Summary: We believe we are headed into recession (again) at some point in 2023. It is too early to tell if it will be a “hard” or “soft” landing with respect to the slowdown in economic growth, but history suggests that “soft landings” are few and far between.
Investment Implications: We may see much more volatility and market disruptions as consumers and investors adjust to a new economic environment. Quality, value and dividends should remain important for equity investors, while bond investors, though facing increased volatility, may find themselves in a more “normal” fixed income environment—one in which they may be able to or have the potential to generate an acceptable level of income for the risk they are willing to take.
As we potentially enter a new market regime marked by rising rates, unstable commodity prices and increased volatility, investors should consider incorporating real assets and alternatives into their portfolios for both diversification and potential return purposes.
The current market environment is one of uncertainty and mixed signals—a trend we believe will continue well into 2023. We believe a recession is on the nearer-term horizon, though we do believe inflation has peaked and will trend downward through next year. The Fed publicly states it remains firm in its policy to aggressively curb inflation, but we believe the primary “story” for 2023 will be recession, not inflation. And not just in the U.S.—we believe we are headed toward a global economic slowdown.
In a terrible year for both stocks and bonds, some things have stood out. After years (maybe even a decade or more) of being “in the wilderness,” factors such as value, dividends, size and quality have generally performed much better on a relative basis. We believe this trend will continue throughout 2023, especially in light of increasing economic uncertainty.
This has two explicit implications for advisors and investors:
1. A continued need for diversification4 within the portfolio, both at the asset class and risk factor levels. 2. A re-emergence of active management (or non-cap-weighted beta) within the portfolio. This is a time when advisors and investors have the potential to add real value in their asset allocation, portfolio construction and security selection decisions.
Our current asset class outlook is represented in the graphic below:
Source: WisdomTree, as of 11/21/22. Evaluations are subject to change as market conditions change. This is for illustration purposes only and does not represent investment advice. All evaluations are on a relative and not absolute basis. Red = a negative relative evaluation; gray = a neutral relative evaluation; green = a positive relative evaluation. You cannot invest in an index, and past performance does not guarantee future results.
Our primary investment themes for 2023 are as follows:
1. Investing with Fed-induced volatility and an uncertain inflation regime: + The “Dividend Decade”: we believe value and dividends continue to outperform + Increased importance of quality as the economy cools + Treasury FRNs: potential income without the volatility + Alternatives (including commodities) to seek hedge against inflation risk and volatility in stocks and bonds
2. The return to “normal” in fixed income: + We would prefer to be late than early to the “duration party” + We believe there is income back in fixed income
3. Don’t overlook the opportunity in small caps, where we continue to see attractive valuations
4 Diversification and asset allocation do not guarantee a profit or prevent loss.
Unless otherwise stated, all data as of November 2022.
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There are risks associated with investing, including the possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Investments in emerging or offshore markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments. Funds focusing their investments on certain sectors and/or regions and/or smaller companies increase their vulnerability to any single economic or regulatory development. This may result in greater share price volatility.
Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline.
You cannot invest directly in an index. Index performance assumes reinvestment of dividends but does not reflect any management fees, transaction costs or other expenses that would be incurred by a portfolio or fund, or brokerage commissions on transactions in fund shares. Such fees, expenses and commissions could reduce returns.
This material contains the opinions of the authors, which are subject to change, and should not be considered or interpreted as a recommendation to participate in any particular trading strategy or deemed to be an offer or sale of any investment product, and it should not be relied on as such. There is no guarantee that any strategies discussed will work under all market conditions. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This material should not be relied upon as research or investment advice regarding any security in particular. The user of this information assumes the entire risk of any use made of the information provided herein.
Kevin Flanagan, Rick Harper, Jeremy Schwartz, Scott Welch and Jeff Weniger are registered representatives of Foreside Fund Services, LLC.
WisdomTree Funds are distributed by Foreside Fund Services, LLC, in the U.S.