Market Insights at a Glance
On the heels of a turbulent 2022, valuations for fixed-income have not been this attractive in a long time. The following summary is intended to aggregate the Firm’s current overall views and present an at-a-glance dashboard.*
Growth
Convictions
- Global growth has downshifted, which should also reduce global inflationary pressures
- In the US, we think growth will be slow this year, but a recession will be avoided
- In China, we’ve just seen a remarkable U-turn toward pro-growth policy with the widespread removal of its Covid restrictions
Rationale
Inflation
Convictions
- We expect inflation to ease substantially in 2023
- We think the stickiness of lagging inflation measures has postponed the Fed’s rate hike pause and elevated the peak inflation rate
- Forward-looking inflation indicators, however, display substantial progress in inflation’s decline
Rationale
Monetary Policy
Convictions
- In the US, as we expected, the Fed hiked 25 bps on Feb 1, a downshift from its last hike of 50 bps
- In the UK, the BoE raised rates to 3.5% in December 2022. Part of the reason why the bond market did so poorly last year was reflected in the challenges we saw with the Liability-Driven Investing debacle and the fear that policy lost its mooring, but we’re encouraged by new UK leadership’s policies
Rationale
Fiscal Policy
Convictions
- Global fiscal stimulus is turning into global fiscal drag, as Covid-related support is now reversing very meaningfully around the globe
- In the US, monetary conditions are tightening, as evidenced by a precipitous decline in the M2 money supply
Rationale
Housing
Convictions
- US home prices appear to have peaked and are declining
- Sales and starts have been plummeting, with the inventory of new homes nearly back to 2007 levels
Rationale
Geopolitics
Convictions
- The Russia/Ukraine conflict continues to pose massive geopolitical uncertainty
- The cessation of Russian natural gas exports forced eurozone energy prices substantially higher in 2022 and will likely push into recession those eurozone countries with greater Russian energy dependence
Rationale
As of Dec 31 2022*
The Case for Fixed-Income in 2023
After a very difficult period last year, we think 2023 will be a time of renewed optimism for fixed-income. Simply stated, valuations in the fixed-income market have not been this good in a very long time. Of course, that’s a reflection of the enormity and pervasiveness of last year’s bear market. Not only did rates move higher but spreads also widened on non-Treasury sectors. The starting point matters and that is what fuels our optimism for the fixed-income asset class this year. More attractive valuations against a backdrop of falling inflation sets the table for a promising 2023.
Falling Inflation Should Bolster Recovery
Declining inflation will likely be extremely supportive for all financial assets, and fixed-income specifically. The Consumer Price Index (CPI) for core goods in the US is clearly on a downtrend. Food and energy prices, as well as home prices in a number of countries, are also well off their highs (Exhibit 1). We think all these indicators are straightforwardly showing that inflation is in a very downward pattern and, perhaps more importantly, are well within ranges that are acceptable to the Federal Reserve (Fed). Service inflation remains a key data point to keep an eye on given the fact that it has been stickier than the other components of the inflation calculation. That being said, we are optimistic that service inflation is trending lower. But on the whole, our view is that the inflation picture is one of decline. Inflation coming down will allow the Fed to pause its hiking cycle and hopefully avoid a deep recession. Slower growth and lower inflation will allow bonds to be bonds once again. In the event that growth slows even more than anticipated, we expect long US Treasuries to resume their negative correlation to other asset classes and serve as ballast to our portfolios.
Investment-Grade Credit Illustrates Opportunity in Fixed-Income
As you can see in Exhibit 2, the yields on investment-grade corporate bonds have risen to a point that we haven’t seen for almost 20 years (with the exception of the global financial crisis). Corporate balance sheets remain sturdy and we aren’t seeing the excesses that we have in the past. While spreads on investment-grade credit have tightened from their wides in 2022, the all-in carry from investment-grade credit makes it an important anchor component of our strategies.
EM Well Positioned to Lead Fixed-Income Outperformance
We’re also optimistic that emerging markets (EM) will outperform in 2023. After a very aggressive tightening campaign by EM central banks, we think they are closer to the end of their tightening cycle relative to developed market (DM) central banks. As a result, we expect EM central banks to pivot toward growth this year, with rate pauses or even cuts. Adjusted for inflation, we think EM yields are attractive. A weaker US dollar and China coming off of its draconian Covid lockdowns also bode well for EM. Of course, issue selection remains key.
Proceeding With Cautious Optimism
Our view for the year ahead is that US growth will slow, but we’ll avoid an outright recession. Although global growth has already seen a downshift, we believe China’s recent and rather abrupt reversal of its “zero-Covid” policies will prove to boost its growth rate and perhaps lift the global rate somewhat. We’re hopeful global inflation will continue to fall, even if just modestly, and believe firmly that inflation “expectations” have the power to help curtail actual inflation. Take, for instance, the experience of the 1970s when inflation was truly remarkable in double digits. When nearly everyone in the US believed inflation would continue to rise they took precautions. It dramatically changed how consumers behaved. But that’s not what we have today—inflation expectations are very well anchored. And while the US dollar is weakening, it’s not even close to what we saw 50 years ago when it was in an outright freefall as investors fled the currency. This is also an ideal time for active investment managers. Looking ahead, we’re confident that our diversified investment approach of using top-down macro strategies along with bottom-up sector/subsector and issue selection—which has historically shown the ability to outperform in a variety of different market environments—will be able to take advantage of current market dislocations.
