2023 Outlook Q&A: Get Fully Invested Now
December 15, 2022
Read Time 10+ MIN
In 2023, we expect a “sideways” year for equities and are bullish on bonds. Since CEO Jan van Eck’s earlier call to “buy bonds today”, the labor market has remained strong, which suggests interest rates stay higher for longer, and quantitative tightening has gone smoothly—despite being something that has only been done once before in Federal Reserve history.
During a recent webinar, Jan also said to “get fully invested now.” So what should investors invest in? We gathered insights from a group of our experienced investment professionals on what to expect in 2023 for their respective asset classes to help investors plan their 2023 allocations.
- What will have the biggest impact on your outlook through the end of the year and for 2023?
- What do you view as the biggest risks and opportunities?
- Why should investors be considering your asset class now?
What will have the biggest impact on your outlook through the end of the year and for 2023?
DAVID SCHASSLER, HEAD OF QUANTITATIVE INVESTMENT SOLUTIONS: The Fed is committed to keeping financial conditions tighter for longer, just as Paul Volcker did in the early 1980s. However, the Fed is hoping to do this without the ugly recession and double digit unemployment that Volcker caused. Chairman Powell is effectively aiming to get drunk while avoiding the hangover. We would love for this to be the case, but this outcome would defy history. The inverted U.S. yield curve seemingly agrees with us and is warning of an impending recession. In fact, the two- and 10-year U.S. Treasury spread is the widest that it has been since Volcker’s interest shock forced a deep recession!
Commodity prices are an important and underappreciated variable in the future path of inflation. Volcker tamed inflation AFTER the oil shocks of the 1970s, as commodity prices fell. This time around, we are facing structural energy shortages, war involving significant commodity producers and their powerful allies, supply disruptions and societal changes from the lingering pandemic, and de-globalization.
The Fed may be successful in lowering inflation in 2023 through demand destruction, which, at these debt levels, is not a sustainable solution. The extreme debt levels have de-fanged the Fed and, therefore, we anticipate an eventual Fed pivot. Inflation will likely remain elevated for an extended period of time, in the 4-5% range, on average, with several peaks and troughs, as the world needs time to work through the abundance of inflationary forces.
FRAN RODILOSSO, CFA, HEAD OF FIXED INCOME ETF PORTFOLIO MANAGEMENT: For global fixed income markets, the two most glaring issues that could affect returns over the next 12 months are global growth and central bank policies. There appears to be a growing consensus that the U.S. economy will experience something between a “soft” and a “bumpy” landing during 2023; the ramifications being that inflation will slow markedly, the Fed will pause somewhere near 5% Fed Funds, and credit markets will avoid a major default/downgrade wave. We believe that while such a scenario is, in fact, possible there remains a significant amount of risk around each of those assumptions. Of course, central bank policies will continue to be set in response to inflation trends, and growth outside the U.S., importantly including China, will have a major impact on credit markets in 2023.
ERIC FINE, PORTFOLIO MANAGER, EMERGING MARKETS BOND STRATEGY: The outlook for emerging markets bonds in 2023 is positive. Emerging markets countries hiked policy rates early and by more than developed markets countries. Emerging markets countries overall have positive real policy rates. Developed markets countries have sharply negative real policy rates, on the other hand. These high policy rates are generating high carry on local-currency bonds, and are set to stabilize inflation (in the countries with high real rates). This sets up the possibility of sharp declines in market interest rates that would be a further boost. In the event of no sharp declines in interest rates, the carry will also generate superior returns.
JIM COLBY, PORTFOLIO MANAGER AND STRATEGIST, MUNICIPAL BONDS: Rates, rates, rates. The biggest concern for municipal bond investors is what the Fed will actually do with rates over the rest of 2022 and all of 2023. The underlying strength of municipalities from the strong economy of Q1 2018 - 2020 and the financial support from the government’s COVID-19 response means credit will be fine for a while yet. If the Fed signals that economic expansion has slowed, investors will return for the tax-free income.
MATTHEW SIGEL, HEAD OF DIGITAL ASSETS RESEARCH: The Fed’s tighter monetary policy is having an outsized impact on digital asset prices. Bitcoin’s correlation with the S&P 500 has averaged 60% year-to-date vs. 33% in 2020-2021 and 4% during the 2010-2019 period. An end to rate hikes and a re-acceleration in money supply might reverse the poor sentiment. As a case in point, global money supply growth has plummeted from 25% in early 2021 to 1.3% today. If and as that reverses, we would expect the Bitcoin price to react positively.
IMARU CASANOVA, DEPUTY PORTFOLIO MANAGER, GOLD AND PRECIOUS METALS: Market expectations regarding the Fed’s tightening path, inflation and the direction of the U.S. dollar will be the main drivers. We expect gold to continue to trade around the $1,700 to $1,800 range in the near term. If inflation remains at or near current levels, real rates are likely to stay in negative territory, and we would expect this to support gold. A pause in the Fed’s tightening program would likely be a strong catalyst for gold. However, gold may rally even ahead of a Fed pause or pivot. The recent gold price action following the CPI report for October is a perfect example of this. Gold broke out as the market anticipated that Fed rate increases might soon start to slow down. It now looks like gold may be back on the longer-term bull trend that has been in place since 2016. This is a significant development for gold.
ROLAND MORRIS, PORTFOLIO MANAGER AND STRATEGIST, COMMODITIES: U.S. Fed policy and the U.S. dollar are likely to be the most important issues impacting commodities and commodity index products through year end and next year. Commodities had another good year in 2022, holding some of the sharp gains from the Russian invasion of Ukraine in Q1. Tighter central bank monetary policies and slowing global growth continue to be headwinds. Commodity index strategies continue to benefit from positive roll yield and higher risk-free interest rates. That is likely to continue in 2023 and is a very positive environment for commodity index returns. Most importantly, the Fed is expected to slow the pace of monetary policy tightening and pause in the first half of 2023. The U.S. dollar may have already peaked this fall in advance of a shift in U.S. monetary policy. If the Fed does indeed slow the pace and pause monetary tightening next year, the U.S. dollar could fall sharply. 2023 could be a very good year for commodities, if the U.S. dollar falls sharply.
SHAWN REYNOLDS, PORTFOLIO MANAGER, NATURAL RESOURCES AND ENVIRONMENTAL SUSTAINABILITY: The natural resource equity sector continues to face a number of historically unprecedented issues, including a potential looming recession and the deepening repercussions of the energy/resource crisis associated with Russia’s invasion of Ukraine. However, the most important issue is, in our view, the path to opening in China. We believe relaxation of zero-COVID restrictions will eventually lead to a strong rebound in China’s economy, a substantial increase in the demand for commodities and a subsequent positive response from resource equities. In fact, we think this is the biggest fundamental supply/demand issue that has been overlooked during the last year—i.e., the largest consumer of commodities in the world has been, essentially, in a recession. If this had occurred during the decade of 2010-2020, commodity and related equity prices would have seen severe underperformance. Instead, we have had strong outperformance, which we believe is clearly related to a structurally tight supply environment. The timing of China’s return to the world market may go a long way to offsetting any new recessionary demand impacts that may unfold in OECD countries. We see China as a tightly coiled spring that, when released, could be a catalyst to an unparalleled rebound in the demand for all commodities.
VERONICA ZHANG, DEPUTY PORTFOLIO MANAGER, ENVIRONMENTAL SUSTAINABILITY: 2022 has given the energy transition markets plenty to digest. Significant policy announcements furthering the buildout of renewables were announced on both sides of the pond (Inflation Reduction Act in the U.S., EU Green Deal in Europe), both putting in play long term investment ramifications for a significant pivot to renewable generation by 2030. Particularly in the U.S., the Inflation Reduction Act, with its extension of lucrative tax credits to 2030, positions it as an economically attractive place to build upstream supply chains serving the domestic solar, storage, and electric vehicle industries, currently dominated by China and the East. We view 2022 as “setting the stage” – and look forward to 2023 as the beginning of “shovels in the ground,” as corporates have had time to digest the policy incentives and can begin executing on longer term build out. Within the next year, we believe it is critical for regional and local level policymakers to streamline permitting and remove administrative red tape to allow development to progress in order to meet longer term targets for renewables generation.
DAVID SEMPLE, PORTFOLIO MANAGER, EMERGING MARKETS EQUITY STRATEGY: Clearly the progression of rate hikes and potential declines amongst central banks, including developed markets, will impact valuations for emerging markets equities, and likely the direction of the dollar, which is very important for emerging markets. We stick to our view here that inflation will decline at a decent clip, opening up opportunities for rate expectations to be lowered. The flip side of this scenario, however, may be slower global growth as economies digest previous hikes, and global growth slow – important for both commodity demand and demand for manufactured goods. On the other hand, China’s swift move away from “COVID zero” on top of a sluggish economy in 2022, means that it is likely the China will be the only major global economy with accelerating growth in 2023.
What do you view as the biggest risks and opportunities?
RODILOSSO: The risks to fixed income markets over the next 12 months include upside inflation surprises, downward growth surprises and the potentially unanticipated effects of quantitative tightening. One obvious risk is that the Fed finds it as difficult to get inflation back down as it did while trying to get inflation higher for most of the QE period. Another is a more pronounced recession than the soft or bumpy landing that the market appears to be anticipating.
Despite the risks, with fixed income markets having repriced in 2022, there are numerous opportunities for investors to consider. A key consideration, of course, is that current income once again can be a key driver of returns and, even if rates rise and/or credit spreads move wider, can act as a buffer against adverse price movements. Given that the market will likely be reacting to news on multiple fronts over the coming months, whether driven by interest rate volatility or other factors, credit spread widening could lead to attractive entry points for adding credit exposure. The same could be said about foreign currency exposure (including in emerging markets) as well as duration. Given our view that there is a wide dispersion of outcomes while market pricing reflects a somewhat benign consensus, we favor adding to fixed income allocations with mix of quality and spread, such as investment grade corporate bonds, municipal bonds, and highly rated CLO tranches. We also favor being tactical about adding duration, and with the two-year to 10-year part of the yield curve inverted by approximately 80 bps as of mid-December, we believe that the short end represents enough relative value to accept the re-investment risk.
COLBY: The risk to municipal bonds is that the Fed or advisors misread the direction of the economy and create confusion, driving investors away from fixed income. The other risk is global: Will there be a severe economic slowdown due to the prolonged war in the Ukraine, and will China retreat into its own COVID shell and create further economic downturn on a global scale?
SEMPLE: For emerging markets equities, risks include:
- Inflation and more rate hikes leading to weaker global growth.
- USD strength picks up again.
- U.S. continues to widen and broaden economic war against China.
- Lower than expected inflation, particularly in the U.S., leading to lower peak rates, and a weaker dollar
- Chinese domestic demand comes back strongly.
- Geopolitics calms down as there is more talking, which may mean less precipitate action from Washington.
- Some kind of settlement in Ukraine.
FINE: Although inflation is a problem for developed markets (which mostly import commodities), emerging markets tend to be commodity exporters or maintain big external surpluses. Coupled with their high real interest rates, it’s reasonable to say that developed markets should benefit from high commodity prices. Commodity prices should remain well-bid, by the way, if there is any pause in Fed tightening. Also, we see the loss of Eurasia as a key unpriced risk. The region is a major resource producer, which will be leveraged as Russia re-directs all oil and gas pipelines toward Asia (which should be finished by 2025). In fact, China and Russia have stated plans to deepen financial infrastructure with ideas such as digital gold, commodity-backed-currencies, and a currency bloc. All of these would attract dollars to emerging markets currencies, especially in Asia and in commodity exporters.
SCHASSLER: Warren Buffet once described diversification as “protection against ignorance.” Your strategic asset allocation should include stocks, bonds and real assets because economic conditions can change quickly and are often hard to predict. We spent a significant portion of time over the past couple of years encouraging investors to diversify into inflation-fighting assets. Too many ignored us. This crowd “knew” that inflation would be either nonexistent, benign or temporary and, therefore, didn’t need to diversify. They were wrong and lost money. Do not fall into that trap in 2023!
The risks leading into 2023 are many and this leads to a wide distribution of potential outcomes. This is an ideal environment for diversification. We see opportunities in both real assets and high yielding assets. Real assets, as time-tested inflation beneficiaries, are expected to continue to outperform as inflation remains stubbornly high. Pay attention to gold. It has lagged other real assets and is expected to rally higher as the inflation cycle matures and there is limited upward mobility in interest rates.
High yielding assets are once again compelling. Short-term interest rates went from 0% to 4%. The reset in interest rates has created opportunities to earn yields not seen in over a decade. This offers the potential to generate strong yields from a diversified basket of high yielding assets, such as high yield bonds, REITs and dividend paying equities. To quote your favorite infomercial: “But wait, there’s more!” If the Fed pivots, as we expect, high yielding assets should also benefit from price appreciation.
Risks are high. Play it smart. Diversify beyond the 60/40.
CASANOVA: We see opportunity for gold’s breakout to intensify, propelling it to its all-time highs around the $2,000 per ounce level, but this would require investment demand to pick up. There are many existing risks in the financial system and global landscape that we believe are supportive of higher gold prices in the longer term. These include (in the U.S. and globally) persistent and elevated inflation, a weakening economy, debt service strains, elevated geopolitical risks and black swan events, such as the LDI crisis in the UK. The biggest risk is that the gold market continues to ignore these risks. Market participants may not abandon the safety of the USD and run to the safety of gold until several conditions are present, including a significantly weaker jobs market and higher unemployment rate; a confirmed economic recession; a drop in corporate earnings and a deeper correction of the equity markets; and sustained inflation above the Fed’s target rate. How long it may take for these risks to become reality is up for debate, but their increasing likelihood, we believe, will support higher gold prices in 2023 and beyond.
REYNOLDS: In our view, the biggest risk to the natural resource equity sector is a belief that inflation is conquered and that we are returning to the low inflationary period of the last decade. The past year was an extremely strong testament that “resource equities do what they are supposed to do, when they are supposed to do it”. Numerous studies (including VanEck’s own, All Things Considered in the Inflation Debate) show that resource equities outperform the rest of the equity and fixed income market when inflation is greater than 2%. The fact that 2% inflation was the norm during the last decade and remains the goal belies the fact that this prolonged period was the anomaly since the end of World War II. While we believe inflation in most parts of the world has peaked, we also see very strong historical evidence that once a mid-single digit inflation threshold has been breached, a return to a lower inflationary regime takes many years, if not decades, to attain. Hence, the prevailing view that central bankers around the world will be able to quickly drive inflation back to the 2% level while balancing economic growth and employment seems extremely unlikely, from our perspective. Thus, our view is that moderate inflation will be with us for a while, and this is positive for the potential performance of resource equities.
An important opportunity, that we also highlighted last year, continues to be that the resource sector in general and individual company fundamental profiles continue to look extremely robust from both an absolute and a relative perspective. Valuation remains historically cheap while balance sheets, returns, free cash flow generation and dividend yields are generally more attractive than the rest of the broad equity market and, in many cases, are the best looking that they have ever been.
ZHANG: COVID’s impact on global supply chains has had long-lasting ramifications. A particular pressure point has been a choppy Chinese reopening and its control over a significant chunk of the value chain, although we are optimistic that should begin to normalize the supply/demand dynamic for a number of critical components. This hindered growth and profitability in 2022.
Swift interest rate hikes have kept growth investors on the sidelines. Cheap financing is behind us, as is the era of easy returns. What remains are companies who will either win or lose based on their technology moat and ability to run their operations more efficiently than their competitors – echoing our core investment tenet of high quality, sustainable growth. Given the urgent demand for energy transition technologies at our backs, we like the macro setup for our investments heading into 2023.
MORRIS: The balance between supply and demand usually provides both the risks and opportunities for commodities and commodity index products. Next year and beyond should be no different. First, the opportunity: we believe that supply will continue to be the dominant challenge for commodity markets over the longer term. Underinvestment in exploration and the development of new sources of commodity supply over the last 10 to 15 years has set the stage for persistent long-term shortages. Slowing global trade along with resource security concerns, driven by the Russia-Ukraine war and a breakdown in U.S.-China relations will promote on-shoring and friend-shoring by Western economies. Lastly, the efforts to transition away from traditional energy to renewable energy sources, while being constrained by environmental concerns and “not in my back yard” local resistance, will be difficult.
All of these factors are likely to constrain supply and raise costs for commodities over the longer term. The big risk is global growth. It is possible that in an over leveraged global economy the U.S. Fed and other central banks already have or will over tighten monetary policy. That could push the global economy into a very serious economic downturn. I think that is a low probability but it’s not zero. It seems more likely that the U.S. Fed and other central banks will err on the side of risking/accepting a little more inflation vs. economic depression.
SIGEL: One of the biggest risks to Bitcoin is that elected officials lean on global institutions like the IMF/World Bank/BIS in a way that makes it harder for citizens and institutions to compliantly access cryptocurrencies, either via higher capital requirements, explicit taxes or outright bans. We are seeing this dynamic in El Salvador, whose government is negotiating to restructure IMF loans and facing an onslaught of negative PR and, so far, no deal. As for the opportunity, crypto and stablecoins are gaining share of payments in high-inflation regimes, particularly in Latin America. We don’t believe that the U.S. will be able to hold back sovereign nations from their preferred payments rails over the long run. Meanwhile in the U.S., more than half of the companies in the S&P 500 Index have announced digital asset partnerships. Real-world applications, such as those we highlighted in a recent webinar with the founder of Hivemapper, will likely gain increasing traction over the next year, thanks to the coordination offered by smart contracts. The emergence of a killer app built on a major layer 1 smart contract platform would likely re-ignite investor interest in these assets.
Why should investors be considering your asset class now?
RODILOSSO: In our view, fixed income has become a far more attractive allocation within diversified portfolios, not only because it has become cheaper but also because it has “normalized” to the degree that traditional return drivers and correlations with other asset classes should return. 2022 was the only year in the last 45 when the Bloomberg Barclays US Aggregate Bond Index and the S&P 500 Index both had negative total returns. Zero-rate policy and 1.5% 10-year yields at the end of 2021 left little room for high quality bond allocations to support declining equity portfolios, as they had in the past.
Within fixed income alone, especially as credit spreads have decompressed over the past year, investors also now have more choices to express views. Duration and quality may offer a more attractive return profile now versus a year ago for investors whose primary concern is a more dramatic growth slowdown or a deep recession. Current yield and price upside in riskier credit, such a high yield and emerging markets, where valuations are more in line with their long-term histories, may appeal to investors with more optimistic growth outlooks, even if they are concerned with the overall level of rates. We favor balancing the risks as 2023 commences by seeking attractive spreads within higher quality alternatives, such as investment grade credit or fallen angel high yield bonds (90% BB-rated) versus broad high yield, investment grade CLO tranches or investment grade floating rate notes versus leveraged loans. We also believe that opportunities should arise during the first half of 2023 to add even higher carry credit exposure in emerging markets credit and local currency, as well as U.S. high yield.
FINE: As bonds become the key investor focus for 2023, the discussion will inevitably turn to emerging markets bonds—not just because of their higher yields in local and hard currency (compared to developed markets or U.S. investment grade and high yield, respectively). Beta, in other words. The high carry in emerging markets debt also cushions returns in rising rate scenarios such that returns could be positive even if risk-free rates rise. The upside-downside for high-yielding emerging markets bonds is arguably superior to the upside/downside of treasuries and U.S. investment grade. When investors examine the return/vol history of emerging markets bonds, based on 19 years of data, the optimum fixed income portfolio should have substantial allocations to emerging markets bonds.
SEMPLE: Rates lower than expectations, a weaker dollar and China’s economy accelerating are a powerful cocktail for emerging markets performance. Our investments have performed and continue to perform well. In particular a number of major companies that emphasized unrelenting growth have scaled back ambitions and focused more on cost control and more conservative capital allocation. This bodes well for investor returns in the medium term.
There has been significant allocation away from the asset class, and positioning is light. There will be FOMO – fear of missing out.
COLBY: Tax free income is one of the few remaining shelters investors can employ to buttress their portfolios if equities do not perform. Currently, with no new tax programs emerging in Congress and the Fed raising rates to choke off inflation, municipal bonds should once again become an important staple (core holding) for individuals as well as professionals to generate some positive returns. Yields have been reaching levels not seen in 10 years and investors should consider both investment grade allocations where the curve is steepest along with high yield to augment income. It is far more likely that rates will cease to rise much further and thus stabilize fixed income for decent if not strong returns in the latter half of 2023.
ZHANG: Rome wasn’t built in a day. Inflation is a knife that cuts both ways, and in our space, has resulted in a structurally more expensive baseline for consumers (food, cars, utility bills). The deflationary nature of technology flourishes in this environment – we have only just started seeing the significant earnings growth trajectory materialize for our investments that compete against traditional technologies. 2022 was a bumpy, transitional year. With policy tailwinds at our backs, continued baseline inflation, and stabilizing cost of capital, our investments with competitive moats can finally being to recognize pricing power and sustainable growth, and we are fully here for it.
CASANOVA: Gold may rally ahead of a Fed pivot, as it did during the last tightening cycle. We saw some signs of that in late November and early December. We do not believe the gold price is yet fully reflecting an outlook of sustained higher inflation. Similarly, the gold stocks have been oversold and are trading at valuations that are historically low both for the sector and relative to the gold price. Given the broader market risks we outline, it seems now would be a good time to consider an allocation to gold and gold stocks given their safe haven, inflation protection, and portfolio diversification benefits.
MORRIS: Why add or invest now in commodities and commodity index products? We believe this new commodity bull market that started in 2020 is likely to be a longer term five to 10 year bull market for the reasons outlined above. This year the market consolidated the gains of the first two years and the Q1 price spike from the Russia-Ukraine war. This consolidation could be the pause that refreshes. Investors may have already priced in the full drop in demand from the global economic downturn. A Fed policy shift and possible U.S dollar decline may make 2023 a very good year for commodities and commodity indexes.
REYNOLDS: The last 22 years have shown that natural resource investing has a strategic and tactical role in portfolio construction. Over that time period, natural resource equities have outperformed broader market indices while also providing a distinctive diversification component to a more traditional portfolio – playing the role they are supposed to. From a tactical perspective, we feel that most investors remain under allocated to the space and have not fully benefited from the strong performance over the last two years. The temptation is to feel that the opportunity has passed. However, we firmly believe we are in a multi-year period where moderate inflation will be a norm, companies and industries will remain extremely disciplined with stronger returns and shareholder distributions (dividends and share buybacks) and robust demand for natural resources, the underpinning of an ever-growing global economy, will continue to create a very compelling investment rationale for natural resource equities.
SIGEL: We see cryptocurrencies as a collection of call options on a different financial future, anchored around Bitcoin, Ethereum and stablecoins. With the top 10 digital assets by marker cap down an average of more than 90% from their peak, and multiple obituaries penned about Bitcoin and crypto in the wake of the FTX bankruptcy, these call options are decidedly cheaper and out of favor right now. At the moment, broadly speaking given where valuations are, we prefer liquid tokens like Ethereum over venture capital, where many down rounds are likely lie ahead.
Bitcoin (BTC) is a decentralized digital currency, without a central bank or single administrator, that can be sent from user to user on the peer-to-peer bitcoin network without the need for intermediaries.
Ethereum (ETH) is a decentralized, open-source blockchain with smart contract functionality. Ether is the native cryptocurrency of the platform. Amongst cryptocurrencies, Ether is second only to Bitcoin in market capitalization.
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