- 2022 was the biggest outlier year in market history as stocks and bonds both registered double-digit declines simultaneously.
- Inflation and monetary policy will moderate in 2023, however, it is likely rates remain higher than we’ve experienced within the last few years for a longer period than expected.
- U.S. equities indices are vulnerable to revisiting the 2022 lows as 2023 forward earnings are revised downward in response to an increasingly challenged macroeconomic environment.
- Our Pacific Wealth Management portfolios remain very defensively positioned with underweight allocations to stocks and bonds and overweight allocations to cash/money market funds, which we will reduce as we identify opportunities through the course of the upcoming cyclical reset.
- The combination of ongoing low unemployment, normalization of the supply shortages, and corporate America’s strong balance sheets should moderate the severity of the upcoming recession.
We hope your holidays were relaxing and festive.
2022 was a challenging year for diversified investors. Stocks and bonds declined in tandem as our U.S. Federal Reserve Bank began to unwind its COVID pandemic monetary stimulus and aggressively increase interest rates. With the sharp rise in yields, the bond market experienced its worst year since 1975 and the worst combined total return for both stocks and bonds dating back to 1872. The financial markets have been almost singularly focused on the highest inflation we have seen in 40 years and the world’s central banks concerted effort to slow down their economies and tamp down persistent inflation.
We expect more interest rate hikes in the first half of 2023, but the end of this pattern may now be in sight. Inflation is decreasing and likely to moderate further this year. It takes time for the higher cost of borrowing (i.e. higher interest rates) to percolate through the economy. In our view, Wall Street analysts have yet to reduce their future earnings estimates sufficiently. As corporate profit expectations are lowered, more stock market volatility is expected in the first half of the new year while the economy slows toward a recession of unknown duration and magnitude. We anticipate stocks to revisit the lower valuations the markets experienced last October.
Our Pacific Wealth Management portfolios remain very defensively positioned with underweight allocations to stocks and bonds and overweight allocations to cash/money market funds. We believe our central bank will be reluctant to cut interest rates as quickly as they have in prior recessions. If the Federal Reserve cuts too early, they run the risk of reinvigorating the inflation they are working so hard to reduce. Our expectation is we will reinvest most of our client’s cash holdings back into the financial markets this year. Initially we plan to increase bond allocations to take advantage of the more competitive yields now available in the fixed income markets. We will follow this bond reinvestment with additions to stocks once the financial markets fully embrace the upcoming economic slowdown.
Fortunately, the recent supply chain disruptions are largely behind us. This should enhance the pace of how quickly inflation eases in 2023. One of the byproducts of the pandemic is low unemployment as many individuals completely left the workforce. We believe the combination of ongoing low unemployment, normalization of the supply shortages, and corporate America’s strong balance sheets should moderate the severity of the upcoming recession.
Please let us know if you have questions or concerns regarding your investments, the economy, or the news of the day. We look forward to speaking with you again soon.