds are going to do well in the first half of the year.
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Favorite sectors for 2023:
· Energy
· Financials
· Utilities
· Consumer staples
Source: BofA Global Research
Well, if bonds are going to do well, so are regulated utilities, the most bond-like equity sector. And consumer staples is another sector that we like because consumer staples is always a good place to be during an economic soft patch.
CHRIS HYZY: Final question. Let’s talk about rays of opportunities for 2023. Savita, let’s talk a little bit about the big surprise potentially, or the big trend for sustainability, ESG, and also just the markets in general. And then Ethan, same question as it relates to the U.S. and global economy, the big potential shifts or surprise that investors will likely see.
SAVITA SUBRAMANIAN: That’s a great question, and I think where we are right now is a really interesting moment in time, because every major economy across the globe has made pretty aggressive pledges about getting to net zero. I mean sure, this is going to take, in some cases, multiple decades, but what we’re hearing is, “This is a real goal, and we are pedal to the metal going to get there by the time we’ve said we’re going to get there.”
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Getting to a net zero world
· More investment in “green” CapEx
· Bullish for renewable energy
· And for traditional sources, including oil
And what that means is we have to spend some money on green CapEx, and that is actually bullish for renewables, but it’s also bullish for traditional sources of energy like oil, because we’re not in a net zero world yet and we need oil to get there. So, I think that’s an area that’s really interesting. It’s the idea that as we move towards net zero, both renewables and traditional fossil fuels can do well along the way.
I think where we’re going is a world where we look at sustainability through less of an exclusionary lens and more of a lens in thinking about who’s improving, who’s getting there. Maybe a company doesn’t look perfect today, but they have a plan in place to get to a better spot. And I think that’s a really a really bullish theme for U.S. stocks.
CHRIS HYZY: That’s great. Now that could possibly be a theme for the entire economy and marketplace next year in terms of improving, off of potentially a difficult first quarter or first half. Ethan, any thoughts, big surprise, big development for ’23?
ETHAN HARRIS: Well, I think – I don’t think it’s so much a surprise as it’s so important that we have to zero in, and that is how quickly do we put inflation behind us? If we can get this genie back in the bottle quickly, then we can get back on track quickly.
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Putting inflation behind us
· Improvement in supply chains
· Cooling job market
· Stable commodity prices
And the way that could happen is perhaps dramatic improvement in supply chains, combined with some cooling down of the job market, combined with stable commodity prices, really does the trick and gets things under control. The Fed then can take its foot off the brake, and we can have a much better growth picture.
I think if you go a little bit further out ahead, then we have these kind of competing structural stories. You’ve got the deglobalization, which is obviously a challenge, but then on the other side of the equation, is there a productivity-enhancing boom? There’s nothing more beneficial to an economy because it creates both low inflation and high growth, than strong productivity growth. So, let’s keep fingers crossed that there really is a technology boom coming here.
CHRIS HYZY: That’s a fantastic discussion. Savita, Ethan, thank you for joining me today.
ETHAN HARRIS: Thank you.
SAVITA SUBRAMANIAN: Thanks.
CHRIS HYZY: We turn now to my conversation on portfolio ideas you could consider now to prepare for the risks and opportunities ahead. For this, I’m joined by Marci McGregor and Matt Diczok, two of our top strategists in the Chief Investment Office.
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Marci McGregor
Senior Investment Strategist
Chief Investment Office
Merrill and Bank of America Private Bank
Matthew Diczok
Head of Fixed Income Strategy
Chief Investment Office
Merrill and Bank of America Private Bank
Marci, Matt, thanks for joining me today. Now, we’ve talked a lot about this really throughout all of 2022, the massive changes that the financial markets and the economy, and portfolios had to deal with. What should clients actually be thinking about right now for the full year of 2023?
So, Matt, let’s start with you first. Yield curve, most of the yield curve is as inverted as we have seen it in many, many decades. Take us through some of the surprises quickly from a 2022 perspective, and then as 2023 develops what you’re seeing.
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Matthew Diczok
Head of Fixed income Strategy, Chief Investment Office
Merrill and Bank of America Private Bank
MATT DICZOK: So, one of the largest surprises, and probably the most positive one from clients was the fact that yields have gone up so much, not just in terms of the regular yields we look at, but what are called real yields. Yields above inflation. So, during the worst of the pandemic, we were at negative 2% real yields, meaning losing 2% to inflation. Now we’re anywhere around one and a half percent. That is a big change.
Savers can now receive a real yield above inflation
on fixed income investments.
That means savers at any point in their life can now achieve a real yield, a yield above inflation on their fixed income instruments, that’s making a very big difference to all financial markets now.
CHRIS HYZY: And in terms of the absolute level of yields, what are the thoughts in terms of generating income at that level?
MATT DICZOK: So, as you mentioned, the yield curve’s inverted.
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An inverted yield curve happens when short-term rates
are slightly higher than longer-term rates.
Meaning that short rates are slightly above longer rates, which is unusual, and usually signals that a recession is coming. But for savers, again, this is good news. Now you don’t have to reach for yield. You don’t have to extend out the curve, even on the short end of the curve, 12 months and in on U.S. Treasury Bills, you can get 4% and above. That is a wonderful change for savers. Again, we haven’t seen that in 10 or 15 years. You can get a lot more income now, without taking a lot of risk.
CHRIS HYZY: And you mentioned the level of yields -- two times or greater than the equity dividend yield, which we also haven’t seen. Take us through that just quickly in terms of what that actually means.
MATT DICZOK: Sure thing. So, right now the S&P dividend yield is under 2% and the 10-year-bond is about 3.5% or so.
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investors can now potentially receive higher income on bonds
than with dividend-yielding stocks.
So you can now get higher income on bonds than you can on stocks, which doesn’t mean that one’s wildly differently valued, but it does mean that you’re finally getting your appropriate level of income on your bonds, such that you can hopefully do better than inflation over a medium to longer term.
CHRIS HYZY: The front end of the curve higher than the long end of the curve, signaling inversion. You talked about that generally signals recession. But let’s talk about the magnitude of the increase at the front end of the curve through the Federal Reserve hiking interest rates, but what the back end of the curve is telling us, at least in our view, for 2023.
MATT DICZOK: So, what we think it’s telling us is that while the Fed has more rate hikes to come, we’re probably going to get to 5% or slightly above in 2023, at some point in the next year or two we’ll probably be in a recession and the Fed will probably be cutting rates at some point. So, even though longer-term rates seem lower than short term rates, you don’t want to be all on the short end of the curve because in a year or two you might be able to reinvest at those lower yields. So, having a broad diversified exposure across the yield curve makes a lot of sense for clients and their balanced portfolios.
CHRIS HYZY: Okay, so let’s hold that thought for portfolio positioning as we get to it in just a moment. Now, Marci, switching to you, Matt talked a little bit about for the first time in a really long period of time, where yields are – the fixed income markets are providing a little competition to the equity markets. But both markets, collectively, globally and in the U.S., had one of the worst years combined in basically either 100 years, or at least in how far back the data goes, overall. Let’s talk about quickly looking back on 2022 before we go forward and give us your thoughts on big developments in the equity markets for 2023.
MARCI MCGREGOR: Yeah, so when I think about 2022, it was, of course, a year where equities went into a bear market.
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Marci McGregor
Senior Investment Strategist, Chief Investment Office
Merrill and Bank of America Private Bank
It was a year of sharp rotations and a year where the Fed was really aggressive. But if I fast forward to 2023, and I think about especially the second half of the year, we’re likely to see that inflation is coming down, by then the Fed will likely be in pause mode. I think the dollar will have peaked, and I think by then we’ll have seen that interest rates have peaked. So, yes, we prefer bonds over stocks in the first half of the year.
But I think the second half of next year is going to be where we see the end to this cyclical bear market. So, then we have to think about what outperforms in recoveries.
In the 2nd half of 2022, value and small-cap stocks
could outperform growth and large-cap stocks
I think when you’re in recovery mode, you see value historically has actually outperformed growth in those recovery stages, and you also see small caps outperform large caps once the Fed pauses, and again, once the Fed cuts. And I would point out that small caps offer valuation-wise, I think, it’ll be a historic opportunity to be investing in small caps.
So, when I think about that dynamic, if we’re in recovery mode, it’s also a time we can take a step back and look at that big picture. So, you know, within value, we still like energy as a sector, but we’re also in a world that’s transitioning to a greener, cleaner world. My answer to “Which do you own” is both. It’s about timeframe. Energy, for example, for the world we live in, where there’s shortages of commodities, but I would own green, clean companies for this transition and this policy tailwind that the whole world is a part of.
CHRIS HYZY: You mentioned bear market, cyclical bear market. Do you want to take us through some of the components that we need to see before we can say that the bottoming process is generally over and then we can start climbing from there?
MARCI MCGREGOR: Yeah, absolutely. On the macro side, I would be looking at a few really important leading economic indicators.
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Economic indicators to watch
· Initial jobless claims
· Credit spreads for investment grade and high yield bonds
· Yield curve
· Corporate earnings expectations
I think about things like initial jobless claims, I think about credit spreads, both on investment grade and high yield. Those are not yet telling us a story where recession is imminent. I think you also want to look at the yield curve. Right now, I think earnings expectations are just too high for 2023. Consensus is still expecting earnings growth. Now, I think that’s going to be reset lower.
So, it’s likely that markets are going to sniff out a Fed pause, they’re going to sniff out a turn in the macro data, all parts of the economy, before we likely see that bottom in earnings. So, I think markets will try to get ahead of it, but it’s so important to look at a bunch of these critical leading indicators.
CHRIS HYZY: So, let’s take that and let’s dive a little bit now into this fact of year-end planning as it relates to any year, and then at the beginning of 2023 and – as we move through ‘23, a lot of people talk about harvesting losses and then rebalancing a portfolio early in the next year. You want to talk to that in terms of just general portfolio allocation perspective?
MARCI MCGREGOR: I do think when we think about tax loss harvesting, it’s something we should think about all year long, not just when we get to the very end of the year. But this is certainly a year where we as investors have seen losses in many parts of our portfolios, so we can think about taking – positioning in a way that takes advantage of that for tax purposes.
[LOWER 3rd]
Market volatility in early 2023 could be an opportunity
for investors to rebalance and reposition for recovery.
But I do think there may be volatility ahead of us in the first quarter. That may be an opportunity for all of us as investors to rebalance. Whether it’s by time frame, or market level, to think about what we’re comfortable with in our portfolios, how to rebalance, and reposition for this recovery. I don’t know that we’re there yet, but I would, frankly, have my shopping list ready in the first half of the year, because I do think we’re going to see some real opportunity, especially in the equity market.
CHRIS HYZY: That’s a very good point. Matt, I’m going to switch to you a little bit now as it relates to portfolio positioning. Take us through right now if you’re coming in and you’re building a portfolio today for full year of 2023, how would we do it?
MATT DICZOK: Well, the good thing right now is things look a lot better across fixed income. End of the day, what you want bonds to do for you is sort of three things:
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3 key benefits of bonds
· Greater price stability than stocks
· Reliable source of income
· Portfolio diversification
You want them to be less volatile in terms of price moves in stocks. You want them to give you reliable income, and hopefully they can move in a different direction than stocks. Stocks go down, bonds can go up and get that diversification. You weren’t getting any of that last year. They were more volatile, they were moving in the same direction, and they weren’t giving you a steady yield.
So, the transition has been definitely challenging, but now we’re in a place where across fixed income markets, you’re getting better valuations, so that reach for yield that people felt really incentivized to do, it’s not necessary now. You can build a diversified, high-quality portfolio across governments, agency-backed mortgages, corporates and get a really good, nice, diversified fixed income portfolio that can really complement your equity portfolio.
CHRIS HYZY: And let’s talk duration. A lot of discussion about certain investment opportunities in extending duration. You want to talk us through that?
MATT DICZOK: Sure. Obviously people are feeling a desire now to invest in cash because you can get, again, Treasury Bills, one year and in at 4% plus, and the longer-term bonds only around 3.5% on 10 years. That doesn’t mean you should put all your money into the short end, because what you’re introducing in your portfolios is what we call “reinvestment risk.” In a year or two, if rates are much lower, you only locked in that short-term for a limited period of time. So, we want to make sure that clients are diversified across their portfolio and move out to a strategic duration target that matches their goals.
If they have a shorter-term goal, like saving for college, shorter makes sense. But for regular investing, long-term planning for retirement, make sure you’ve got a long enough duration or portfolio that could take advantage of higher yields for a longer period of time.
CHRIS HYZY: Right, that’s the most important part, matching the duration and the cashflows you need, to your own personal situation and goals.
CHRIS HYZY: Final question as it relates to the long-term investor. Matt, let's start with you. Over the horizon three, four, five years plus, what gives you promise?
MATT DICZOK: What gives me promise now is that that balanced portfolio, you can do very well without trying to take too much risk right now and that really gives me a lot of promise. You don't have to reach for yield. You have to get too risky on your investments, either equity or fixed income.
[LOWER 3rd]
In 2023, a balanced portfolio should provide opportunities
for investors to build wealth over time.
And a balanced portfolio should do reasonably well, both in nominal terms. meaning just the actual money you're making, and in real terms. Adjusted for inflation, you should be able to build wealth now over whatever time period you're looking at. That's a very big change. It's a very positive development. That's got me excited.
CHRIS HYZY: That's fantastic. Marci, how about the same question for you? What gives you promise three, four, five plus years out from now?
MARCI MCGREGOR: First I’m going to stick a little closer to home. A well-diversified portfolio, I think, is teed up in ’23 to perform better than we’ve seen in recent history for a lot of the reasons we discussed today.
But the thing that’s got me excited is actually all the ways the world has been changing over the last few years, that leads us to longer-term investing.
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5 themes for the future
· Automation
· Digitization
· Healthcare infrastructure
· Reshoring of supply chains
· Climate change
If I think about themes like the automation of the economy, the digitization of our economy, investment in global healthcare infrastructure, a world where supply chains are moving closer to home. And then, finally, I think the investment around climate change. I think there’s a lot of policy money supporting this, this is where it turns into capitalism.
I do think that when we get to the end of this decade, many of these themes, they may feel glacial right now, but we’ll see all of the things we’ve been through in the last three years, like the pandemic, like the supply chain crisis, inflation, are really all accelerating all of these themes in front of us.
CHRIS HYZY: So, as we talked about, a lot of opportunities in fixed income. The ability to generate income at these levels, like we haven’t seen in many, many years, coming off a big reset in 2022. Same thing in the equity markets, we’re getting closer to the end of the bottoming process, in our view. And Marci, as you talked about, a lot of promise as it relates to big themes and the ability to build a diversified portfolio for the first time in many years, that helps us get through the end of this reset onto a new, renewed, bull market cycle. Marci, Matt, thank you very much for joining me today. Thanks.
CHRIS HYZY: And thanks to all of you for joining me. I hope you’ve come away with at least a few useful insights and ideas that you can put to work in your portfolio.
Here are a few final thoughts to keep in mind as you plan for the year ahead.
First, we see a number of bright spots amid today’s challenges.
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Likely bright spots amid the challenges
· Equity valuations are more attractive
· Rising rates could provide greater income for bond investors
· Volatility is creating long-term investment opportunities
For example, equity valuations have become more attractive. Rising rates could provide greater income for bond investors, just to name two. And as we’ve been discussing, the sharp volatility of 2022 is creating potential new opportunities for long-term investors.
Also, as you think about positioning your portfolio for the year ahead, be sure to consider your personal investment style, including your risk tolerance and liquidity needs, along with your overall financial goals.
Finally, keep in mind that everyone’s situation is unique. An advisor is a great resource for helping you understand how the ideas discussed in this program fit into your overall financial picture. If you’re currently working with an advisor, we hope you’ll continue the conversation with them.
Thanks again for watching.
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Head of Fixed Income Strategy, Chief Investment Office, Merrill and Bank of America Private Bank
Senior Investment Strategist, Chief Investment Office, Merrill and Bank of America Private Bank
Head of U.S. Equity & Quantitative Strategy and Head of ESG Research, BofA Global Research
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