2022 Review + 2023 Outlook
6min video
The last quarter of 2022 has now come to a close, so let’s break down what moved markets over the previous year, how we were positioned, and our outlook for 2023.
Video transcript:
A historic year:
Last year was tumultuous for financial markets. We saw a lot of extreme events that had a significant impact on the global economy. One of the most significant was the conflict between Russia and Ukraine, which caused energy prices to skyrocket and contributed to already high inflation. The Federal Reserve had to take action and raise interest rates more than they have in decades.
But that wasn't the thing that shocked markets last year. The gilt crisis in the United Kingdom was also caused by market forces punishing the government for excessive spending with higher yields and falling currencies. And just days before the end of the year, the Bank of Japan caught everyone off guard by changing its yield control policy.
These events remind us that we have to be ready for a broader range of potential outcomes because today’s economic climate is more volatile than usual, so we have to stay vigilant and keep a wide lens when considering possible scenarios for next year.
Market backdrop:
These are global returns; the last Nasdaq was almost double the amount, and the S&P 500 was down nearly 20% here in the US. But before we move on to 2023, last year, global stocks and bonds experienced a rare joint selloff, with global stocks falling 18% and bonds dropping 16%. This is only the third time an event has happened since 1990, with the other two instances occurring in 2015 and 2018.
Positioning over the last quarter:
Now, every one of our clients is invested differently. We're about to discuss it with a customized game plan, so your experience may differ from what you have. So how were we positioned over the last year? This is just a general reflection on some of the moves that we’ve made.
Since the middle of last year, we've been taking steps to reduce risks, which have generally been successful on a relative basis. We did this by getting closer to the benchmark in various ways.
We've also successfully avoided being fooled by bear market rallies and more optimistic narratives last year. That said, some people who believed in the recent "Fed pivot" hype at the end of the year were only disappointed when yet another short-term market bounce caught them out because what ends up happening is that it gives the Fed fuel for an even more aggressive stance on rates.
So to stay balanced, we kept a mix of stocks and bonds and tweaked but tactical exposures. We did this last quarter by starting to buy back into tech stocks after having them underweighted for most of the year, and we used the gains from our overweights in energy in commodities.
We started to favor stocks in other developed countries, as well as more of the low-volatility stores, specifically in emerging markets. The outperformance of internationally developed markets compared to domestic over the last six months is a great example of why we want to be diversified. We strategically take proceeds from this outperformance to rebalance into other areas of the market.
And finally, we positioned ourselves to have a slightly lower amount of long-term bonds and instead focused on shorter-term investments like credit and mortgage-backed securities.
2023 Outlook
So 2023, where do we go from here: if we consider all of the historic shocks of 2022 - like war, high inflation, and a perfect market storm between stocks and bonds - have taught us a few lessons for the new year. First, we must consider a wider range of possible scenarios and be aware of things like inertia and other behavioral biases. Second, we should factor in compensation for geopolitical risk. And third, we need to tweak our investment playbook.
This year, there will likely be a lot of changes in the economy, including more volatility and possible recessions in some major countries. To deal with these changes, it's important for investors, when we look at this new playbook, to consider three themes: pricing the damage, rethinking bonds, and living with inflation.
Our first theme is pricing the damage. This means we need to take stock of how much economic damage has happened and how it is reflected in current pricing. In terms of the compression of the P/E multiple that stocks are trading at.
Our second theme is rethinking bonds. Our new playbook requires us to look at bonds differently, including the role of duration in a portfolio, specifically at times of a recession. This means we will have to be much more granular in the tenor and types of bonds we own. For those who don’t know, the course measures how sensitive a bond’s price is to changes in interest rates.
Our third theme is living with inflation, which means we need to be aware that there are factors that will keep inflation higher than before the pandemic, even if it decreases in the coming year, including an aging workforce, geopolitical fragmentation, and the net-zero transition.
Bottom line:
We need to be ready to make more frequent changes to portfolios this year, as the old recession playbook might not work as well in the upcoming recession.
With that said, if you're a client of BWM and want to talk about how you're precisely positioned, please reach out.
As always, stay the course and stay on point. Take care.
