Fourth Quarter 2022 Capital Markets Outlook Video

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By Walt Czaicki, CFA

Transcription

Hello everyone and welcome to our Fourth Quarter Capital Markets Outlook. Clearly, it was a rough third quarter, with the S&P 500 down nearly 5%, adding to the painful returns investors have experienced all year to date. the board. This year, there has been no place to hide. The three big problems of the year continued this quarter: persistent inflation, the central bank’s tightening in response to it, and questions about global economic growth.

Starting with the Federal Reserve, they have continued on their aggressive path of rate hikes, which is not expected to slow down any time soon. While market expectations have also risen for rate hikes, they have remained somewhat below the Fed’s projections. This is based on the notion that all this tightening will ultimately lead to economic growth. slower, which, in turn, could lead to a less restrictive monetary policy. But the bottom line is that the Fed would rather err on the side of caution than relax too soon and end up with bigger inflation problems down the line.

We already see signs that his policy is having an effect. For example, freight costs between areas such as the US and Asia have fallen significantly, and the prices of key goods have fallen from their peaks, in particular many commodities. A persistent concern for the Fed, however, is that both wage growth and employment costs have accelerated rapidly and show no signs of cooling yet. This is likely to keep the Fed in its tightening phase.

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Consequently, we have lowered our forecasts for economic growth, while raising our forecasts for both inflation and short-term interest rates. With so much going on, many are wondering where things are headed and how to invest in both the equity and fixed income markets.

So, let’s start with the actions. Earnings estimates continued to rise in the first part of the year only to be lowered in recent months. That is the case for this year and for 2023, with the exception of the energy sector. While energy is an outlier, utilities have seen modest forecast revisions, and these two sectors comprise significant weighting among value stocks.

But within growth stocks, their year-to-date sell-off represents not only a more attractive entry point, but also a timely opportunity to rebalance them, where appropriate. With all the bad news out there, this may be creating a contrarian but good opportunity for investors with intermediate time horizons. At a time when consumer confidence has reached its lowest levels, we have historically seen attractive future returns for one and three year periods. But the return opportunities are not unique to equities, given the higher return environment that has enhanced the return potential for fixed income investors. To get a higher return on your fixed income, you need the yields to rise. And that is exactly what has happened, albeit abruptly. In fact, this has been the fastest rate-raising environment since the 1970s.

One area of ​​fixed income that looks particularly attractive is US high yield, where the current worst-case yield (which is a very good indicator of future 5-year returns) is about 10% . But it’s important to remember that during periods of high-yield bond sell-offs, their subsequent rallies have been swift and powerful.

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Over the past four decades, high-yield bonds have generated an average annualized return of more than 8% for those investors who have remained committed to the asset class. However, if an investor missed the best month of each year, the returns earned would have been halved.

And if only the best two months of each year were lost, the returns were much lower. Right now, that nearly 10% worst-case return is at the upper end of the historical range for US high yield.

And we are currently near the top end for select European bonds as well as investment grade securitized assets.

We know that it has been a very difficult time for investors. But, as always, we hope that our comments on AB’s best ideas will help investors get through this difficult time that is really a marathon and not a sprint.

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Publisher’s note: The bullet points in this article were chosen by the editors of Seeking Alpha.

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