Q4 2022 Capital Markets Outlook Video

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By Walt Czaicki, CFA

Transcription

Hello everyone and welcome to our Q4 Capital Markets Outlook. Clearly, it was a tough third quarter, with the S&P 500 down nearly 5%, adding to the painful year-to-date returns investors have experienced across table. This year there has been no place to hide. The three big issues of the year continued this quarter: persistent inflation, central bank tightening in response to it, and issues surrounding global economic growth.

Starting with the Fed, they have continued their aggressive rate hike path, which is unlikely to wane in the near term. While market expectations also rose for rate hikes, they remained somewhat below Fed projections. This is based on the notion that all this tightening will eventually lead to slower economic growth, which, in turn, could lead to less restrictive monetary policy. But the bottom line is that the Fed would rather err on the side of caution than ease too soon and end up with bigger inflationary problems down the road.

We are already seeing signs that their policy is bearing fruit. For example, transportation costs between regions like the United States and Asia have fallen significantly, and the prices of major goods have fallen from their peaks, especially many commodities. Still, a lingering concern for the Fed is that wage growth and employment costs have accelerated rapidly and show no signs of slowing down yet. This will likely keep the Fed in its tightening phase.

Consequently, we have lowered our forecast for economic growth, while increasing our forecast for inflation and short-term interest rates. With so much going on, many are wondering where things are going and how to invest in both equity and fixed income markets.

So, let’s start with stocks. Earnings estimates continued to climb at the start of the year and then fell in recent months. This is the case for this year, and for 2023, with the exception of the energy sector. Beyond energy being an outlier, utilities saw modest estimate revisions – and both of these sectors represent a significant weighting among value stocks.

But within growth stocks, their year-to-date sell-off not only represents a more attractive entry point, but also a timely opportunity to rebalance, if needed. With all the bad news floating around, this can create a contrarian but good opportunity for investors with intermediate time horizons. At a time when consumer confidence has bottomed out, we have historically seen attractive forward-looking returns for one-year and three-year periods. But the yield opportunities aren’t exclusive to equities — given the higher-yield environment that has enhanced return potential for fixed-income investors. To get a higher return on your fixed income securities, you need yields to rise. And that’s exactly what happened, albeit abruptly. In fact, this is the fastest rising rate environment since the 1970s.

One area of ​​fixed income that looks particularly attractive is US high yield, where the current worst-case yield (which is a very good indicator of 5-year yields) is around 10%. But it’s important to remember that during periods of high-yield bond sell-offs, their subsequent rallies were swift and powerful.

Over the past four decades, high yield bonds have generated an average annualized return north of 8% for investors who have remained committed to the asset class. However, if an investor missed the best month of each year, the returns realized would have been halved.

And if they only missed the best two months of the year, the returns were significantly lower. Right now, this near 10% worst yield is at the high end of the historical US high yield range.

And we are currently close to the high end for some European bonds, as well as higher quality securitized assets.

We know that this period has been very difficult for investors. But, as always, we hope our comments on AB’s best thoughts will help investors get through this difficult time which is truly a marathon, not a sprint.

Original post

Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

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