2023 Market Outlook

For many, 2022 was a year to forget. It’s hard to recall an uplifting headline that dominated the news during the past twelve months and the desire to move on is in our nature. Investors had no place to hide during the year, with stock and bond investments declining together for the first time in many years. Investors in assets such as cryptocurrencies suffered even deeper losses. Asset prices staged a modest recovery in the fourth quarter (see index return table) and while we anticipate several challenges throughout this coming year, our outlook is encouraging.

Inflation likely peaked in 2022 with signs pointing to a declining rate throughout 2023 (and closer to the Federal Reserve’s (Fed) long-term target rate of 2%). Following a series of aggressive rate hikes this past year, we are also now closer to a peak in the Fed Funds rate for this tightening cycle. We anticipate market sentiment improving when the Fed’s restrictive policy comes to an end (or a pause).

The economy has shown some signs of slowing, specifically in areas like real estate, which is more sensitive to rising interest rates, but a strong labor market continues to support the economy. While it may be impossible to avoid a recession, and we reiterate that recessions are normal within an economic cycle, a tight labor market would be a key factor in avoiding a deep economic contraction.

Long-term (10-15 year) capital market return expectations have increased for both equity and fixed income asset classes, when compared to last year, and are now more in line with historical averages. We do not believe investors need to see the Fed achieve its stated inflation goals immediately, however we do need confidence that the Fed will achieve their goal without inflicting too much damage. In other words, we believe the trend is in the right direction and subsequently we may be closer to the end of the bear market in equities than its beginning.

The path forward will not be smooth and in 2023 we expect the market to have multiple fits and starts throughout the year as we transition to a Fed “pause” with its interest rate policy. The strength of the economy will be in focus, and corporate earnings may be a headwind risk to the market as earnings contract. Gaining clarity on inflation and economic conditions will go a long way in reducing market volatility to more normalized levels. As always, it is important to maintain a perspective on the markets in line with the overall construct, risk profile and time horizon of your own personal investment mandate.

Q4 AND FULL YEAR 2022 MARKET RETURNS

• Index returns¹:

Major Asset Class Returns in Q4 & FY 2022

Source: 2022 Total Return as of 12/31/22, Bloomberg

THE FED, THE LABOR MARKET, & RECESSSION CHANCES IN 2023

While many economists predict that the economy is headed towards a recession this year, the strength of the labor market should ultimately determine the depth of any economic contraction that occurs. Consumer spending is the largest contributor to economic growth and therefore the tight labor market we have today, along with stable wages and household savings, indicates that spending could take a considerable amount of time to decline significantly. This is a healthy place for the economy to be as it braces for slowing growth and headwinds from the Fed which is focused primarily on fighting rising costs (not maintaining full employment).

In order for the Fed to execute a soft economic landing (i.e. not push the economy into a recession), inflation must fall to acceptable levels while earnings and overall economic growth remain steady. The labor market is expected to soften further in 2023, as corporations look to cut payrolls and fend off declining profits. Several notable companies have already announced layoff plans and lowered earnings guidance. The strength of the consumer will be in focus as labor conditions deteriorate. In some areas, such as credit card and auto payment delinquencies, there are signs of softening. However, there are signs of resiliency in other areas, such as consumer spending within the services sector.

We are at the very beginning stage of understanding what the impact of higher rates will be for long-term growth. A likely scenario is that the Fed will pause raising rates by the end of the first quarter and maintain its Fed Funds rate for the remainder of the year (assuming the Fed takes sufficient time to see how higher rates have impacted demand, rather than continuing to tighten further). This Fed “transition” will be a major adjustment period for the market, and it is important to keep in mind that economic data tends to bottom after the stock market.

THE INFLATION STORY

Why is Inflation Priority #1 For the Fed?

This should come as no surprise, but persistent high costs hurt consumers and the economy. Most importantly, low and middle income individuals are impacted the most and protecting quality of life is critical.

Over the past two years the economy has been hit from multiple angles. Severe supply disruptions materialized during the Covid pandemic while at the same time demand (mainly for goods) rose dramatically. Similarly, the Russian invasion of Ukraine set off a new round of concerns over food and energy supply.

To control elevated levels of inflation, not only does the demand or supply side of the equation need to be addressed, but consumer and business expectations of future cost increases must also return to moderate levels. This is key to understanding why the Fed has maintained such a cautionary tone during its many press conferences.

How Can Inflation Be Controlled?

The Fed, and central banks around the world, attempt to control inflation by regulating the pace of economic activity. The Fed most consistently relies upon interest rate policy to adjust aggregate demand in the economy.

The Fed has raised interest rates aggressively this past year, which ultimately trickles down to the consumer resulting in less demand. Combined with improving supply (as the supply disruptions ease), demand is expected to slow and therefore price increases should moderate.

How Does the Fed Measure Inflation?

The most recognized measure of inflation is the Consumer Price Index (CPI), released by the Bureau of Labor Statistics. CPI tracks changes in the prices of goods and services that households pay. Economists, however, focus on “Core CPI”, which is CPI without food and energy prices. Energy and food prices tend to be more volatile over a short period of time, making it harder to gauge long term inflation trends. Another measure is the Personal Consumption Expenditure Index (PCE), which is preferred by the Fed. In short, PCE is released by a different agency and is considered by the Fed to provide the most comprehensive reading on inflation. CPI and PCE will track closely to one another, but it is important to know that the Fed’s 2% inflation target is based on the PCE reading.

Where is Inflation Today?

CPI has steadily declined from its recent peak of 9.1% in June 2022 to 6.5% in December2. While some prices are still elevated, such as food costs and rents, there have been significant improvements in components such as lumber, used cars and gas prices.

The chart below shows annual CPI (orange line) alongside the month-over-month changes in CPI (blue bar chart). Over the next few months, as inflation returns to more normal levels the year-over-year reading should decline (as last year’s higher monthly readings drops out of the annual calculation). It is unknown when we will get to the Fed’s 2% PCE target (currently at 4.7%) yet based on this trajectory we should trend closer to this target over the next couple of quarters.

Source: U.S. Bureau of Labor Statistics, December CPI Release

SUMMARY

2022 was a challenging year for investors, with conservative investments declining alongside riskier assets. Persistently high inflation, a cautious Federal Reserve, rising interest rates, recession fears and political uncertainty lead markets lower. The S&P 500 index, which had declined nearly 25% during the year, finished with its worst annual decline (~20%) since 2008. This was, however, only the fourth annual decline for the S&P 500 index over the past 20 years. Furthermore, due to the low starting point for yields and the unprecedented rate of change in tightening, returns in nearly every segment of fixed income were historically weak. We do see opportunities for investors, particularly in fixed income, where a portfolio of high-quality bonds with managed duration targets will provide yields that we have not experienced in many years.

We are optimistic about the coming year. Inflation is trending lower and showing signs of coming under control and for now the labor market is supporting economic activity. Even if the Fed is unable to execute a ‘soft landing’ and the economy heads into recession, we do believe that we are closer to the end of the bear market than its beginning. With uncertainty around the Fed’s interest rate policy, economic contraction and corporate earnings, equity markets are likely to remain volatile. However, the resiliency of the labor market and consumers encourage us, and we expect financial markets to find stability as these uncertainties become clearer.

Like so many, we are ready to move past 2022 and focus on the year ahead. As we connect in the new year, as always, it is important that we revisit your investment policy statement, account for any anticipated changes in your plan, and identify opportunities that lie ahead.

Gregory Slater, CFA, CFP®, CIPM®
Chief Investment Officer

APPENDIX

Chart A: 2022 Total Return of Major Asset Class Indexes

Source: Bloomberg; 2022 Total Return, MSCI EAFE, MSCI Emerging market, S&P 500, Barclays Agg & Barclays Muni indexes

1 – Source: Bloomberg: S&P 500 Total Return Index; Emerging Markets Stock Index = MSCI Emerging Markets Net Total Return Index; International Markets Stock Index = MSCI EAFE Total Return Index. Bloomberg Barclays Aggregate Bond Index

2 – https://tradingeconomics.com/united-states/consumer-price-index-cpi

IMPORTANT DISCLOSURE:

Hightower Altium Holding, LLC (“Altium”) is an SEC registered investment adviser with its principal place of business in the State of New York. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of Altium, please contact Altium or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov).

The information contained herein is provided for general informational purposes only, reflects the opinions of Altium which may not come to pass, and should not be construed as personalized investment advice. This newsletter contains certain forward-looking statements that indicate future possibilities.

Due to known and unknown risks, other uncertainties and factors, actual results may differ materially from the expectations portrayed in such forward-looking statements. As such, there is no guarantee that the views and opinions expressed in this newsletter will come to pass. Additionally, this newsletter contains information derived from third party sources. Although we believe these third party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility therefore. Information presented herein is subject to change without notice.

The performance results presented herein simply reflect the performance of various benchmark indices over a period of time and do not represent any actual performance results of Altium. Past performance is no guarantee of future results and there can be no assurance that any particular strategy or investment will prove profitable.  Indices are unmanaged. Any reference to a market index is included for illustrative purposes only as it is not possible to directly invest in an index. The figures for each index reflect the reinvestment of dividends, as applicable, but do not reflect the deduction of any fees or expenses, or the deduction of an investment management fee, the incurrence of which would reduce returns. It should not be assumed that your account performance or the volatility of any securities held in your account will correspond directly to any comparative benchmark index. Bonds and fixed income investing involves interest rate risk. When interest rates rise, bond prices generally fall.