By Brant Walker
Dear Clients, Colleagues, and Grey Ledge Friends,
Below is a synopsis of our firm’s thoughts and views regarding the economy and investment markets as we enter 2023. Our investment team continually monitors the investment environment and makes changes to your portfolio as time unfolds and economic and market conditions adapt to change in Federal Reserve policy, inflation data, and other relevant factors. We invite you to contact your portfolio manager or advisor if you would like to discuss these issues further.
Thank you for the trust you’ve placed in us.
Grey Ledge Advisors summary and outlook 2023
As we move forward in 2023, the following points relating to the U.S. economy and financial markets will be taken into consideration in the structuring of investment portfolios.
Global trade friction and inventory buildup
During the past few years, there has been a trend toward “de-globalization”, or the desire to bring manufacturing back onto American soil. This has ramifications for the inflation rate as it is generally more expensive to manufacture in the U.S. as opposed to China, for example. This trend may complicate the Federal Reserve’s desire to lower inflation via interest rate increases. In the present, more and more companies are saddled with excess inventory due in part to COVID disruptions in the supply chain, signaling a possible slowing in economic growth.
Should economic growth slow as anticipated, this will favor companies in steady growth sectors such as consumer staples (food, beverage) and health care stocks.
Federal Reserve fight against inflation and rising interest rates
The Fed’s intention to lower inflation is well underway via structured increases in short-term interest rates, namely the Fed funds rate, to slow economic growth and raise the unemployment rate a modest degree. Inflation has been running at 40-year highs, approaching 10% at times in 2022. The Fed target for inflation is the 2% to 3% range. As 2023 unfolds, particularly in the first half of the year, there is likely to be elevated volatility in the financial markets as each inflation-related data point is released in the press and parsed by the investment community.
Past periods of rising interest rates have generally created headwinds for stocks that exhibit real or perceived high growth rates and pay low or no dividends (technology and communications).
Navigating sticky inflation, slower growth, and the possibility of economic recession
The aforementioned intent by the Federal Reserve to lower inflation poses risks to the economy should the Fed push interest rates up further than the economy can withstand. Previous Fed tightening cycles have often led to a period of negative economic growth (a recession) accompanied by a bear market in stocks and ultimately, lower interest rates. We are somewhere in the middle of this cycle as we speak. Grey Ledge’s focus on quality investing should act as a buffer against possible future market volatility.
Having said this, high quality, low volatility common stocks have provided a refuge in the storm. Technology and communications stocks have suffered relative weakness and are becoming attractive on a valuation basis.
Aging populations and a shortage of qualified workers
We speak above about Federal Reserve actions to lower inflation by potentially reducing the near-term growth rate of the economy. From a demographic perspective, major world economies—including the United States, Japan, and much of Europe—are experiencing aging populations and reduced birthrates. This has profound implications for future economic growth as the number of retirees grow and is not offset by an equal number of younger people entering the workforce.
Additionally, many baby boomers have opted to retire early and live off savings and retirement benefits. This, in part, explains why the unemployment rate hovers near a 50-year low at the same time the Fed is attempting to slow the economy and create a temporarily higher unemployment rate.
Should wage growth continue to be strong, companies with pricing power can navigate with little risk to their ability to increase future earnings. Companies with pricing power can be found in many different industries. Grey Ledge Advisors’ research process seeks to identify such companies for potential future investment.
New pockets of value emerge after 2022 market weakness
2022 was a difficult year for both stock and bond investors. The broad U.S. stock market index dropped by close to 20% and the technology heavy NASDAQ index lost a third of its value. High quality, intermediate duration bonds offered little respite by dropping close to 13%. The dichotomy in performance between stock sectors was as wide as at any time since the tech bubble unwound 23 years ago in the year 2000.
Consumer oriented stocks (think food, beverage, health care) fared very well in 2022; in fact, many of these names hit all-time highs. Conversely, anything associated with the name technology likely suffered a precipitous drop in value. Many of the large technology stocks we are all familiar with dropped 50% or more in value. This is understandable during a period of rapidly rising interest rates. Investors tend to gravitate toward stable, blue-chip stocks that pay robust dividends as opposed to some of the tech names that pay no dividends and rely on future earnings growth to support their stock price. As mentioned earlier, we are starting to see value in some of these technology names and plan to reallocate to this area, on the margin, as the year progresses.
As 2023 unfolds we will be carefully monitoring events discussed above and will make adjustments to portfolios as necessary.
Chief Investment Strategist
END OF YEAR MARKET COMMENTARY
By Brant Walker