Happy New Year 2023!
Coming off a tough investing environment in 2022, it is safe to say the investment world is ready to move on to a new year. Very few areas held up last year with both stocks and bonds generally putting up negative returns for the year, although value stocks did much better than growth stocks. The Fed played a large role in the adjustments that happened in the markets with the most aggressive interest rate hike cycle in over 40 years. Here is a quick snapshot of the major index performances:
US Core Bond Index
*Morningstar, as of 01/03/2023
As we look ahead, we are still going to have to keep focus on Federal Reserve interest rate and monetary policy. While it appears they may be heading towards a pause on interest rate hikes by the end of Q1 or potentially Q2 when rates get above the PCE measure, Fed policy will remain a headwind at least until they hit the pause button.
Additionally, we are keeping an eye on signs of a slowdown across the economy. Many are predicting a recession on the horizon, and the key to navigating this from an investment standpoint is understanding what areas will be hit hardest if a recession does come to pass. Currently, the main areas experiencing pain are those that are heavily reliant on debt and interest rates. Keep in mind that Fed monetary and interest rate policy has long and variable lags, meaning it takes time for the changes to ripple through the entire economy. Take housing as an example. According to First Trust Advisors, assuming a 20% down payment, the change in mortgage rates and home prices since December 2021 amount to a 52% increase in monthly payments on a new 30-year mortgage for the median new home! That is just one example of how the increase in interest rates (correspondingly borrowing costs) are having an effect on the overall market.
Within our own portfolios, we are maintaining a defensive posture given the uncertainties and headwinds we believe are present in the markets. We have a focus on value equities that have strong cash positions and pay good dividends, as well as recession-resistant areas of the economy such as utilities and consumer staples. On the fixed income side of the equation, we’re finally experiencing some decent yield. While we are still short term weighted on the fixed income side, we are carefully evaluating how and when to move out on the yield curve as the Fed nears a possible end point in this interest hike cycle.
On top of the usual market particulars, Congress used the time in the hours before Christmas when most people were not paying attention to pass another large spending and policy bill. This was passed in a hurry, so we are still deciphering the resulting implications and changes in law. However, they did not include changes to certain scheduled business tax increases which will take effect in 2023, thus presenting another headwind to the economy. A big area of change relates to the investment world and we’ve summarized some of the updates that were passed below.
All in all, prepare for more volatility going forward as the economy continues to adjust to the Fed’s change in interest rates and monetary policy, and we are keeping a focus on generating yield in the meantime!