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Continued turbulence with a better investment climate on the horizon

Continued turbulence with a better investment climate on the horizon

January 19, 2023

Halfway through last year, I wrote here that we had just entered bear-market territory following the worst six-month period the financial markets had seen in decades.

I’d like to be able to report that the second half of the year brought improvement.

But that’s not the case. Financial markets weren’t in much better shape at the end of December than they were in June. U.S. equities delivered their worst 12-month returns since 2008. So did Real Estate Investment Trusts and global stock markets. 

Returns in emerging markets were at the lowest point since 2011, and the U.S. aggregate bond index lost more than 13 percent of its value—its worst year ever.

The reasons are probably familiar by now:

  1. Economic whiplash: The COVID-19 pandemic caused an unprecedented drop in global demand during 2020 for just about everything, followed by an equally historic snap-back that left global supply chains in shambles—and still recovering even today.
  2. War in Ukraine: Russia’s invasion disrupted the supply and transport of everything from oil and gas to steel to essential cereal grains—creating new worldwide shortages of basic commodities.
  3. Inflation: With just about everything in short supply, prices rose around the world. Last summer, the U.S. inflation rate hit a 40-year high of 9.06 percent; and when all the accounting is done, the global inflation rate for 2022 is expected to be about 8.8 percent.
  4. Rising interest rates: The Federal Reserve raised interest rates seven times in 2022 in an effort to cool overall economic activity.

If you’re open to the notion that there is any good news in this, it’s that the problems for the economy in 2022 were essentially limited to Wall Street. While investment returns were miserable, corporate profits were strong, hiring was healthy and consumers were spending money.

The near-term outlook

Many economists are predicting a global recession this year, and the big concern is that it could spill over to Main Street in the form of lower corporate profits, layoffs, stalled housing markets and less economic activity.

But there are a number of factors that argue against that happening. First, if there is a recession, it will be the most anticipated global recession in history. There has been so much focus on the possibility of this recession that much of its potential impact is already reflected in the financial markets.

For example, housing activity has already cooled considerably from its peak in 2020-21—largely attributable to the Fed’s interest rate hikes. And returns on equities have done poorly despite record corporate profits. That’s because stock prices tend to be forward-looking—reflecting the earnings expected nine to 12 months in the future.

American consumers have been putting their house in order too—refinancing mortgages, college loans and other debt to historically low rates. They were well positioned coming out of the pandemic with cash on-hand, rising wages and essentially full employment.

Of course, that’s part of what drove last year’s record inflation in the first place. But it also mitigates the potential effect of a recession by supporting corporate profits and reducing the likelihood of mass layoffs.

So we don’t anticipate that a recession in 2023 will feel the same as the Great Recession of 2008-09, when so many people were out of work and underwater on debt.

Inflation is still likely to have an impact on daily life for the next several months, but it’s been coming down steadily since July. The U.S. inflation rate was 6.45 percent in December, compared to a high of 9.06 percent and an average of 7.04 percent over the past 12 months. Demand for goods and services appears to be slowing gradually, which is what we want to see happen. 

The Fed has already announced that it won’t be cutting interest rates in 2023, so the markets are well informed. We’ll be watching inflation closely, hoping it slows to something close to the target level of 2-3 percent by year-end.

We expect volatility to continue—particularly through the first half of the year. But I don’t think we’re going to decline beyond the lows we’ve already seen, and even if predictions of a global recession prove correct, I believe it’s likely we’ll close out 2023 better off than it started.

Putting this insight to use

From a perspective of financial planning and security, you don’t want to wait on the sidelines until the clouds clear out and the sky turns blue. By that time, you’ll have missed out on the important early gains of the recovery.

At JK Investment Group, we’re both optimistic and cautious. We’re continuing to look for companies with quality balance sheets—alpha generators that can add to investment returns without a significant increase in risk. We’re not ready to look at investing in high-growth companies that don’t have strong cash flow or positive income.

We’ve been following this approach for the past year and will continue for the foreseeable future. We also believe the bond markets have been through the worst of it, and over the course of this year will again become a stable part of a balanced portfolio.

Anthony Kulka is Chief Investment Officer for JK Investment Group, overseeing the firm’s overall research strategy through an approach based on Behavior Evaluation. He uses his strengths in quantitative analysis to translate information into insight. He earned an MBA with a focus on finance at Cleveland State University. Outside of work, he is passionate about Cleveland’s food scene and avid about all things outdoors.