As we enter a new year, the entire PMAM team would like to wish you a healthy and prosperous 2023. After enduring a year marked by the highest inflation in four decades, a record-setting selloff in the bond market and equity markets moving in and out of bear market territory, investors are likely to witness more volatility in 2023.
The economic and market outlook for the year ahead will in all likelihood remain challenging as global central bankers try to tighten at a pace that will keep inflation moving lower while avoiding a material contraction in economic growth. Despite the uncertainties, the best news for investors is a materially more attractive starting point for financial asset valuations, particularly high-quality, fixed-income investments.
Even though economic growth rebounded during the second half of 2022, a consensus has been building among economists that the U.S. economy is on the brink of another recession. Research from the Philadelphia Federal Reserve confirms that more economic forecasters expect a recession than at any other point in the last half-century.
While joining the consensus view has never been comfortable for us, we do believe an economic downturn is likely this year as both consumers and corporations pull back on spending. The pandemic-induced fiscal and monetary supports that helped fuel unprecedented private-sector wealth creation and spending are gradually unwinding. Global economic growth is already beginning to feel the strain from the rapid Federal Reserve (Fed) tightening to date, with a growing list of central banks now trying to catch up with the Fed.1
The flipside of slower economic growth will likely mean better news for the biggest drag to financial market performance during 2022 — persistently high inflation. Even though tight labor markets have yet to show signs of easing, recent disinflationary trends in energy, food and manufacturing are likely to keep inflation and inflation expectations in check, helping to prevent a self-reinforcing inflation dynamic from taking hold. The bond market’s inflation outlook as measured through breakeven inflation — nominal Treasury yields relative to real yields for Treasury Inflation-Protected Securities — is pricing in a rapid and sustainable decline back toward the Fed’s 2% target.2
Equity market valuations will likely face headwinds again this year in the face of under-pressure corporate earnings and real competition from the bond market. Last year’s market-leading energy sector will face more difficult earnings comparisons ahead, leaving the earnings picture without an obvious growth leader. Eventually, more sustainable growth drivers will need to emerge from somewhere else — such as a de-escalation of the war in Ukraine or the Fed taking a more tempered approach to monetary policy — in order for equity performance to turn the corner.
Corporate credit fundamentals are expected to soften this year in the face of slowing economic growth and tightening liquidity. Fortunately, U.S. companies have been able to take advantage of ultra-low borrowing costs in previous years to push out maturity walls. In contrast to this point last year, credit risk — not duration risk — is likely to be the biggest driver of performance for fixed income assets this year. Our overall outlook for high-quality, fixed-income asset performance this year is favorable, benefiting from the historic and long-anticipated repricing of the bond market during the past 12 months. We expect that fixed-income assets are again well positioned to offer diversification benefits to risk assets, as inflation concerns shift toward fears of an economic downturn.
Exhibit 1. 2021 and 2022 Actual; 2023 and 2024 Forecasts
1Source: Federal Reserve Bank Philadelphia- Data Files - Survey of Professional Forecasters; as of 1/9/23
2Source: CNBC- U.S. Treasurys; as of 1/9/23
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S&P 500 Index — An index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe.
Russell 2000 Index — An index measuring the performance of approximately 2,000 small-cap companies in the Russell 3000 Index, which is comprised of 3,000 of the largest U.S. stocks.
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The views expressed in this material are the views of PMAM through the year ending December 31, 2022, and are subject to change based on market and other conditions. This material contains certain views that may be deemed forward-looking statements. The inclusion of projections or forecasts should not be regarded as an indication that PMAM considers the forecasts to be reliable predictors of future events. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate. Actual results may differ significantly.
Past performance is not indicative of future results. The views expressed do not constitute investment advice and should not be construed as a recommendation to purchase or sell securities. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed. There is no representation or warranty as to the accuracy of the information and PMAM shall have no liability for decisions based upon such information.