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There are still challenges facing the economy and earnings despite the recent optimistic move in asset prices. Regardless of direction, we expect bouts of volatility to resurface as new headlines work their way through markets, including the ongoing negotiations on the US debt ceiling. Consensus continues to expect a recession in the US during 2023. However, the gloom is partially offset by optimism that those conditions could bring us closer to brighter days when the Federal Reserve might halt or even reverse its interest rate hikes. Economic statistics are holding up reasonably well so far which allows some hope that any recession might be shallow and tolerable overall. Consumers are vulnerable though and are not out of the woods yet from threats like layoffs, higher energy costs, higher utility bills and higher credit card bills.

Fourth quarter earnings season is underway with forward guidance for 2023 under intense scrutiny. As shown below, the consensus forecast for 2023 S&P 500 earnings has been coming down steadily (red dotted line), and now only expects 3.5% growth next year (gray shaded area). Even under these reduced expectations, there is a material possibility that earnings could go through a period of further contraction commensurate with recession conditions.

 source: Strategas, 1/23/2023

Market Outlook and Q4 Summary

Overall Asset Allocation

Our asset allocation stance remains the same in the major categories. We are maintaining a cautious stance and are underweight in equities, neutral (market weight) in fixed income and slightly overweight to cash as dry powder for new opportunities while earning relatively attractive short-term yields in the interim.  Some clients also have a small “alternatives” position via a call writing fund in US equities that helps generate additional income to offset downside market exposure.

Our baseline view is for a recession to play out this year. We hesitate to use the phrase “soft landing” since that implies a gentleness or dismissiveness that is not our approach. If pressed on what type of landing we will face, based on current data, we would expect something in the middle range between “soft” and “hard”—some bumps and reshuffling of labor markets and profit margins but without a prolonged and massive recession. A recession is a challenging and volatile situation regardless of ultimate size or duration and needs to be treated with respect from a portfolio risk-management perspective. With that baseline, the good news is that there do not appear to be as many excesses left to work out, at least financially, and therefore, the unfolding situation should be manageable and provide opportunities.

We are cautious and patient while remaining on course according to long-term expectations and client goals. Portfolios have moderate cash buffers in place which creates room to dial up exposures as opportunity arise. We have already added to international equities to catch that upswing, and the analyst team continues to evaluate individual stock swaps and better entry points for their favorite US ideas. Similarly, the bond team has a playbook ready to go if we get material widening in credit spreads.

Global Equities

In equities, the S&P 500 was up +7.6% for the quarter with individual sectors performing in a range of -10.2% (consumer discretionary) to +22.7% (energy).  Despite the Q4 rally, the S&P 500 finished at -18.1% for the full year.  The Nasdaq was down -32.5% for the year.  International markets rallied in Q4 with the MSCI All Country World Index (ACWI) ex-US up +14.3% yet finishing the full year at -16.0%.  After being underweight international versus the US for multiple years, we are moving client portfolios back to neutral to our global benchmarks.  We are evaluating if an overweight to international equities might be on the horizon as well.

Fixed Income

In Q4, the major segments of fixed income were up 1-4% depending on the type of bond.  After a difficult year and reset in valuations, the key aspect of bond allocations from here forward is the attractive starting yields (4+% in Treasuries and 6-11% in corporate bonds) that create a great “head start” on total return for these assets.  These yields are markedly improved versus prior years and create a new, more attractive hurdle rate to consider versus other asset classes.

The Epicenter of Markets in 2022 - The US Yield Curve

(solid green line = current yeilds as of 1/17/23. dotted yellow = approximately one year ago)
source: Bloomberg, 1/17/2023
In addition to core holdings in high-quality municipals, Treasuries, agencies or corporate bonds (depending on tax status of each portfolio), we continue to recommend satellite positions in specialty areas like bank loans, high yield or emerging markets via active managers where appropriate. We value the diversification and unique opportunity set that these positions offer portfolios, but we are keeping position sizes moderate considering credit spreads could also face disruption in the coming months.

Alternative Asset Classes 

We are monitoring commodities for a re-entry point but are not yet making that recommendation. Research continues on liquid alternative strategies to further enhance the risk-adjusted characteristics of portfolios. Currently, our only widely held alternative investment is in a US equity fund that generates additional income via call writing. Though we have no plans to directly invest in foreign currencies, we are also monitoring the US dollar and its recent weakness for what that might signal in terms of headwinds or tailwinds for multinational companies and other global relative value opportunities such as commodities and gold.


2022 was a challenging year with stocks and bonds down at the same time.  The traditional offset and counterbalance between the two asset classes were not there to protect portfolios. As challenging as that environment was for risk-management and portfolio construction, the good news is that the revaluation has set up portfolios with better forward-looking prospects, especially on the bond side where yields now offer better value. 2022 can be summarized as stocks going down in large part because of rising bond yields in the face of spiking inflation.  In other words, stocks were in trouble because bonds were in trouble. 
For 2023, if stocks get in trouble (from earnings declines, for example), there should be a degree of the traditional counterbalance from high grade bonds as safety and ballast for portfolios. After short-term pain, a worsening earnings outlook could allow the Federal Reserve to consider lower interest rates (or at least stop hiking them).  Even if interest rate relief might not actually come into play until later 2023 or 2024, the market will begin to price in that outlook sooner. The issue that could undermine an easing of financial conditions would be if inflation proves sticky and persistent such that the Federal Reserve is forced to keep rates high or even move higher as a recession sets in.


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