As we turn the corner of a new year, it is time to check in with Regions leaders focused on economic and market conditions. Regions Chief Economist Richard Moody, Chief Investment Officer Alan McKnight and Chief Market Strategist Brandon Thurber share their respective insights on the year ahead.
Moody takes a particularly stoic approach in recognizing the improbability of a crystal ball prediction of what the future of the economy and the markets may hold.
“If in your 2022 outlook you had Russia invading Ukraine and thus adding further fuel to already elevated inflation, the FOMC raising the Fed funds rate by over four hundred basis points, TCU in the national title game, mortgage interest rates doubling and sending the housing market reeling, a notably resilient labor market being seen by many analysts and central bankers as more of a threat than as a valued ally in a still supply-constrained economy, and the S&P 500 turning in its worst year since 2008 then, by all means, step right up and present your 2023 outlook.”
–Richard Moody, Regions Chief Economist
“Surging demand in a supply-constrained economy helped push inflation up to a more than four-decade high in 2022, with an unwelcome boost from even higher food and energy prices in the wake of Russia’s invasion of Ukraine,” shared Moody in his January 2023 Economic Outlook “Lots of Stuff May or May Not Happen in 2023.”
Inflation is lower, but still too high
Moody’s take on inflation is that despite declines in the key indexes, it remains considerably higher than the Federal Open Market Committee’s (FOMC) target rate.
“Some of this persistence, however, reflects nothing more than the lag with which falling market rents and now falling house prices will enter into measures of inflation,” Moody said. “But, that will ultimately come, at which point services price inflation will slow materially, thus pulling overall inflation lower.”
He notes that while the FOMC is unconvinced by the declining inflation, he has a different take and sees more progress than cited by Chairman Powell.
“If we use June as a point of demarcation, simply because June marked the peak of inflation, inflation across a host of services categories has been slower since June than it was in the six months ending with June,” said Moody.
Resilient labor market despite aggressive rate hikes
“The FOMC sees reducing the demand for labor as the channel through which it can slow wage growth,” noted Moody. “How that reduction in labor demand manifests itself matters for how the broader economy fares in 2023, with three possible channels – lower job vacancies, reductions in hours worked, and layoffs. What makes this cycle different than past cycles is the role of job vacancies which, while off record highs, remain significantly above the number of potential workers.”
What’s next from the FOMC?
After a fast and furious series of rates hikes, Moody sees the FOMC slowing down as we move forward in the new year.
“We anticipate the FOMC raising the Fed funds rate by twenty-five basis points at their Jan. 31-Feb. 1 meeting, with another like-sized increase possible at their March meeting,” said Moody. “With clear, and at least to us convincing, evidence of the economy slowing, the labor market cooling, and inflation decelerating, we expect the FOMC to wind down its series of rate hikes.”
Moving to the markets
Checking in with Regions Chief Investment Officer Alan McKnight, we look at the volatility of the markets and if that rollercoaster ride will continue in 2023.
“Equity market volatility will remain elevated over the course of 2023, as the market attempts to reset valuation levels on increasingly lower earnings estimates due to stubbornly high costs coupled with slowing revenue growth,” McKnight said. “In that environment, we favor higher quality exposures that can better manage the broader slowdown, as well as domestic over international developed securities.”
Brandon Thurber, Chief Market Strategist at Regions, agrees.
“In 2022, we saw a painful repricing of risky and less risky assets alike, but after a valuation reset investors are now presented with a more attractive opportunity set across which to allocate capital,” said Thurber. “Equity valuations are less demanding, albeit still rich relative to bonds, and interest rates are higher, increasing expected returns for fixed income and select alternative strategies.”
He noted that at the start of 2022, many forecasted a rise interest rates but few fathomed the magnitude and speed at which global central banks sought to extract liquidity from the financial system.
“With short-term interest rates rising substantially in 2022, the starting point for fixed income investors is more attractive and our 7- to 10-year expectations have been ratcheted higher to reflect that.”
In this environment, we believe bond investors will finally be rewarded for allocations that went against them in the past two years and should get back to generating positive returns.”
Alan McKnight, Chief Investment Officer
After experiencing one of the worst bond markets in 50 years in 2022, fixed income investors are finally seeing a light at the end of the tunnel, according to McKnight.
“And there is no train coming – as rates begin to stabilize with the Federal Reserve nearing the end of rate increases that began in 2022,” said McKnight. “In this environment, we believe bond investors will finally be rewarded for allocations that went against them in the past two years and should get back to generating positive returns.”
The fixed income opportunity set holds more appeal than it has at any point in the past decade as higher yields better compensate investors for taking interest rate and credit risk,” Thurber added. “Given the backdrop, we anticipate in 2023, bonds should again become the risk-off asset class of choice. Broadly speaking, bonds offer the most attractive yields we have seen in over a decade, and in the case of investment-grade and high yield corporate bonds, credit quality metrics are encouraging and superior relative to historical norms when entering economic slowdowns/recessions.
McKnight noted that with 2022 being the worst return for a 60/40 (stocks/bonds) portfolio since 1937, expected returns should certainly improve from the current starting point.
“From a total portfolio perspective, we recommend a neutral allocation between stocks and bonds, while also leveraging diversified strategies, when possible, to manage the risk in portfolios and smooth the returns,” said McKnight.
Thurber expects the coming year to be a repeat of 2022 with investors being rewarded for exposures to “quality” factors such as profitability, low leverage, and dividend growth/yield again generate outperformance relative to the broader S&P 500.
“With central banks continuing to tighten monetary policy into the new year, and with short-term rates expected to remain elevated for some time, owning the best and most consistent operators capable of weathering an economic storm should continue to pay off for investors,” concluded Thurber.
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