Our 2023 investing outlook started with a theme of returning to normalcy. Considering 2022’s market volatility and the aftereffects of the pandemic, the idea of finding balance was certainly a welcomed change. It’s a theme we could all embrace six months ago and what we will continue to rally around through year-end. That’s not to say that 2023 hasn’t come with its own challenges. We saw two regional banks fail in rapid-fire succession in March – and another closed its doors in May. Collectively representing more than $530 billion in assets, the trio ranks as the second, third, and fourth largest bank failures to date. We also held our breath as a last-minute deal to raise the debt limit came together as the clock ticked closer to default. Despite the market gyrations these events caused and the banking sector still on tenterhooks, the overall financial system seems stable. Counterbalancing the challenges, some bright spots include:
- Inflation is less than 5 percent at home, significantly lower than its 8.3 percent level this time last year.
- The Federal Reserve (Fed) funds rate potentially has reached its apex with the Fed’s quarter percent rate increase in May.
- Global inflation has fallen from its 8.7 percent high in 2022 and is following a slow descent to a projected 6.5 percent for 2023.
By and large, these are things we know, definitively or directionally, a guiding force that shapes our perspective during the next six months. Like anything, they come with some potential opportunities for investors – opportunities that may present themselves in international equities, core bonds (particularly if the Fed is indeed done raising rates), and industrials, to name a few.
On the flip side, there are uncertainties out there. Recession is probably the biggest unknown, with some of the biggest questions around when it might hit, how long it might last, and how significant it could be. That said, any recession that occurs would appear more in the mild range. Perhaps recession is the largest unknown, but we also should factor in the possibility of interest-rate volatility. For example, rates could move higher if inflation remains stubbornly high. Or, they could see a fairly sizable move lower in the event of a recession.
Ultimately, how rate volatility resolves itself will be a big market driver. While we do not have a crystal ball, the insights in this report will help position businesses, along with guidance from their financial professional, to achieve their goals.
The baseline forecast is that the domestic economy will slide into recession in the late half of 2023 as consumer demand cools, especially for services. If job growth cools and the unemployment rate rises, consumers likely will experience declining disposable income, which could be the impetus for a recession as consumers pull back on spending. In the near term, consumers still are unleashing pent-up demand for services. We expect the Fed to end its rate-hiking campaign in the latter half of this year and introduce the possibility of a cut in rates as economic conditions weaken. But as inflation convincingly cools, markets likely will respond favorably to the slight pivot in Fed policy. So far, an improving Chinese economy has not had a material impact on global inflation.
In the first half of 2023, progress was made toward a better balance as inflation fell and interest rates stabilized. However, macroeconomic risks remain top of mind as a potential recession looms. Earnings are likely to decline this year, but solid revenue growth and stable profit margins may help limit the magnitude of any decline. An improved inflation outlook by year-end may enable market participants to see through the economic malaise and toward recovery in 2024. Against this backdrop, LPL Research sees modest second-half gains for stocks, though with the potential for elevated volatility, until investors get more clarity on the likely depth and duration of a potential recession.
After the most aggressive rate-hiking campaign in decades from the Fed, short-term interest rates are at levels last seen in the early 2000s. At the currently elevated levels, the risk is that these rates won’t last, and upon maturity, investors will have to reinvest proceeds at lower rates. So, unless investors have short-term income needs, they may be better served by reducing some of their excess cash holdings and extending the maturity profile of their fixed-income portfolio to lock in these higher yields for longer. If the Fed is finished raising interest rates, we could see lower yields on intermediate-term securities before the Fed actually cuts rates. Historically, core bonds, as proxied by the Bloomberg Aggregate Bond Index, have performed well during Fed rate hike pauses.
The global dynamic has shifted as 2023 has progressed. The Russia-Ukraine conflict continues. Chinese President Xi Jinping is the latest world leader to offer a framework for ending the fighting. This framework also helps underpin China’s unrelenting determination to establish a global leadership position as it seeks to broaden its trade and political relationships and undermine the economic power that the U.S. commands. Regarding U.S. and China bilateral relations, the backdrop increasingly has become fraught with concerns that China has intensified its efforts to secure technology that enhances its military buildup.
As prospects for the reopening of China finally became a reality, analysts cautioned that demand for industrial metals from the world’s second-largest economy would help ignite a bout of inflation. Concerns that the global economy was nearing the cusp of a downturn placed significant pressure on oil prices, though China’s economic activity initially was delayed due to an escalation in COVID-19 cases. Still, China’s economic growth is projected to gain momentum in the second half of 2023, potentially improving demand for a broad swath of commodities. Precious metals, however, have seen robust interest and higher prices as global central banks have been major buyers.
As measured against a basket of developed market currencies, the U.S. dollar has been trending steadily lower since reaching 20-year highs late last September, as the key factors supporting the strengthening dollar for much of the last two years have dissipated. With markets pricing easing from the Fed beginning early next year, the dollar’s large interest-rate advantage has eroded, making the dollar a relatively less attractive destination for global capital. Global usage of the dollar is more than stable. Nearly 90 percent of global
foreign currency transactions involve the dollar, which suggests reports of the dollar’s imminent structural demise are exaggerated greatly.
Given the economic backdrop of the last six months, globally and at home, we’re constructive on alternative investments, which can offer portfolio diversification and performance that exceeds traditional benchmarks. It’s important to note that against our economic backdrop, we may see a wider range of performance among fund managers – depending on things like their trading style or geographic focus. Understanding the opportunities, risks, and overall strategy of any given alternative investment will be more important than ever.
The economy and markets progressed toward regaining balance in the first half of 2023, but more work lies ahead. Reclaiming that state of balance helps us feel grounded, rooted in stability and the comfort of the familiar. From a financial perspective, it can mean a return to lower prices on housing, groceries, and more. It also can translate into greater spending on experiences like dining out. Put the two trends together, and we could see a return to the more typical 70:30 spending mix of services to goods.
The path to balance undoubtedly will include opportunities for investors, as we discussed. But there are several unknowns – most notably, the potential for recession, fluctuating interest rates, and geopolitical instability. All the unknowns come with their own implications and ensuing counterbalances. The good news is that the back-and-forth dynamic between the economy, markets, and global events is what attracted so many of us to invest in the first place.
After all, as we look to 2024, a year that includes a presidential election, the goal is to start it from a position of balance.
The LPL Financial Research team provided this information. LPL Financial is located in Chesterfield, Missouri. Contact Jonathan Benner, Certified Financial Planner™ with LPL Financial, at email@example.com or 636.200.4204. To view the complete Midyear Outlook 2023: The Path Toward Stability, visit lplmycfo.com.