Roger Banks, RRC
Early 2023 Outlook
Welcome to our 2023 Outlook. We hope you’re having a great start to your year! For the Banks family, our year began in Italy where we welcomed grandchild number 7 to our ever-growing numbers! Such a blessing. And we are now fully moved into to our new offices in downtown Hamilton. Here’s a quick video launch showing the building process and transformation. Please take a couple of minutes to see the new home of Banks Financial…exciting times indeed!
Last year was a tough one for the Stock and Bond markets, and also a very rare one. However, when we look ahead to 2023, we are excited about the opportunities not just in equities, but fixed income as well. I think 2022 can be classified as a year of multiple unexpected negative surprises. The primary surprise was higher stubborn inflation and the central banks’ reactions to it. Using the U.S as an example, we start 2022 with the expectation that the Federal Reserve would raise rates by approximately 1% at most. But a stubbornly higher inflation rate has resulted in an increase to 4.5% by end of year for the Federal Reserve. Second, an unexpected conflict in Ukraine in February added fuel to the inflationary fire by impacting energy and food prices. And finally, China's ambitious zero-COVID policy resulted in large scale shutdowns of major city centers, including Shanghai and Beijing, which delayed the full opening of supply chains, negatively impacting global economic growth.
Fortunately, we are starting to turn that corner. We're not saying the market's going to be shooting out of the gates to begin the year, as we're likely to experience some choppiness over the next couple of months to start. But once we get through that choppiness, the backdrop will be quite constructive for both Stocks and Bonds.
From an interest rate pause perspective, we're getting closer and we're getting clarity on that. If we're there by the
Fed. meeting in March, I think the forward returns are going to be quite strong, and that's a quarter from now. We've seen it happen in the past, and I think that's a very strong playbook. Not just for 2023, but as we look into 2024. There are opportunities that exist today, not necessarily from a one-year perspective, but a longer-term horizon.
In regards to a recession, in my view, it's not a question of whether we're going to get a recession… we are. The question is to what degree will the recession reach. We believe a mild recession will take place, and the reasons for the view of a mild recession include things like:
· Supply chain. Meaning, the time it takes you to get your product from your factory to the end point or to the end consumer. That lead time has been declining over the past months and that's a positive thing for the global growth at some point in 2023 and also for inflation because we know one of the factors that led to inflation in the first place was the supplier delay. So that's a positive.
· Another factor are the inventories that have built up in the short-term, which is a bad news story right now because we have to go through these inventories. But once we've gone through them, they have to be replenished! And historically, that's a positive thing for the global economy.
· Also, labor market strength is part of the calculation. We're going to get an increase in the unemployment rates as we are currently seeing layoffs in the Tech and Financial sectors and that's going to increase, but it's not going to get to the level that would lead to a severe recession. Total unemployment is expected to top around 5% which is still far below the historical average unemployment rate of 8% in the U.S.
· Financial conditions are another big one. Despite rates increasing from basically zero to nearly 5% today, financial conditions have tightened at the margin. However, I would say they are in general, neutral, just slightly tightened. Despite the overnight rate being higher, financial conditions are not overly loose, but they're not extremely tight either. And as long as those conditions remain neutral, odds of a hard recession are most likely off the tables, because companies and consumers can continue to borrow.
In the near term there are going to be some more challenges, but we believe that lays the groundwork for the remainder of 2023 to be positive. Where we're wrong is if there's a shock to the system. And as of right now, we don't see any signs of that.
The big shocks, the negativity, is standing behind us. Valuations have fallen as rates have moved higher. And we've talked about this before, it's important not to look back. It's important to look forward. An analogy we used before remains true: the windshield is bigger than the rear-view mirror. It's important to know where you come from, but it is more important to see where you're going. Staying on that path to achieve those goals over longer term is key… and it's starting to look attractive.
For example, an area that has done a near 180-degree swing is when we look at fixed income. This is one area that has become extremely attractive and market analysts are extremely excited about. We haven't been this excited about fixed income in 15 years. As we get weaker economic data, recession occurs. What happens with recessions? Yields tend to fall. And what happens when yields tend to fall? Bond prices tend to go up. And that's where you generate returns. The opposite is what happened last year, when yields went up, prices fell. Now we're entering the phases where the bond environment is working in our favor, the mathematics are working in our favor. We are also seeing big blue-chip corporations issuing bonds with Coupon Rates (the interest paid by the issuer) at 6%, 7% and even 8% plus!
Moving forward, Bonds will act as they should, that is to bring return to a portfolio while reducing risk and volatility.
I believe 2023 will remain a bumpy ride for the real economy as it recovers from the shocks and adjusts to the monetary tightening of the past year. However, this year should be much better for asset markets as they adjust at a far quicker pace. The true silver lining of the past year has been a normalization of interest rates. Zero interest rates, common over the past decade, are not a sign of a healthy economy and are a significant burden on savers. Following the great rate reset of 2022, asset market valuations have normalized. Economies are also normalizing and should continue to rebalance toward a sense of equilibrium over the course of 2023 – it just takes time.
Economic adjustments can cause unease and a sense of dislocation, but unlike the past few years of discombobulation, the current trajectory is one of recovery from extreme shocks back towards a more broadly balanced and healthy economy.
This is cause for cautious optimism, not the time to be a bear!
Roger Banks, RRC