OUTLOOK 2023 INVESTMENT STRATEGY GROUP - JANNEY MONTGOMERY SCOTT LLC Published: December 15, 2022
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INVESTMENT STRATEGY GROUP
OUTLOOK 2023
JANNEY MONTGOMERY SCOTT LLC
Published: December 15, 2022
TWO-WAY RISK The economy continues to move in a positive fashion even as its cadence stutters at times. The strength of the labor market and the abundant level of savings still held by households provide an impulse for spending—a key driver of domestic activity. However, high inflation and the Federal Reserve’s efforts to thwart its harmful impact have significantly raised the probability of a recession occurring in the coming year. There is the possibility of things going much better than expected, or much worse. In our outlook for 2023, we present the challenges and opportunities that come with this two-way risk.
I N V E S T M E N T S T R AT E G Y G R O U P
OUTLOOK 2023
OVERVIEW
Outlook 2023 offers the Janney Investment Strategy Group’s baseline forecasts for the economy and equity and fixed income
markets in the coming year.
Economy & Equity Markets............................................................................................................................................... Page: 4
• The economy slips into a shallow recession around midyear. While the unemployment rate rises, the labor market
remains sufficiently strong to support consumption.
• Corporate profits may decline marginally year-over-year, which will keep stock prices from advancing in a sustainable
manner until later in the year.
• Commodities, particularly oil and industrial metals, could rise given that tight supplies will underpin prices. The prospects
improve exponentially if China relaxes its stringent COVID measures.
• Evolving geopolitical tensions emanating from relations with Iran and the war in Ukraine, while not an imminent threat,
can emerge as fissures that impart exogenous volatility at any time.
Fixed Income & Interest Rates........................................................................................................................................ Page: 10
• Inflation should decelerate in 2023, but it will likely remain too high for policymakers to quickly cut interest rates as they
have in past downturns.
• For bond markets, the probable outcome is a deeply inverted yield curve with short-term interest rates holding well
above long-term rates, despite economic slowing.
• Although it is tempting to buy shorter-term bonds at higher yields, we see better value in the range of maturities from
five to 10 years—an area where investors can lock in yields for longer.
• Credit fundamentals are unusually solid at this point in the cycle, but we believe an up-in-quality bias will perform better
in the face of a probable economic contraction.
© JANNEY MONTGOMERY SCOTT LLC • MEMBER: NYSE, FINRA, SIPC • JANNEY OUTLOOK 2023 • REF: 889807-1222 • PAGE 3 OF 13
ECONOMY & EQUITY MARKETS
The U.S. economy may flirt with, or encounter, a recession in 2023. The evolution of that
development will likely keep markets volatile until data offer certainty. The signals from
many leading indicators that have been prescient in forecasting a measured economic
contraction portray a gestalt that a downturn is developing.
The lack of excesses in private sector Chart 1: US GDP
leverage, or indebtedness, that typically
precede more severe or protracted recessions
MARK LUSCHINI, CMT gives us reason to believe that if a recession
Chief Investment Strategist
is encountered, it should be relatively mild
President and Chief and brief. If that is the case, financial market
Investment Officer, Janney participants’ fears will be eased.
Capital Management
Mark Luschini serves as
If a recession is avoided because inflation
Janney’s Chief Investment dissipates soon, thereby allowing the
Strategist and leads the Federal Reserve to curb its need to deeply
Investment Strategy Group, tighten policy and restrict economic activity,
which sets the firm’s view on markets would likely inflect bullishly. On (Source: Janney ISG, US Bureau of Economic Analysis)
macroeconomics, as well as
the other hand, if the pace of inflation fails
the equity and fixed income
markets. In addition, Mark to moderate, which further emboldens the the National Bureau of Economic Research
is the President and Chief Fed’s resolve to slay it, the recession that (NBER). They define a recession more
Investment Officer of Janney could ensue may be deeper and lengthier qualitatively and include measures of job
Capital Management (JCM), in nature. In that scenario, financial markets growth, income, and business activity. By that
the asset management may suffer a significant de-rating from measure, a recession has yet to occur (not
subsidiary of Janney
Montgomery Scott. Under current levels. at least since the historically brief one that
his leadership, JCM has lasted two months in 2020) and for as much
delivered competitive results
Investors should be aware of the potential as advertised by pundits and the media,
across its suite of investment conditions that could stem from these one need not be inevitable. Much depends
strategies and grown its different scenarios. on the evolution of inflation and the Fed’s
assets under management
to more than $3.5 billion.
response to it. While perhaps low odds, a
U.S. recession could be avoided if the fever pitch
Mark has spent more than
of inflation breaks hard and quickly.
thirty years in the investment The economy is ending 2022 with a rate
industry. He draws on that of growth that is accelerating from the more Indeed, the economy continues to post
experience to speak on topics tepid pace seen during the year’s first half.
related to macroeconomics
activity that remains quite healthy even as
and the financial markets at After posting two consecutive quarters of there are fissures starting to emerge that
seminars, client events and negative growth (defined by the quarterly foreshadow a slowdown or worse in 2023.
conferences. He is frequently report of the annualized pace of the gross While the monthly report on employment is
quoted in publications domestic product, or GDP), the economy a lagging indicator, it does offer some insight
ranging from the Wall Street expanded at almost a 3% pace in the third into the economy’s momentum. The most
Journal and Barron’s to
the New York Times and
quarter and real-time data for the fourth recent release from the U.S. Bureau of Labor
USA Today. In addition, he quarter indicate a nearly similar tempo. Statistics (BLS) showed job gains in excess
regularly appears in various of 250,000 in the month of November,
media outlets including While the blunt definition of a recession
and that was sufficient to maintain the
CNBC, Fox Business News, being two consecutive quarters of negative
unemployment rate at 3.7%—near its
and Bloomberg Television economic activity was met earlier in 2022,
and Radio. He has an historic low. It is estimated that there needs
that was somewhat misleading as it had
undergraduate degree in to be about 100,000 new jobs created
more to do with trade flows and inventory
Psychology and an MBA each month in order to account for those
in Finance from Gannon destocking than it did with the underlying
entering the workforce for the first time, so
University and holds the and all-important support that comes from
the recent pace of job creation has been
Chartered Market Technician consumer spending. Examining those first
more than enough to absorb new entrants
(CMT) designation from two quarters’ figures, private consumption
the Market Technicians to the workforce, as well as those who are
was positive throughout and remains so. The
Association. marginally attached.
unofficial arbiter of declaring a recession is
© JANNEY MONTGOMERY SCOTT LLC • MEMBER: NYSE, FINRA, SIPC • JANNEY OUTLOOK 2023 • REF: 889807-1222 • PAGE 4 OF 13
Chart 2: US Unemployment Rate Chart 4: JOLTS
(Source: Janney ISG, Bloomberg) (Source: Janney ISG, US Bureau of Labor Statistics)
The pace of job creation also helps contain the rise in the Occam’s Razor is the problem-solving principle of distilling
U.S. Department of Labor’s weekly jobless claims, a leading complex or multiple theories into fewer or simpler
indicator for the state of labor conditions. Unemployment explanations. The U.S. economy is complex and dynamic.
insurance claims have been creeping higher lately, as an However, its growth is driven by consumer spending
increasing number of companies—including those in the that accounts for almost 70% of its ongoing impulse. To
tech and mortgage industries—have announced layoffs oversimplify, get the consumer right and you will get the
due to overly rapid hiring or the impact of the dramatic economy right. The litmus test taken of the consumer, in our
decline in housing activity. Still, those insurance claims as a view, suggests consumers in aggregate are in quite good
percentage of the total U.S. labor force continues to plumb shape. Along with jobs, income growth has been robust,
all-time lows. Also, continuing claims—a count of those who with the latter showing gains of around 5% on average
have been receiving benefits for weeks—are rising but weekly earnings reported from the U.S. Bureau of Economic
slowly implying that jobs are being found and taken fairly Analysis (BEA). Even better, the Atlanta Federal Reserve’s
quickly by displaced workers. Wage Growth Tracker, which is the median percent change
Chart 3: US Initial Jobless Claims in the hourly wage of individuals observed 12 months apart,
is annualizing near a multidecade high north of 6%.
Chart 5: US Personal Income
(Source: Janney ISG, US Department of Labor)
Another indication of the strength of the labor market can (Source: Janney ISG, US Bureau of Economic Analysis)
be surveyed via the monthly JOLTS (Job Openings and
Labor Turnover Survey) report issued by the BLS. Among In addition, consumer bank accounts remain well stocked.
other things, probably the most-watched component is The abundance of savings that accumulated during the
the number of job openings available, especially as it pandemic because of deferred spending and/or fiscal
compares to the number of those unemployed. Today, transfer payments, stands north of $1 trillion. Of course, this
there are more than 10 million unfilled jobs and given the accrued to all income cohorts, but it is those with incomes
total of unemployment at roughly a level of 6 million, the that are amongst the lowest quintile of earners that have
job-openings-to-unemployed ratio is approximately 1.7, near largely used those savings for any number of reasons,
its record high. Once again, this a good sign for job stability including combating the deleterious effects of rampant
and all that comes with it including its residual impact on inflation on their discretionary income.
consumer confidence and consumption.
© JANNEY MONTGOMERY SCOTT LLC • MEMBER: NYSE, FINRA, SIPC • JANNEY OUTLOOK 2023 • REF: 889807-1222 • PAGE 5 OF 13
Yet, roughly 90% of spending comes from those in the top activity, and the National Association of Home Builders
four quintiles, so there remains a considerable amount (NAHB) index reflects the collective sentiment of
of horsepower available to drive consumption, and thus homebuilders as they see activity such as completed
economic activity. Together, jobs and income, as well homes selling and the traffic touring their showrooms.
as a healthy consumer balance sheet, form a formidable Together, these offer insight into prospects for the
foundation upon which consumer-driven activity can housing industry, which is sensitive to interest rates
produce a positive impulse to propel growth going forward. and thus a de-facto proxy for financial conditions.
However, not all is well. The housing market has been The Conference Board’s monthly Leading Economic
on its heels for months. The sharp spike in mortgage Index (LEI) is a widely followed gauge consisting of
rates, basically doubling from the low of around 3.5% 10 components that are viewed as forward-looking
on a standard 30-year note of a year ago until falling indicators of economic activity. Among them are
back below 7% more recently, caused massive sticker credit conditions, the stock market, new orders for
shock for homebuyers. Housing is important because no manufacturing, and consumer expectations. Its utility for
other industry has a similar multiplier effect. The activity signaling the state of the economy in the future is robust.
associated with housing, from residential construction Over the last 50 years, if the LEI went negative on a year-
to labor and materials from suppliers, financial services, over-year basis, a recession usually followed within 12
furnishings, and so on, radiates throughout the economy. months on average. The first negative print occurred in
July 2022 and subsequent months have seen the number
Chart 6: US Housing - Building Permits
deepen further.
The LEI is not infallible—it has had a false positive
in the past. However, the index and other variables,
including the Fed’s current exercise to tighten monetary
policy to help slay inflation, serve as signposts for a
looming recession.
Although monetary officials could swiftly adopt a softer
policy stance if they deemed inflation tamed, and try
to manipulate rates to avoid a recession, their dubious
record under previous regimes suggests the odds
are exceedingly low. In fact, not dissimilar to the LEI’s
predictive value, historically once the Fed raises its
overnight interest rate, a.k.a. the federal funds rate, to a
(Source: Janney ISG, US Census Bureau)
level that is considered tight and slows economic activity,
a recession often ensues in about 12 months. By the
Leading indicators from the housing market are often a Fed’s own measures, interest rates have been restrictive
tell on the broader economy. Two preferred measures for growth since September.
are building permits and homebuilder sentiment. Both Chart 8: US Leading Economic Index (LEI)
have had the propensity to turn in advance of broader
economic activity that follows. Building permits are useful
because they are an indication of future construction
Chart 7: US NAHB Homebuilder Index (SAAR)
(Source: Janney ISG, Conference Board)
It is likely inflation will dissipate over the next year.
Evidence is mounting that supply-chain distortions are
clearing, which accounted for some of the stiff price
(Source: Janney ISG, National Association of Home Builders)
increases that have occurred. Surveys across many
© JANNEY MONTGOMERY SCOTT LLC • MEMBER: NYSE, FINRA, SIPC • JANNEY OUTLOOK 2023 • REF: 889807-1222 • PAGE 6 OF 13industries show shrinking delivery times and the prices INTERNATIONAL
paid for feedstock have fallen precipitously. That should
help shrivel the pass-through to the consumer. Per usual, our primary focus on non-U.S. activity is China.
As the second-largest economy on earth, China’s yearly
Goods prices, which represent less than a third of the growth impulse accounts for more than a fifth of the world’s
Consumer Price Index (CPI), have been deflating for annual GDP. Slowing global growth has weighed heavily
months, relieving a pressure point for overall pricing. on China, which is to be expected given its exports are
The goods category includes items such as computer now close to contracting. Meanwhile, Chinese imports—
equipment, TVs, and furniture. On the other hand, services, a reflection of the country’s fragile property market and
which represent more than two-thirds of the CPI calculation, inhibited consumer—have collapsed. Chinese officials have
have moderated some but are still rising. A contributing instituted myriad, albeit so far timid, stimulus measures this
factor to that is cost of shelter. While price gains in the year and had a marginal impact on stabilizing growth so far,
housing and rental market have begun to ebb, the feed falling short of President Xi’s target of 5.5%.
into the CPI formula operates with a lag of about one year.
Therefore, it will take some time for lower shelter costs to As such, we do not believe that an economic recovery
contribute to lowering inflation readings. in China is likely within the next few months. Certainly,
we expect Chinese policymakers to ease policies further
The risk is that services inflation, which beyond shelter in 2023 to support the economy, but it remains unclear
includes wages across industries such as travel, leisure, whether these policies will merely firm economic activity
and entertainment, remains sticky. After all, one only at middling levels or whether they will cause a significant
has to drive down a commercialized street to see an acceleration in growth. Speculation about China’s
abundance of “Now Hiring” signs posted outside of any relaxation of its dynamic zero-COVID policy is rampant, but
number of enterprises. this will not likely unfold in a meaningful way until the spring
despite ongoing protests in China. Improved vaccination
If services inflation fails to abate, this will likely reinforce the efforts are necessary to ease COVID restrictions. When
resolve of monetary officials to raise rates and hold them at these efforts are successful, the growth prospects for
a sufficiently restrictive level for long enough to stamp out China should rise and the feedback loop to Europe and
inflation and quell consumer expectations of it. The price other developing countries could be pronounced.
to be paid, however, is likely to be a recession perhaps
midyear 2023. While it may not be as severe as those of Chart 9: Chinese GDP
other Fed-induced contractions, unemployment is likely to
rise, nonetheless. Historically, once unemployment rises
by more than 0.5% it usually doesn’t stop there. Indeed,
the Fed’s own forecast calls for the unemployment rate
to reach the mid-4% level next year. That is certainly not
welcome news, and it could cause consumers to retrench
if sentiment erodes. Watching retail sales activity, which has
been remarkably vigorous, will be critical to ascertain if any
negative feedback from rising unemployment is infiltrating
consumer behavior.
A further support for the labor market, even if the
economy slows and businesses adopt a margin-saving
posture, is the scarcity of labor. Businesses could be
reluctant to shed many jobs during a recession because (Source: Janney ISG, National Bureau of Statistics of China)
of fear that the eventual re-hiring effort might be too
costly. The best case would be for the labor markets to Even then, by all accounts President Xi is shifting China toward
loosen, thus softening demand, by reducing the unfilled a more nationalistic state. In his speeches to the Communist
job openings (shown in JOLTS) that exist without trampling Party Congress, Xi’s comments about national security
on the ranks of the employed. That again is plausible, eclipsed those about the economy, market, and reforms,
but unlikely. Having said that, given the current strength underscoring that Chinese policy continues to gravitate
of the labor market, the lack of excess leverage in the toward self-reliance. This could raise tensions in the coming
private sector, the well-endowed state of the consumer, years among allies and adversaries as to where allegiances
and prospects that we could be nearer to the nadir of lie regarding trade, financial support via China’s Belt and
the weakening global backdrop (barring an unforeseen Road Initiative, and military cooperation. A more positive
spark of geopolitical agitation from Eastern Europe, view towards the Chinese economy may be warranted when
Iran, or China), we expect better economic conditions to the second half of 2023 approaches, but only in response
ultimately prevail once past the relatively mild and brief to tangible evidence of a growth catalyst. For now, we urge
downturn we envision for next year. a cautious stance towards China-related investments.
© JANNEY MONTGOMERY SCOTT LLC • MEMBER: NYSE, FINRA, SIPC • JANNEY OUTLOOK 2023 • REF: 889807-1222 • PAGE 7 OF 13The European economy is facing stronger near-term financial market volatility it can unpredictably induce, is a
headwinds than the U.S. economy. The manufacturing and constant threat. While the conflicts mentioned do not as
services sectors are slowing, beset by a massive decline of yet have clear resolutions, there are paths to reduce
in European real wages and a substantial terms-of-trade tensions depending on how they evolve. From a geopolitical
shock precipitated by high energy prices. The decline in risk perspective, it’s a challenge to design an actionable step
real wages means that consumption in the euro area will to be taken except to raise awareness that these “known
likely be weak, and the profitability impact of a sharp rise in unknowns,” as coined by the late Donald Rumsfeld, lurk in
euro-area energy costs will also likely hamper employment the macroeconomic sphere of risks.
growth. In the chart that follows, the Organisation for
Economic Co-operation and Development’s (OECD) INVESTMENT IMPLICATIONS
leading economic indicator for the euro area is falling,
suggesting an uptick in the prospects for growth has yet The following outline demonstrates how we would express
to materialize. our central thesis that the U.S. economy will experience a
recession, but one that is neither severe nor protracted,
Chart 10: OECD Euro Area Composite Leading Indicators
yet nonetheless causes demand to slip as unemployment
rises and inflation to subside. We also assume the Fed’s
narrative will move toward lowering rates, but not actually
do so until late into the year or into 2024. In our opinion, this
suggests that even as growth recovers, it will be slow before
accelerating when monetary officials begin to taper rates.
Overseas, the growth driver will be hinged off China’s
successful application of COVID vaccinations and
treatments, which would allow its economy to reopen
more fully. If, and as that happens, many European and
emerging-market countries will benefit from the increased
trade flow they depend on with China. This could lead to a
shift in equity capital toward international equities, where
valuations are far more compelling than in the U.S., and
(Source: Janney ISG, Organisation for Economic Co-operation and Development) the potential returns are greater should risk premiums in
foreign markets fall as global uncertainty recedes. It should
That said, Europe may have scope to outperform the also reboot the rally in commodity prices that has been
grim prognosis many pundits offer for it. A stabilization underway since fall 2020, but stalled recently as worries
of the European energy market is essential for euro- about global demand propagated markets.
area consumption to improve and news on that front is
• G
lobal Equity Markets – U.S. equities may struggle early
encouraging. European economies are switching their
in the year, as slowing nominal growth and rising costs
mix away from natural gas toward less-costly forms of
weigh on profit margins. As the economy pushes through
energy. France’s nuclear electricity generation should
the downturn, the earnings picture should brighten and
improve next year, subsidizing the need for fossil fuels,
foster a better foundation for stocks to advance. Many
and the fiscal policy backdrop is also supportive by way
foreign markets are more cyclical in nature and have
of the various programs implemented across Europe
fared worse than U.S. stocks. As global activity stabilizes,
to contend with the energy situation. This does not
boosted by a stimulus-induced improvement in China’s
completely offset the encroachment of energy costs to
economy, too-cheap-to-ignore valuations overseas
consumers and businesses, but it goes a long way toward
should draw interest. We look for non-U.S. stocks,
mitigating its impact.
particularly those in emerging markets, to present a
In our judgment, without any further impact from the compelling opportunity later in the year.
Russian-Ukrainian war on Europe’s energy market, the
• Sectors – We find Energy and Metals to be attractive
fate of China’s economy remains the primary driver for
as investable themes around inventory depletion and
European economic activity. European exports to China are
de-carbonization. Also of interest is the housing and
sizable, especially for Germany, Europe’s largest economy.
related industries that have performed poorly given the
Therefore, a growth boost in China from policy-induced
spike in mortgage rates, yet the long-cycle thesis of an
sources or relief from stringent COVID mitigation protocols
undersupplied market remains intact. Biopharma also
would reflect well for Europe’s economic lot.
offers potential as large drug companies face patent cliffs
and have sizeable war chests to replenish their product
OTHER GEOPOLITICAL RISKS stream via acquisition. Technology should be attractive
Russia’s invasion of Ukraine, the possibility of another as decelerating growth tends to favor those companies
Taiwan Strait Crisis, and Iran’s nuclear breakout greatly that are capital-lite and have more predictable cash
reinforce the notion that rising geopolitical risk, and the flows. Additionally, we favor small-company stocks where
© JANNEY MONTGOMERY SCOTT LLC • MEMBER: NYSE, FINRA, SIPC • JANNEY OUTLOOK 2023 • REF: 889807-1222 • PAGE 8 OF 13valuations relative to their larger-company counterparts
Scenario 2: Soft(ish) Landing
are uncommonly low, therefore offering the prospect for
appealing returns. The economy succumbs to the slowdown engineered
by the Fed’s effort to dampen demand and stave off
• Commodities – Ongoing global demand and years of
inflation. While a recession occurs perhaps around
underinvestment are drivers for commodity prices to rise.
midyear, it is neither deep nor lengthy. Later in the year, as
The seemingly continuous risk that a disruption in the
unemployment rises modestly and consumers pull back
tight supply of oil could cause a price spike, let alone
on their spending, the underlying strength in the labor
the strict supply management conducted by OPEC+,
market is sufficient to sustain purchasing power, allowing a
suggests prices offer asymmetrical risk to the upside.
recovery to ensue concurrent with inflation subsiding and
Industrial metals, especially copper for its ubiquitous
the Fed on pause. Stocks typically move higher in advance
usage as an electrical conductor, should benefit from fiscal
of the end of the recession, so weak prices in the first
expenditures on infrastructure both here and abroad, as
half of the year in anticipation of a recession give way to
well as the manufacturing of electric vehicles (EVs) and
strength in the second half. As corporate earnings fall into
alternative fuel sources. Used as a hedge in a diversified
the recession before recovering as prospects brighten in
portfolio, precious metals, namely gold and its higher-beta
the year’s latter half, stocks oscillate within a range before
brethren silver, may be used in part to address the risk of a
ultimately resolving higher. Commodities, particularly oil
geopolitical or inflationary shock.
and industrial metals, advance as years of underinvestment
tighten balances as demand slowly begins to improve. The
VARIOUS ECONOMIC SCENARIOS S&P 500 struggles to surpass 4,300.
AND PROBABLE OUTCOMES
Probability: 55% (our Base Case)
Our prognostication for the U.S. stock market’s path
forward includes three potential outcomes that emanate
from various economic scenarios that could unfold, Scenario 3: What Could Go Wrong Did
assigning a probability to each. In preview, we see a path
for a bullish view to be validated over the course of the Inflation moderates but remains well above the Fed’s
year, even as we may encounter some downside in equity target of 2%. At the same time, consumer expectations
prices early in the forecast window. Our confidence interval related to inflation’s prospects risk coming unmoored. The
between the bull and bear case is wide, given the myriad Fed tightens policy by raising rates well above neutral and
and fluid variables that are shifting rapidly today and will holds them there through the year in a concerted effort to
likely continue to throughout 2023. quell inflation. Even as inflation moderates, falling below
the Fed’s interest-rate setting, the Fed remains resolved
to ensure it does not reignite should policymakers loosen
Scenario 1: The Needle is Threaded prematurely. Financial conditions tighten meaningfully;
businesses devoted to protecting margins shed workers
Inflation plunges, mostly due to clearing supply-chain
in earnest; and consumers retrench to weather unstable
distortions and not crippling demand. As a result, the
labor conditions. Economic activity contracts as is typical
Fed shifts its rhetoric toward a more dovish tone. While
in a Fed-induced recession, and corporate earnings fall
the rate setting may not be reduced until late in the
double digits. With inflation high, economic activity weak,
year, the fundamental support for the economy, namely
and unemployment rising, the definition of stagflation is
consumer spending, stays firm as job stability with
fulfilled. Bonds and cash returns prevail. The stock market
steady and improved real incomes induce higher levels
falls below its recent low in October 2022 and nears
of confidence about the future. The economy averts a
3,200 before rebounding to 3,800.
recession. Inflation fails to reignite as rates remain high
enough to act as a governor on demand but allows Probability: 30%
growth to expand at a moderate pace. After a volatile
and somewhat directionless first half, the S&P 500
begins to discount improving prospects for corporate BOTTOM LINE: ENSEMBLE FORECAST
earnings and a sustained rally develops. Cyclical sectors
lead the rally and commodities rise on better domestic Considering the probabilities around three different but
and global prospects. The market appreciates as rising plausible scenarios, we look for an S&P 500 Index level
earnings estimates accompanied by multiple expansion at 4,195. Our confidence around this outcome is almost a
drive the price to 4,600. coin toss, therefore we are prepared to adjust accordingly
as new information is collected in the coming months.
Probability: 15% Stay tuned.
© JANNEY MONTGOMERY SCOTT LLC • MEMBER: NYSE, FINRA, SIPC • JANNEY OUTLOOK 2023 • REF: 889807-1222 • PAGE 9 OF 13FIXED INCOME & INTEREST RATES
Fixed income markets faced many challenges in 2022, as interest rates increased across
maturities and credit spreads widened. 2023 is poised to offer better outcomes for fixed
income investments.
In reviewing 2022 bond markets, it is Chart 12:
Chart 12: Interest
Interest Rates
Rates Increased
Increased Across
Across Maturities
in Two Separate
Maturities in TwoWaves
Separate Waves
difficult to avoid superlatives. Through mid-
December, return from the U.S. Aggregate 5.00%
5.00%
-11.3%, easily
Bond Index measured -12.6%, easilythe
the 4.50%
4.50%
GUY LEBAS, CFA® worst since the invention of bond indices 4.00%
4.00%
Chief Fixed Income Strategist
in the 1970s. While data are sketchy going 3.50%
3.50%
Director of Custom Fixed back further, some studies point to the worst 3.00%
3.00%
Income Solutions, Janney performance since the 1920s (Morningstar),
2.50%
2.50%
Capital Management 2.00%
2.00%
the 1840s (Prof. Ed McQuarrie), or even 1.50%
1.50%
Guy LeBas is responsible the Washington Administration (Vanguard). 1.00%
1.00%
for providing direction to Whether its 40, 140, or 240 years, suffice it to 0.50%
0.50%
the firm’s clients on the say that bond markets have been particularly 0.00%
0.00%
Oct-21 Jan-22 Mar-22 Jun-22 Sep-22 Dec-22
macroeconomic, interest Oct-21 Jan-22 Mar-22 Jun-22 Sep-22 Dec-22
rate, and bond market troubled in 2022.
(Source: Janney
(Source: Janney ISG,
ISG, Bloomberg)
Bloomberg)
investing climate.
Chart 11: 2022
2022 US
US Bond
Bond Market
Market Total
Total Returns
Returns
Guy authors bond Among Worst Ever fundamentals
strong credit this this risk
year, investor year,aversion
investor
market periodicals which risk aversion
(evident (evident
in equities) in equities)
meant meant a
a sizeable
provide relative value sizeable underperformance
underperformance in corporate
in corporate and otherand
recommendations across 30%
30%
other “risky”
“risky” bonds.bonds. Investment-grade
Investment-grade credit credit
the fixed income spectrum.
Bloomberg named him the 20%
20% spreads rose from a fairly tight +0.92% at
most-accurate forecaster of the beginning of the year to about 1.30%
10%
the Treasuries market in 2015
10%
as of mid-December, leading risky bonds to
and previously recognized underperform and compounding the effects
0%
0%
him as a “Bloomberg Best”
for his work in bond market of higher interest rates. A similar theme
applies for different reasons to mortgage-
-10%
-10% Dec 5,
Dec 5,
Dec 2022:
15,2022:
2022:
forecasting. -12.1%
-11.3%
-12.1%
Prior to joining Janney in -20%
-20%
backed securities, which performed very
2006, Guy served as Interest
Jan
Jan Feb
Feb Mar
Mar Apr
Apr May
May Jun
Jun Jul
Jul Aug
Aug Sep
Sep Oct
Oct Nov
Nov Dec
Dec
poorly and which comprise about 20% of the
Rate Risk Manager for U.S. (Source:
(Source: Janney
Janney ISG,
ISG, Bloomberg
Bloomberg Indices
Indices (((FKA
FKA Barclays
FKA Barclays Indices
Indices &&
Barclays Indices Lehman
& Lehman Indices))
Lehman Indices))
Indices)) Aggregate Index.
Trust’s bank asset and liability
portfolios, a role in which he Chart 13: Credit
Credit Spreads
Spreads Moved
Moved Steadily
Steadily Wider
Wider
oversaw risk and return on
The reasons for negative
negative returns
returnsare
aretwofold:
twofold. Alongside the Spring and Fall Equity Market Selloffs
an $11 billion balance sheet. First, interest rates across maturities are
First, interesthigher,
significantly rates across
largelymaturities
a functionareof 175bps
175bps 650bps
650bps
He received his education
from Swarthmore College significantly
Federal higher,
Reserve largely
rate hikesathat
function of
brought 165bps
165bps 600bps
600bps
and is a CFA Charterholder. Federal Reserve
overnight interestrate hikes
rates fromthat brought
zero to
155bps
155bps 550bps
550bps
overnight interest rates from zero to 4.50% 145bps IG Credit
IG Credit Spreads
Spreads
145bps 500bps
4.50% at year end. As of mid-December, HY
HY Credit
Credit Spreads
Spreads 500bps
135bps
at year end. As of mid-December, 10-year
135bps
450bps
benchmark 10-year Treasury yields were
450bps
125bps
125bps
bond yields were trading about 3.50% 400bps
trading about 3.60% after a +2.10% increase,
400bps
115bps
115bps
after a +2.0% increase, while 2-year yields 350bps
350bps
while 2-year Treasury yields were trading
105bps
105bps
were
at abouttrading
4.30% about
after 4.20%
a +3.55% after a +3.5%
increase—
95bps
95bps
300bps
300bps
increase—one
one of the largest of the
moves largest moves Fed
on record. on 85bps
85bps
250bps
250bps
record. Fed tightening is, in turn, a function
75bps
75bps 200bps
200bps
tightening is, in turn, a function of stubborn
Oct-21
Oct-21 Jan-22
Jan-22 Mar-22
Mar-22 Jun-22
Jun-22 Sep-22
Sep-22 Dec-22
Dec-22
of stubborn core inflation, which will end the
core inflation, which will end the year (Source: Janney
(Source: Janney ISG,
ISG, Bloomberg)
Bloomberg)
year slightly above 6% year-over-year (YoY).
slightly above 6% year-over-year (YoY). In
In the Outlook 2022 fixed income article, we
the Outlook 2022 fixed income article, we If bond markets were a function of Fed
highlighted good odds of significantly higher
highlighted good odds of significantly higher tightening in 2022 and Fed tightening was
interest rates
interest rates in
in 2022,
2022, butbut the
the degree
degree ofof the
the
moves far exceeded even our bearish case. a function of inflation, it stands to reason
moves far exceeded even our bearish case. that the most significant economic variable
Second, credit spreads on corporate bonds in 2023 will also be inflation. While core
Second, credit spreads on corporate bonds
are significantly wider in 2022. Despite inflation has remained elevated through
are significantly wider in 2022. Despite
© JANNEY
© JANNEY MONTGOMERY
MONTGOMERY SCOTT
SCOTT LLC
LLC •• MEMBER:
MEMBER: NYSE,
NYSE, FINRA,
FINRA, SIPC
SIPC •• JANNEY
JANNEY OUTLOOK
OUTLOOK 2023
2023 •• REF:
REF: 889807-1222
889807-1222 •• PAGE
PAGE 10
10 OF
OF 13
13October 2022, there are signs that many components Table 1: U.S. Interest Rate Forecasts
are easing. For example, healthcare costs in the CPI were
steeply positive in 2022, but will flip to somewhat negative Date
Date FedFunds
Fed Funds 2yrUST
2yr UST 5yr
5yrUST
UST 10yr UST
10yr 30yr30yr
UST 2s10s 5s30s
5s30s
in 2023, peeling 0.05% each month from consumer prices. Target
Target UST UST
Private indices of rental rates are showing deceleration. 12/30/2022
12/30/2022 4.25
4.25- -4.50
4.50 4.30
4.25 3.85
3.70 3.80
3.60 3.85
3.60 -0.50
-0.65 0.00
-0.10
Moreover, leading indicators of core inflation, such as 3/31/2023
3/31/2023 4.50
4.50- -4.75
4.75 4.15
3.95 3.75
3.55 3.60
3.30 3.70
3.50 -0.55
-0.65 -0.05
commodities prices, are outright declining.
6/30/2023
6/30/2023 4.50
4.50- -4.75
4.75 3.95
3.65 3.65
3.45 3.55
3.15 3.70
3.50 -0.40
-0.50 0.05
Chart 14:
Chart 14: Inflation
Inflation Markets
Markets are
are Pricing
Pricing CPI
CPI (All
(All Items)
Items) to Decline to 3% 9/30/2023
9/30/2023 4.50
4.50- -4.75
4.75 3.75
3.45 3.55
3.35 3.45
3.10 3.70
3.50 -0.30
-0.35 0.15
YoY
to in 2023
Decline to 3% YoY in 2023
10.00%
10.00% 12/31/2023
12/31/2023 4.25
4.25- -4.50
4.50 3.55
3.25 3.50
3.30 3.40
3.00 3.70
3.50 -0.15
-0.25 0.20
9.00%
9.00% 12/31/2024
12/31/2024 3.25
3.25- -3.50
3.50 3.05
2.85 3.35
3.15 3.25
3.05 3.70
3.50 0.20
0.20 0.35
0.35
8.00%
8.00%
(Source:
(Source: Janney
(Source: Janney ISG)
Janney ISG)
ISG)
7.00%
7.00%
6.00%
6.00% which in many ways makes the current inversion stranger.
5.00%
5.00% Stranger still, we anticipate the inversion could last through
4.00%
4.00%
the end of 2023. The last time the curve was this inverted,
it returned to positive slope in just three months!
3.00%
3.00%
2.00%
2.00% Reported
Reported CPI
CPI Inflation
Inflation Implied
Implied by
by Inflation
Inflation Swap
Swap Fixings
Fixings
With short-term yields significantly above long-term yields,
1.00%
1.00%
the temptation to buy shorter-term bonds with less interest
Sep-21
Sep-21 Dec-21
Dec-21 Mar-22
Mar-22 Jun-22
Jun-22 Sep-22
Sep-22 Dec-22
Dec-22 Mar-23
Mar-23 Jun-23
Jun-23 Sep-23
Sep-23 Dec-23
Dec-23 Buffett-ism,yield
rate risk is high. But, to twist a Buffet-ism, yieldisiswhat
whatyou
you
(Source:
(Source: Janney
(Source: Janney ISG,
Janney ISG, Bureau
ISG, Bureau of
of Labor
US Bureau Labor Statistics,
Statistics,
of Labor Bloomberg)
Bloomberg)
Statistics, Bloomberg)
buy, value is what you get. In today’s market environment,
the biggest risk in our view is no longer interest-rate risk,
These indicators make it likely that the CPI will decelerate, but rather reinvestment risk. In 2023 (or 2024 or 2025),
even as economic growth wanes. On the topic of growth, interest rates will likely be lower than they are today, and
interest-rate-sensitive sectors of the economy such as investors who buy short-term bonds today will be faced
housing and auto sales are already flagging. While the with reinvesting at lower yields when those bonds mature.
impact of slowing sales takes some time to be felt (e.g., Table 2:
Table 2: Rolling
Rolling Short-Term
Short-Term Bonds
Bonds Creates
Create Reinvestment
ReinvestmentRisk
Riskifif
construction industries have yet to shed any jobs), there is Rates Fall
Rates Fall
a very high probability of a significant contraction in these
sectors that could expand into the broader economy. Dec-22 (Act) Dec-23 (Proj) Dec-24 (Proj) 3yr Avg. Yield
We can envision a scenario in which industry-specific 1yr T-Bill 4.70% 3.60% 2.60% 3.63%
contraction does not lead to a recession, but that scenario
is the exception, not the rule. Ultimately, by raising interest
rates rapidly, the Fed has engineered a recession in order (Source:
(Source: Janney
(Source: Janney ISG)
Janney ISG)
ISG)
to control inflation.
As inflation fades, growth slows, and rates reach their The simple way to reduce reinvestment risk is to avoid
highest levels in 15 years, the question for bond markets short-term maturities, despite their headline appeal. We
becomes: What will the Fed do about it? Nothing, probably. prefer the 5-to-10-year portion of the yield curve, which is far
Fed Chairman Jerome Powell has repeatedly highlighted enough out to avoid the most problematic reinvestment risk,
what he views as the error of the 1970s, namely that the but short enough to avoid the swings in market value from
Fed declared high inflation “over” and then eased too very long-duration bonds in a still-volatile climate. Finally,
quickly, exacerbating long-term inflation risks. While we the 5-to-10-year part of the curve provides significant carry,
think the February rate hike will be the last in this cycle, it regardless of which way interest rates move in the coming
is premature to expect cuts. Given Powell’s perception, we 12 months. Our outlook for economic growth is cautious,
instead expect the Fed will remain on hold for most if not and historically that outlook has also proven challenging
all of 2023, bearing
barring aa surprisingly
surprisingly deep
deep downturn.
downturn. ItIt might
might for leveraged credits. Accordingly, we prefer higher-quality
take a year of persistently near or below 2% core inflation investment-grade issues, a preference that generally holds
before Powell is willing to pull the trigger on cuts. across corporate and municipal sectors.
For the level of term interest rates, a not-ready-to-cut CORPORATE CREDIT
Fed is likely to create an unusually deeply inverted yield
curve that progresses forward without de-inverting. With On a fundamental basis, leverage across investment-grade
the spread between the 2-year and 10-year Treasury yield and high-yield credit sectors is still relatively low. Moreover,
(-0.75%), we are already at that point, but we see a chance the high-yield sector has a lot of liquidity runway as there
of a deeper -1.00% 2s/10s inversion early in the new year. are virtually no maturities among index-eligible high-yield
The last time the curve was this inverted, in the early 1980s, names in 2023 or 2024. Historically, however, lower
the absolute level of interest rates was far higher (11%+), credits have struggled in terms of investor perception in
© JANNEY MONTGOMERY SCOTT LLC • MEMBER: NYSE, FINRA, SIPC • JANNEY OUTLOOK 2023 • REF: 889807-1222 • PAGE 11 OF 132012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2021 2022
(Source: Janney ISG, Bloomberg)
MUNICIPAL CREDIT
One area of the markets that fared poorly in the spring but
weak
has held economic environments
up surprisingly well inlike
the the
fall one we will
of 2022 haslikely
been Going forward, we expect muni ratios to have limited room
face in 2023. With current spreads at +1.30%
the high-grade municipal markets. Muni/Treasury ratios (investment- for further improvement, but the lack of supply should also
grade)
startedand the +4.50%
year well(high-yield)
lower thanabove Treasuries,
historical averages onand prevent any sharp widening—barring another round of
top of andup
rocketed slightly
abovetighter
100% than
in thethe long-term
10-year averages
maturity range. more severe risk-off activity in overall financial markets. Our
respectively,
Ratios have sincethereretreated
remains scope
as muni forissuance
wideningdived,
and credit preference in munis is like that in investment-grade credit:
underperformance.
creating a favorableHolding higher-quality
supply dynamic namesthe
that helped willsector Avoid reinvestment risk from maturities in 2023-2025
help reduceinthe
outperform theimpact of further
subsequent six spread
months.widening—and
At present, muni with higher-grade 5-to-10-year holdings as a way to take
itrelative
doesn’tvaluations
hurt that income generation
are in the even but
neutral range, amongtherehigh-
are no advantage of greater carry.
grade
obvious bonds is near
negative decade highs.
catalysts.
Chart 15:
SUMMARY
16: Historically, Credit Spreads Continue to Widen through the
First Halfthe
through of an Economic
First Downturn
Half of an Economic Downturn In brief, after an extremely tough 2022 for fixed income
1500bps
investors, we anticipate smoother sailing with respect
to interest rates in the coming year. The period of rapid
1300bps
Recession
Fed rate hikes is coming to an end, which should reduce
1100bps
6m Change IG Credit Spreads volatility. Even though we believe cuts are further in the
future than the market is pricing, the odds fall in the favor
900bps 6m Change HY Credit Spreads
700bps
of lower, not higher, interest rates in 2023. Still, given the
500bps probability of a recession or near-recession, we hold an
300bps up-in-quality bias across sectors and anticipate that higher-
100bps grade credits and municipals will broadly outperform lower-
-100bps grade ones in the coming year.
-300bps
-500bps
1995 1998 2000 2003 2006 2009 2011 2014 2017 2020 2022
(Source:
(Source: Janney
Janney ISG,
ISG, Bloomberg)
Bloomberg)
MUNICIPAL CREDIT
One area of the markets that fared poorly in the spring
but
weak held up surprisingly
economic well
environments
© inMONTGOMERY
JANNEY the fall
like the of one
SCOTT2022LLC • is
we will the
likely
MEMBER:
Going forward, we expect muni ratios to have limited room
NYSE, FINRA, SIPC • JANNEY OUTLOOK 2023 • REF: 889807-1222 • PAGE 12 OF 13
high-grade municipal markets. Muni/Treasury
face in 2023. With current spreads at +1.30% (investment- ratios for further improvement, but the lack of supply should also
started
grade) andthe year
+4.50% well(high-yield)
lower thanabove historical averages
Treasuries, onand prevent any sharp widening—barring another round of
rocketed
top of andupslightly
abovetighter
100% in thethe
than 10-year
long-term maturity range.
averages more severe risk-off activity in overall financial markets. Our
Ratios have since
respectively, thereretreated as muni
remains scope forissuance
widening dived,
and credit preference in munis is like that in investment-grade credit:
creating a favorableHolding
underperformance. supply dynamic
higher-qualitythat helped namesthe willsector Avoid reinvestment risk from maturities in 2023-2025
outperform
help reduceinthe theimpact
subsequent six months.
of further spread widening—and At present, muni with higher-grade 5-to-10-year holdings as a way to take
relative
it doesn’t valuations
hurt that are
incomein the neutral range,
generation evenbut amongtherehigh-
are no advantage of higher carry.
obvious
grade bonds negative catalysts.
is near decade highs.
In brief, after an extremely tough 2022 for fixed income
Chart 16:
15: 10yr AAA Muni/Treasury Ratios are in the “Neutral” Range, investors, we anticipate smoother sailing with respect
although Absolute Yields are Near the Highest in Years to interest rates in the coming year. The period of rapid
Fed rate hikes is coming to an end, which should reduce
190%
volatility. Even though we believe cuts are further in the
170%
future than the market is pricing, the odds fall in the favor
of lower, not higher, interest rates in 2023. Still, given the
150% probability of a recession or near-recession, we hold an
130%
up-in-quality bias across sectors and anticipate that higher-
grade credits and municipals will broadly outperform lower-
110% 2Q 2017 - 2Q 2019 Avg
4Q 2022 Avg
80% grade ones in the coming year.
83%
90% Historically Cheap
Historically Neutral
70%
Historically Rich
50%
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2021 2022
(Source:
(Source: Janney
Janney ISG,
ISG, Bloomberg)
Bloomberg)
MUNICIPAL CREDIT
One area of the markets that fared poorly in the spring but
© JANNEY MONTGOMERY SCOTT LLC • MEMBER: NYSE, FINRA, SIPC • JANNEY OUTLOOK 2023 • REF: 889807-1222 • PAGE 12 OF 13
has held up surprisingly well in the fall of 2022 has beenDisclosures Definition of Ratings
This is for informative purposes only and in no event should be construed Overweight: Janney ISG expects the target asset class or sector to
as a recommendation by us or as an offer to sell, or solicitation of an offer outperform the comparable benchmark (below) in its asset class in terms
to buy, any securities. The information given herein is taken from sources of total return.
that we believe to be reliable, but is not guaranteed by us as to accuracy Marketweight: Janney ISG expects the target asset class or sector to
or completeness. Opinions expressed are subject to change without perform in line with the comparable benchmark (below) in its asset class in
notice and do not take into account the particular investment objectives, terms of total return.
financial situation, or needs of individual investors. Employees of Janney
Montgomery Scott LLC or its affiliates may, at times, release written or oral Underweight: Janney ISG expects the target asset class or sector to
commentary, technical analysis, or trading strategies that differ from the underperform the comparable benchmark (below) in its asset class in
opinions expressed here. terms of total return.
Returns reflect results of various indices based on target allocation
weightings. Weightings are subject to change. Index returns are for Benchmarks
illustrative purposes only and do not represent the performance of any
investment. Index performance returns do not reflect any management Asset Classes: Janney ISG ratings for domestic fixed income asset classes
fees, transaction costs, or expenses. Indexes are unmanaged, and you including Treasuries, Agencies, Mortgages, Investment Grade Credit, High
cannot invest directly in an index. Yield Credit, and Municipals employ the “Barclays U.S. Aggregate Bond
Market Index” as a benchmark.
Performance data quoted represents past performance and is no
guarantee of future results. Current returns may be either higher or lower Treasuries: Janney ISG ratings employ the “Barclays U.S. Treasury Index”
than those shown. as a benchmark.
This report is the intellectual property of Janney Montgomery Scott LLC Agencies: Janney ISG ratings employ the “Barclays U.S. Agency Index” as
(Janney) and may not be reproduced, distributed, or published by any a benchmark.
person for any purpose without Janney’s prior written consent. Mortgages: Janney ISG ratings employ the “Barclays U.S. MBS Index” as a
This presentation has been prepared by Janney Investment Strategy benchmark.
Group (ISG) and is to be used for informational purposes only. In no Investment Grade Credit: Janney ISG ratings employ the “Barclays U.S.
event should it be construed as a solicitation or offer to purchase Credit Index” as a benchmark.
or sell a security. The information presented herein is taken from High Yield Credit: Janney ISG ratings employ the “Barclays U.S. Corporate
sources believed to be reliable, but is not guaranteed by Janney as to High Yield Index” as a benchmark.
accuracy or completeness. Any issue named or rates mentioned are
used for illustrative purposes only and may not represent the specific Municipals: Janney ISG ratings employ the “Barclays Municipal Bond Index”
features or securities available at a given time. Preliminary Official as a benchmark.
Statements, Final Official Statements, or Prospectuses for any new
issues mentioned herein are available upon request. The value of and
income from investments may vary because of changes in interest rates, Analyst Certification
foreign exchange rates, securities prices, and market indices, as well We, Mark Luschini and Guy LeBas, the Primarily Responsible Analysts for
as operational or financial conditions of issuers or other factors. Past this report, hereby certify that all views expressed in this report accurately
performance is not necessarily a guide to future performance. Estimates reflect our personal views about any and all of the subject sectors,
of future performance are based on assumptions that may not be industries, securities, and issuers. No part of our compensation was, is, or
realized. We have no obligation to tell you when opinions or information will be, directly or indirectly, related to the specific recommendations or
contained in Janney ISG presentations or publications change. views expressed in this research report.
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