This year, inflation ballooned to a 40-year high and financial markets reported double-digit losses. Now, many experts say a recession is likely: Goldman Sachs economists give the likelihood of a recession next year a 35% chance, J.P. Morgan called for a “mild recession” in its latest market outlook, and Bloomberg economists said it’s a near-100% certainty.
Economic growth and inflation are also wild cards. According to estimates from fund giant Vanguard, most major economies outside of China are expected to see “flat or slightly negative” growth over the next year. And while the money manager suggests unemployment will “rise over the year,” that key figure — which the Federal Reserve has said said its fall is essential to slowing inflation — will likely not elevate to levels “near as high as during the 2008 and 2020 downturns.” With all that in mind, we asked several pros: How should we be investing in 2023?
Some pros say certain parts of the equities market could be a bright spot in 2023. Vanguard’s Capital Markets Model (VCMM), the firm’s financial simulation tool used to help power its global capital markets outlook, points to expected improvements for global equities, suggesting “higher 10-year annualized returns for non-U.S. developed markets (7.2%–9.2%) and emerging markets (7%–9%) than for U.S. markets (4.7%–6.7%).”
And Caleb Tucker, director of portfolio strategy for Merit Financial Advisors, says diverse equity exposure will be an ally for investors in 2023. “Regardless of the exact path ahead for interest rates, the fact is that rates will likely remain higher than they have been in recent years,” Tucker says, adding that he expects “significant outperformance of growth stocks over value,” as a result, “making diverse exposure including companies generating current cash flows more attractive.”
Despite general global uncertainty this year, Tucker says international valuations are “low relative to stocks,” and that although that may be a poor predictor for short-term returns, “buying stocks at relatively low prices has been shown to add value over the long run.”
For his part, Marc Pfeffer, managing director at S64 Capital Innovation, added that if corporate earnings at the start of next year show declining headcount, which he expects they will, “firms are going to be operating with fewer people — and [if] the Fed is lowering interest rates — then I think that’s good for stocks.”
To combat persistent rising prices, Vanguard predicts next year that central banks will be forced to go “well past their neutral policy rates — the rate at which policy would be considered neither accommodative nor restrictive — to quell inflation.” Economists at the fund manager add that despite rising interest rates creating an abundance of near-term pain for investors, “higher starting interest rates have raised our return expectations more than two-fold for U.S. and international bonds.”
In the coming year, Vanguard also predicts U.S. bonds will see a net positive return of 4.1% to 5.1% per year over the coming decade, compared with the 1.4% to 2.4% annual returns the firm called for over the period a year ago. “For international bonds, we expect returns of 4% to 5% per year over the next decade, compared with our year-ago forecast of 1.3% to 2.3% per year.”
Lido Advisors President Ken Stern says now more than ever it’s time to look into more opportunistic investment ideas like bonds. “Fixed-income opportunities can offer a steady stream of income that’s generally seen as less risky than stocks,” Stern said, noting that “two-year US Treasury yields over 4%, a more favorable rate than we’ve seen since 1987.”
Pfeffer adds that he’s looking at certain Treasurys in 2023, too. “If the Fed is going to increase interest rates, you will want to have a little more duration in your portfolio,” Pfeffer says, adding that he “would be extending here into the belly of the curve with investment grade corporate bonds,” and “the 2-5 year Treasurys sector … to give some protection.”
Real estate, infrastructure and more
Another sector Stern says should not be overlooked next year is real estate. With real estate investment trusts, or REITs, posting a YTD average loss of 25.22% in 2022, as measured by the Dow Jones Equity REIT Index, Stern says it may be time for a tide change.
In the private sector, J.P. Morgan Asset Management too says those assets seem “well positioned to deliver stable cash flows and public market diversification, even if capital values decline,” in its latest market outlook. The firm also mentioned “infrastructure can help hedge against inflation,” while transportation assets may also see some improvement “as global trade continues to normalize.”
When considering real estate as a sector, Stern said he always “gets excited” when the real estate sector “is worth more than the stock price.” As for private real estate assets, Stern says “rising interest rates are impacting home affordability, so people continue to rent. Investors, however, have purchased apartment buildings over the last several years. Now, many of those same investors are angling to unload — see the potential opportunity?”
Bottom line: Make sure you have a long-term plan that you honor
Of course, no one has a crystal ball, and pros say that’s why it’s important to have a long-term, diversified strategy that you mostly stick too, while also looking out for other oppourtunities. As Warren Buffett simply advises: “Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value,” he wrote in his 1996 shareholder letter. “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”
But what about the fact that the 60/40 portfolio split — a traditional diversified portfolio of 60% in equities and 40% in bonds, which once produced an average 9% annual gain— produced a year-to-date loss of more than 30%, as of Q3? While that is the worst start to a year since the aftermath of 1929, investment pros say it’s still critical to diversify. Indeed, Vanguard expects targets for the balanced approach are still likely on track.
One lesson here may be this, Tucker says: Any long-term investor should remember that past averages don’t always predict what will happen in the future. “If this year has proven anything, it’s that good times don’t always last,” he says. “Now, when things are looking up, we direct more energy into planning for the worst-case scenario instead of waiting until the storm clouds roll in.”
When looking ahead, Stern agrees that it’s critical to not let past performance power your future decisions. “Consider more about where the economy will be tomorrow instead of where it is today,” he said. “Half of this is motivated by trying to look past the doom and gloom of this year, but the other half is learning to be opportunistic no matter the conditions. If this year has proven anything, it’s that good times don’t always last.”
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