In this month’s market update host and Heritage Financial CEO, Sammy Azzouz, and CIO, Bob Weisse, provide a quick recap of the record-breaking challenging year investors experienced in 2022 and discuss our market expectations for 2023.
We believe the drivers of markets in 2023 will be inflation, fed policy, and earnings. While the beginning of the year may be choppy with continued volatility and the potential for weakness, we expect that as these themes work themselves out throughout the year balance will come to light. In fact, today we are finding more attractive opportunities than we could a year ago. Until that time comes, listen in as Bob discusses how to get defensive without moving to cash, what factors he sees already priced into markets, and the bright spots on the horizon.
We’d love to hear from you! Email us questions, ideas, or feedback at firstname.lastname@example.org.
January Market Update: Finding Balance in 2023
This automated transcript may contain grammatical errors.
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Welcome to Wealthy Behavior, talking money and wealth with Heritage Financial. The podcast that digs into topics strategies and behaviors that help busy successful people build and protect their personal wealth. I’m your host, Sammy Azzouz president of Heritage Financial, a Boston based wealth management firm working with business owners, executives, and retirees for longer than 25 years. Now, let’s talk about the wealthy behaviors that are key to a rich life.
Welcome to the January investment edition of the wealthy behavior podcast where I talk to heritage financials, chief investment officer Bob Weiss about what’s going on in the markets and the investment universe right now. And with us closing the books on a somewhat forgettable 2022 for investors, Bob and I thought a good way to kick it off is recapping what happened last year, what it means this year for investors and what investors may be on the lookout for in 2023. So, Bob, welcome to another edition of Wealthy Behavior. Thank you, Sammy. Happy new year. Happy new year. I feel like I haven’t talked to you since last year. That joke never gets old. That’s a great dad, joke. Anyway, I’ve got a full list of them. Don’t get me started. Bob, what happened last year in the market, so as you look at it, how are you thinking of it? What are you explaining to people? Yeah, so last year, the story was inflation. We started the year and inflation wasn’t really on people’s radars as a top concern. It was transitory according to the fed and then early in the year we had some high prints and then we were kind of, off to the races as far as inflation is the number one issue. The fed was aggressive raised rates for a bunch of times taking the fed funds right up to four and a half percent from zero. And as a result, the bond market sold off bonds were down about 12% for the year and stocks were down about 20%. So very tough year for investors with both stocks and bonds. Decline in double digits. So that’s the quick recap of 2022. So, then what’s happening in 2023? And I think a theme that we’re seeing now is the fewest changing from the inflation watch to the recession watch. So, the fed got aggressive for race rates to combat inflation. We think they’re going to win that battle. And the question is, will they send the economy into recession in 2023 and a lot of indicators are pointing towards yes. So that’s what we’re looking at closely. So, digging into 2022 a little bit more Bob before getting into some more recession talk. Stocks are down 20 plus percent, depending on what market you look at. I think longtime investors are used to that. They know that the great long-term return comes with comes with years like the one that we had. I would say bond investors or investors in general maybe not expecting 12% declines in bonds. How rare is that? What kind of a kind of an anomaly was that in 2022? What drove it and kind of any context for people who are invested in fixed income in 2022? Yeah, it’s simply put, it’s the worst year in history for bond investors. I’ve seen back tests where they try and calculate what the bond market would have returned to going back hundreds of years and you don’t get a minus 12% return for investment grade bonds in a calendar year. What happened in 2022, you had a rise in rate. Rates going up by about 4%. And in addition to that, you’re starting yield was near zero. So, in some people, more experienced investors would say, well, in the 70s rates went up 4%. Yeah, but at that time, you’re clipping a 10% coupon while they were going up 4. This time you were not clipping a coupon to begin with. So, the price action really hits you with the price decline and there was really no yield cushion. So, in historical context, it was the worst year ever for bond investors. So, there are two sources of returns with bonds. The yield, the interest rate, the coupon, and the price movement and last year, prices went down, and yield started off at zero. So, you had nothing to kind of offset the price decline. Correct. And now we’re much better positioned as bond investors where yields aren’t treasuries yields are 4%. And you don’t have to take too much credit risk to get yields in 5’s or 6’s. So now you are clipping in that 4, 5, 6% yield, which gives you a great cushion. So that rates can move, say, 1%, and you break even for the year. So mechanically, what caused prices to decline last year, Bob? That’s the fed raising rates. So, the fed raises the fed funds rates, and the market adjusts because now when the fed fund rate is in the range of four and a quarter to four and a half, if you can buy a T Bill up four and a half, you’re not going to buy a ten-year treasury at 2%.
00:05:10 – 00:10:01
So, the market just supply and demand investors say, well, I’m not buying at 2%. I’m not buying it at 3%. I’m not buying it at 3.5, but okay, 3.75, that’s where it is and that’s how the yields move up. So, when yields are going up, the market will reset prices on lower yielding bonds to make them as attractive as newer issues, basically. Exactly. Could that happen again in 2023? Yeah, definitely. It can happen right now the market’s expecting the fed to get the fed funds rate to 5% by May, I believe. And peak there. So, we’re in the four and a quarter to 5 range and so they do two more 25 basis point increases in the first half of 2023. You get to 5 and then eventually see cuts. That’s, I think, what is priced in? If they need to do more than that, then we would likely see higher rates so, you know, in the past when investors have owned both stocks and bonds, they had the hope or the expectation that in ugly years when stocks won’t do well or didn’t do well, there’d be a flight to quality and people would buy bonds. That didn’t happen last year because there was no yield in those bonds or what was not causing the flight to quality to improve fixed income prices. Yeah, it’s more bonds where the story and the stocks went down because of bonds. My POA put in it in 2022. Inflation was high, so Fed raised rates to sell off and bonds and then that spreads to stocks because stock investors, there’s an acronym Tina. There is no alternative. When bonds yield nothing, then you have to invest in stocks. There’s no alternative. But when bonds yield four and a half percent, all of a sudden, it’s interesting. Maybe I’m not going to pay 30 times earnings for stocks. Maybe I’ll pay 20 times and you just see stocks go down 33% when you do that math. So, it’s one thing we say with investing, it’s all relative. There’s a lot of different asset classes out there, a lot of ways to invest and it’s all relative. You line them all up. And you invest in what’s relatively attractive. And as bond yields have gone up, stock prices need to come down to adjust. To earn their keep. So that was a factor in why stocks struggled in 2022. Do you think it was the predominant factor or do you think recession and slowdown fears drove investors maybe more to take some profits after a pretty nice stretch? Yeah, I think a combination. So, one, it’s all relative bond yields going up to recession fears. And then three, we call it animal spirits. Euphoria, there was some exuberance in the economy. Cryptocurrency was at the center of it. People buying trillions of dollars of value of crypto that has no value, no intrinsic value. And the stock market close to equivalent is companies with tens or hundreds of billions of dollars that aren’t profitable aren’t making any money. So that’s the area that got hit the most in the stock market, spacs, special purpose acquisition vehicles, seeing those go down. So, areas in the market where that exuberance carried over, that’s really gone down a lot too. So, the three things I was saying there that the tide bonds being one 2 recession fears and three just some of the exuberance deflated out of markets. Great. Thanks, Bob for that. Recap of last year and I know you were getting started in talking about what to expect in 2023 and that the themes maybe have flipped from inflation to recession watch yeah, yeah, so something that we’ve been watching we’ve talked about this many times is the but not in too much detail, the leading economic indicators produced by the conference board. And there are all kinds of economic data points that come out and some are leading some are lagging, some are coincide in the leading ones are the most interesting because that’s kind of telling you what’s in the future. And the leading composite has been negative now for 9 months in a row at peaked in February and every month since it’s been a decline. And this data goes back to 1960. And you don’t see 9 months in a row of negative leading economic indicators without a recession that’s nearly imminent. So, it’s a pretty telling sign to be looking at 60 years of data and not seen this pattern happen without a recession.
00:10:03 – 00:15:05
And then you step back and not just sometimes you look at data points and it’s like, well, if the NFC wins the Super Bowl, it’s a good year for stocks. It’s like, okay, that’s a coincidence. It’s meaningless. But is this just a coincidence or does it actually mean something? And so, when you look under the hood, like in the last month’s print for the LAI, the biggest detractor was average consumer expectations for business conditions, so they do a survey. Of consumers and say, what are you expecting for business conditions? And I came back pretty negative. So, you think about that if people are saying, well, I think things are going to be bad. Well, how are they going to behave? And that’s how you get recessionary behavior. Another one is building permits. Building permits are down. That was a detractor. So, when building permits are low, that means no new construction means there are going to be construction jobs in the coming months because it takes time from when you file a permit to when the actual work gets done so you can see these things aren’t just random noise that coincides with a recession. It’s actually meaningful data, which is why people look at it and I think that’s why a lot of the big banks are calling for recessions in 2023. And it’s something we’re watching closely. Well, and you’ve been calling for it for a while as well. So, what could that mean for investors? Great question. So, the main thing that we’ve done in this regard is we’ve made some big changes in fixed income. So, we rebalanced our fixed income portfolio and added about a 20% allocation to intermediate term US Treasury bonds. This is where when you set up the opening typically, investors are risk on risk off and we’ll sell stocks and buy bonds. In an inflationary environment, bonds aren’t attractive, but in a recession, the one that could be coming, it would be more deflationary, or the fed puts us in a deflationary environment trying to pop the inflation bubble. That would be good for treasuries. So, we think the best place to be would be an intermediate to long-term treasury bonds because yields would eventually fall. That investors would sell their stocks, they’d be looking at bonds, inflation wouldn’t be a concern, so we really tightened up the quality of our fixed income and just getting pure treasury exposure. So, and in doing so, we’re getting about a 4% yield. So, when you look at ways to get defensive, one thing that’s very difficult to do, with market timing stocks to get out of stock, here’s an extreme get out of stocks and go to cash. There’s a huge opportunity cost there on average over time. So, we know stocks do about 8% better than cash. And it’s a time that rights very difficult, but to hold treasuries that you’re getting a 4% yield on in lieu of more credit sensitive bonds, that’s something where we feel like we’re not sacrificing much of anything. We’re getting a very acceptable yield. And it will be there to get some price appreciation and opportunities for rebounds. And if things get bad in 2023. Great. And then the fear with stocks, if we enter a recession, you and I were talking about is that earnings expectations, even after the 20 to 25% sell off, we had last year earnings expectations may still be too high. And the market may be pricing in earnings that are too high. And now that’s kind of a scary proposition to plan around or make an overly bearish call for because I think it does still depend on whether we get into a recession or not. I think you and I both are more comfortable thinking that we will. But the depth of the how extensive it is, would impact directly how much corporate earnings would be hit. So, there’s a fear out there that maybe corporate earnings expectations are too high. But there’s not a ton you can do about it. If I could summarize that in layman’s terms. Yeah, you said that well, we wrote a blog post about this. The average recession sees earnings decline by about 25%. And right now, analyst estimates are I think about flat. That’s nowhere near expected to see that big of an EPS decline in 2023. So, there is risk to the downside, but that does go hand in hand with investing. One thing that we look at is if you rewind the tape and go back a year going into 2022, we talked about this extensively year in two years ago. There’s a big spread between value and growth stocks. That there are growth companies mentioned this a little bit to trading at crazy valuations. I think our first podcast was actually on the fangs was on this topic. That’s where we kicked it off, talking about U.S. tech and how expensive. The fangs were, meanwhile, value stocks were about average.
00:15:06 – 00:20:03
Emerging market stocks were about average foreign stock average in the U.S. tech was expensive. Everything’s has come down. In the aggregate, when everything comes down, you still have some of the growth areas of the market, not stand out as really attractive right now, still a little expensive. Which means there’s more room to go down on the growth side. But value that started as reasonably priced, then went down 15 to 20%. We think there are some bargains out there. And you’re especially seeing it overseas. We started talking about emerging markets in China in particular. I think a couple episodes ago. Sure. And China’s really turned. I think in Q4, China was up 15 to 20%. So Chinese markets moving at some businesses in a 2023. And I think China stock markets are up about 5% this year. So, I think that there’s a saying there’s always a bull market somewhere. And it’s just not as simple as over in a recession. It’s going to be a bad year for stocks. So that’s where being value investors looking at some of these markets that were reasonably valued to begin with went down with everything else in 2022. So, a good place to have an allocation and don’t try and be too cute. And Bob, you know, because I’ve been looking at some of those numbers as well. And I saw something of a performance spread between value and growth, the Russell 3000 value versus the Russell 3000 growth. It was about a 20% between the two indices. Can you just take two seconds to explain what each benchmark is and what that 20% difference signifies in your mind? So, if you take the market and I’ll simplify but cut it in half and use price to book. So, buck looking at the balance sheet and rank the company, so companies that have a strong balance sheet. That half is the cheaper half as value, the more expensive half is growth. And you can also use income statement measures like price to earnings, so companies that trade at a very high price relative to earnings that’s growth, a low-price relative earnings that’s value. And its investors polite way of calling expensive companies growth because you pay a premium because you think it’s going to grow and value companies cheap, it’s a good value because it’s cheap. Then what we saw last year, you said it was about a 20% spread between value and growth. So, the value basket did about 20% better than the growth basket, which is a very big spread, but there’s still a cheaper than average. So, I think there’s still room to run for that outperformance. Got it. Thanks for the explanation Bob. I appreciate that. I don’t want to maybe put you on the spot with this, but if everybody’s been talking about a recession, including you and me, not that I would say the whole world is listening to you and me. And the fed has raised rates. We’ve had an inverted yield curve. There’s just been a lot of signals. We know that the fed wants to slow things down, inflation was out of control. Why haven’t we seen stronger signs of a recession yet? Yeah, the economy has remained strong, and the jobs markets has remained strong, there’s, I think, the numbers 1.8 jobs per unemployed person. You know, it’s strong we’ve seen some companies announced like big layoffs. It’s been a strong economy. Monetary policy Powell always says that it has lags as a lagged effect. So, they raise rates and it takes time to trickle through. But like I said, the leading economic indicators that month 9 of being negative. This has been pointing in a flashing red for a little while now, longer than normal. It is tough too. I guess explain other than there is a lot of money still out there and the economy is still performing. And that can continue. And I think a lesson from it is to not overreact to these things to not be trying to guess on the whims of markets and fortunately we have been disciplined and we talk about these things monthly, but it’s not like we’re dancing in and out of stocks every month. We’re keeping our allocation high and really making changes on the margin, like in fixed income and in real assets. What was that GDP number you shared with me earlier today, Bob? I think it was like an unofficial Q4 number. Atlanta fed has a stat called GDP now, where they look at the economic data that they can get their hands on. And it’s Q4 GDP now. So it’s kind of like a sneak peek. What they think is going to come in. I think it was 3.7%. So strong accelerated higher than Q3.
00:20:03 – 00:25:02
So, I think this doesn’t add up power. We have an accelerating GDP growth when everyone is saying we’re in a recession or going into one. So definitely some inconsistencies there. Has it, I guess, altered your perception of whether we’re definitely going to face a recession in 2023. I know you never said the word definitely before, but has it changed your conviction level? I think with investing those art and science and that the science, I think, leading economic indicators is some point to look the art, like maybe like a little more sentiment and sometimes like if it’s too good to be true or if everyone’s saying the same thing, you just kind of your gut tells you wait a minute like everyone is saying this is going to happen maybe it won’t. That’s definitely it’s almost too much of a consensus too obvious. And the fed is well aware of this. So, there’s definitely a good possibility that we don’t hit a recession. They have a soft landing inflation does slow and we’re off to the races with stocks. So, at the end of the day, what really matters is what we’re doing as far as decisions for our clients and we’ve made some tweaks to the stock allocation across portfolios, but for the most part, our view with stocks has stayed the course. Not adding much not subtracting much. It’s more within bonds or more active right now. So, when it comes to the bottom line of how we’re acting and face of a potential recession in 2023 with stocks, stay the course. We like our positioning with value and global, and we think that these levels investors will be rewarded, and volatility is part of investing, so we have enacted. If we said a recession step in the comment on the stock market is going to tank, we would cut stock exposure and we’re not doing that. Right. And for people who haven’t been following along, remind us what’s your favorite cryptocurrency? I hate them all. You hate them I get it. Oh, they’re all equally tied for zero. Bob, anything else in your mind, as we either recap 2022 or think about this upcoming year for investors? Not much. I mean, I think just a reminder that volatility is part of investing and it’s not easy and it’s not smooth, of course, for investing in stocks, but valuations are pretty attractive now, long-term investors will be rewarded first half, 2023, might be bumpy, but that shouldn’t be a surprise that that’s what you get when you sign up to invest in stocks and overall. With that historically have come very good long-term returns and valuations are more attractive now than they were a year ago. Yeah, and I look at some trailing returns, meaning just looking back over a certain time periods, even though we ended 2022 with a year, as you said, was down 20% from stocks, you know, globally stocks still averaged around 4% a year for the last three years, 5% for the last 5, closer to 8 for the last ten. So, you know, you could take a snapshot and look at your portfolio from January fourth last year, which I think was the market high through 12/31. And I’m down if you owned all stocks, so I’m down 20, but the reality is what we always talk about is if you take the lens out further, either longer term in terms of future expected returns or just looking at what markets have done, historically, over the long run, even after a 20 plus percent decline year, you’re getting close to 8% in your global stocks. So, you can’t always anchor to the absolute high versus the current low point that you’re facing right now. Yeah, I agree. So, you have a webinar coming up next week, Bob, where you and the chief investment officer at fiduciary advisers, Brad long will be talking about expectations for stock and bond markets in 2023. It’s our 2023 market outlook webinar. It’s January 10th at 12 p.m. Eastern Time. You can register for that through our heritage financial website, heritagefinancial.net, and if you register and still ultimately can’t make it, we will send you the recording. So, you have, if you have any interest at all, please register for it. You make sure you get the recording, but of course obviously we’d like to have you join us live. Bob, thanks for a great conversation as always. I think it’s really valuable for our listeners to be able to hear from a chief investment officer who’s looking at the market’s day in and day out, what you’re thinking about the economy, portfolios, investing. I always learn a lot. So, thank you very much. And have a great day. Thanks, Sammy. And thank you all for listening. If you’re enjoying wealthy behavior, please subscribe and leave us a review wherever you get your podcasts. Please send in any questions or feedback to wealthy behavior and heritagefinancial.net. Thank you for listening to Wealthy Behavior. If you found the conversation useful, please consider leaving us a review wherever you listen to your podcast and sharing this episode so those around you can live a rich life too. For more insights, subscribe to our weekly blog at heritagefinancial.net and follow heritage financial on Facebook, Twitter, and LinkedIn.
00:25:03 – 00:25:42
Check out my personal finance blog at thebostonadvisor.com. Wealthy behavior is produced by Kristin Castner and Michele Caccamise. This educational podcast is brought to you by Heritage Financial Services, LLC located in the greater Boston area. The views and opinions expressed in this podcast are that of the speaker, are subject to change and do not constitute investment advice or a recommendation regarding any specific product or security. There is no guarantee that any investment or strategy discussed will be successful or will achieve any particular level of results. Investing involves risks including the potential loss of principle. *This automated transcript may contain grammatical errors.
About Wealthy Behavior: Heritage Financial Services
Wealthy Behavior digs into the topics, strategies, and behaviors that are key to building and protecting personal wealth and living a rich life. We’re Boston Massachusetts-based wealth managers who have been helping busy, successful people pursue their financial goals for more than 25 years. Hosted by Sammy Azzouz, President of Heritage Financial, Wealthy Behavior digs into the topics, strategies, and behaviors that are key to building and protecting personal wealth and living a rich life.