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As we leave 2022 financial markets in the history books, not many will be sorry to see it go. Last year was one of the worst on record for markets across-the-board. The S&P 500 fell into bear market territory -a term used when securities prices fall 20% or more from recent highs- in June, but managed to recover somewhat to close the year down 18.1%, while returns were worse in the tech-heavy Nasdaq (down 33.1% for 2022). Meanwhile, in fixed income, the annual losses were without precedent. The Bloomberg US Aggregate bond index returned -12.9% in 2022, the worst total return on record (since 1976) due to the Federal Reserve’s (Fed’s) aggressive ramp up in interest rates. Like a one-two punch from a prize fighter, the combination of history-making bond losses and dismal equity returns served to beat up even the most conservatively positioned investors, driving traditionally balanced portfolios to post double-digit annual losses, the worst return for these portfolios in decades.
For Q4’22, the US dollar index (DXY) decreased 7.7% (up 8.2% YTD), while the benchmark 10-year US Treasury rate (UST10) moved up 12 bps to end December at 3.88% (up 236 bps YTD). The price per barrel of WTI oil increased by 0.3% (up 6.4% YTD), closing out December at $80.2.
As we look ahead to 2023, we believe that the Fed’s cycle of interest rate hikes is nearing the end. The driver of the Fed’s rate hiking cycle was, of course, the path of inflation. The U.S. experienced inflation far above the Fed’s 2% target for 2022 with headline Consumer Price Index (CPI) peaking at 9.1% in June 2022. Since June, CPI has declined for six straight months to 6.5% as of December 2022. Looking ahead, we expect CPI should continue to decline for 2023 and allow the Fed to ease up on its pace of hikes before stopping altogether by the spring. We do expect the Fed to keep rates elevated until it sees convincing evidence that core (PCE) inflation is approaching its 2% target. That said, we think financial markets will welcome the shift from the most hawkish Fed in a generation to a more balanced one, giving the economy more time to absorb past hikes. Futures markets are currently pricing in just two more +25 bps Fed hikes for 2023, for a total of +50 bps for the full-year, compared to the +425 bps total increase in the Fed funds rate in 2022.
Looking globally, other global central banks also raised rates materially in 2022. Most notably, the Bank of Japan (the “BoJ”) -the Japanese central bank- intervened to support the Yen after it touched forty-year lows in September. In December, BoJ announced that it would allow the 10-year JGB to rise to a target yield of 0.5%, compared to 0.0% previously. While the BoJ maintained its official policy of yield curve control, the loosening stance helped stabilize the yen. Meanwhile, the big news out of China was the abandonment of its “Zero Covid” policy. We think this is a positive development for global growth, as the Chinese economy is a crucial contributor and supplier of goods. For full-year 2022, China’s GDP growth was only 3.0%, down from 8.1% in 2021 and the slowest growth for China in several decades, excluding the 2020 pandemic year. We expect China’s growth to rebound in 2023, despite an uptick in Covid cases likely as the government lifts pandemic controls.
For 2023, we are optimistic that the interest rate volatility of 2022 is largely behind us. The backdrop of slower growth and a more stable interest rate policy is favorable for market conditions. Turning to U.S. equities, early indications from 4Q’22 earnings season are for lower expectations and some misses, but overall solid conditions. We note, for example, that despite thousands of announced layoffs in the tech sector, the most recent monthly employment report showed healthy labor market conditions with an unemployment rate of 3.5%. Importantly, the jobs report also showed that average hourly earnings rose by 4.6%, compared to a peak of nearly 6% in mid-2022. This figure, along with a continued easing of inflation, makes the case that a soft landing for the U.S. economy is possible.
Perhaps just as importantly as the macro environment, we expect 2023 to restore more normalcy to market correlations. Given last year’s rise in rates, bonds are once again positioned to perform their role as portfolio stabilizers, with Treasury yields of 4% or higher across the curve. These starting yields on bond offer sufficient “carry,” or coupon income, to offset potential price pressure even if rates rise further. For equity markets, we have seen much of the froth come off of unrealistic valuations, especially in the tech sector. Equity markets naturally overshoot both on the way up and on the way down, but we emphasize that industrial and financial sectors remain reasonably priced in valuation terms. We believe the Fed still has a chance to stick a “soft landing,” but even if the U.S. does experience a recession, it could be relatively mild.
Overall, we look for 2023 to be return to normalcy, which has been lacking since the pandemic: more normal fixed income yields, more normal global growth, more normal returns. We believe this “new normal” could be a lot more like the “old normal” with the prospect for solid, if unspectacular, financial market returns. Recession remains a risk, but long-term investors should take advantage of potentially lower entry points to add to core positions.
Notes: Asset class performance is in USD and refers to the following indices: Equities: US Large Caps (S&P 500), Emerging Markets (MSCI EM), Europe (MSCI Europe), Japan (MSCI Japan). Fixed Income: 10-Yr. US Treasuries (BofAML US Treasury Current 10-Yr.), Emerging Markets Sovereign (USD) (JPM EMBI Global), Emerging Markets Sovereign (LCL) (JPM GBI EM Global Diversified), US High Yield (BofAML US HY Master II), US Investment Grade (Bloomberg US Aggregate Bond), and Developed Markets Sovereign (excl. US) (JPM GBI Global Ex US). Source: Morningstar. (1) Strategy returns net of mutual fund expenses and Amerant Investments standard management fees.
You can see the returns for each of the quarters as well as those for all 2022 above.
Q4’22 saw strong positive returns across all asset classes, but it was not enough to offset the losses of the first three quarters.
As mentioned in the “Markets Overview” section above, the fourth quarter saw some optimism on the path of rate hikes reaching an end, providing support for markets. Most notably, 10Y U.S. Treasuries were down -16% for 2022, the worst returns in decades. The rise in Treasury yields punished all other sectors of fixed income, with losses ranging from -11.2% for U.S. High Yield to -21.9% for developed (Ex-US) markets sovereigns. In equities, U.S. large caps declined -18.3% for 2022, while both European and Japanese equities did somewhat better in usd terms, despite de dollar appreciating 8.2% for the year.
We believe that the Fed’s rate hiking cycle is nearly over, with two small (+25 bps each) rate hikes priced in for the first half of 2023. While we are somewhat cautious on High Yield, given the likelihood of a slowing economy, we believe Investment Grade bonds are poised to do well in the current environment. For equities, we believe that equities may not yet be pricing in recessionary valuation multiples, so we would advocate a targeted approach with a focus on sectors with reasonable multiples. With a tough 2022 behind us, we believe that all financial assets are entering 2023 from a better starting place.
(1) Strategy returns based on the total return of the underlying mutual funds, including reinvestment of dividends and change in NAV. Net of mutual fund expenses and Amerant Investments standard management fees. Returns may vary. Past returns are no indication of future performance..
(2) Monthly returns before February 2010 are those of the offshore corresponding strategies. For the Dynamic portfolio, monthly returns before November 2009 are those of the Income & Growth portfolio, which is the neutral positioning of the Dynamic portfolio. Dynamic portfolio started in November 2009..
During Q4’22 all Portfolios rebounded (1) strongly, but still posted a loss for the full year 2022.
The Income Portfolio returned 4.6% in 4Q’22 (-14.9% for the year), the Income & Growth Portfolio returned 7.7% (-17.3% for the year), the Growth Portfolio returned 9.3% (-20.1% for the year), and the Dynamic Portfolio, positioned in the Income & Growth Portfolio until November 21st , returned 8.2% during the quarter (-17.1% for the year).
As mentioned previously, there were few places to hide. Last year markets faced significant headwinds: High and persistent inflation (exacerbated by the Russian invasion of Ukraine), tightening monetary policy, rising interest rates, and slowing economic growth.
You might have also seen purchase and sale activity taking place in late November. We repositioned the Dynamic portfolio from its base position (Income & Growth) to the more defensive (Income) position. At the time of the change, the S&P500 was trading close to 3.950 and the UST10 rate was close to 3.83%. We believed -and still do- those levels didn’t reflect a potential US recession (S&P 500) and provided great value for bonds (UST10), so we took the opportunity to turn conservative by increasing our bond allocation and decreasing the equity exposure of the Dynamic portfolio.
We will be on the lookout for opportunities to return the Dynamic back to its neutral (Income & Growth) position.
In 2022, we positioned portfolios more defensively to be better prepared to withstand an environment of increased volatility due to continued fears of recession and geopolitical risk, and to take advantage of what, in our view, would be continued dollar strength in the near term. Looking ahead, we are positioned cautiously given the heightened economic uncertainty and recession risk. That said, we are preparing to add risk if valuations become attractive and breach our downside price targets.
As always, we take the trust you have placed in us very seriously. In our day-to-day operations, we continue to follow current events and the reactions of the markets closely, and we stand ready to adjust your portfolios accordingly.
To obtain more detailed information on our market views or the performance of your advisory portfolio, please contact your investment consultant at Amerant Investments by calling (305) 460-8599.
Amerant Investments, Inc.
The model portfolios offered by Amerant Investments and described herein invest solely in mutual funds. Before investing, you must consider carefully the investment objectives, risks, charges, and expenses of the underlying funds of your selected portfolio. Please contact Amerant Investments to request the prospectus of the funds containing this and other important information. Please read the prospectus carefully before investing. Past performance is no guarantee of future returns. The value of the investments varies, and therefore, the amount received at the time of sale might be higher or lower than what was originally invested. Actual returns might be better or worse than the ones shown in this informative material.
This release is for informational purposes only. Past performance is no guarantee of future results. While the information contained above is believed to be from reliable sources, no claim as to their accuracy is made. Amerant Investments, Inc. provides no advice nor recommendation, or endorsement with respect to any company or securities. Nothing herein shall be deemed to constitute an offer to sell or a solicitation of an offer to buy securities. Member FINRA/SIPC, Registered Investment Adviser. Amerant Investments does not provide legal or tax advice. Consult with your lawyer or tax adviser regarding your particular situation.
Not FDIC Insured | Not Bank Guaranteed | May Lose Value | Not Insured By Governmental Agencies | Member FINRA/SIPC, Registered Investment Advisor
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