3 Trends They're Seeing For 2023
Did somebody say paradigm shift?
For the first time in more than a decade, the investing world is undergoing a fundamental shift. In the midst of a new interest rate regime, my guest Kristy Akullian (BlackRock investment strategist extraordinaire) joins me to unpack the implications of what the Fed’s moves—and broader economic conditions—might mean for markets.
Hint: There’s probably an asset class or two partially or totally absent from your portfolio right now, thanks to the overwhelming S&P 500 dominance of the last 10 years.
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Katie: 2022 saw a marked shift in US monetary policy, and the US economy and stock market are reacting accordingly. In December 2022, BlackRock released their 2023 investor guide, with three key takeaways for this paradigm shift. Today I'm breaking it down with the help of Kristy Akullian, a senior strategist for BlackRock's iShares investment strategy.
Welcome back to The Money with Katie Show, Rich Girls and Boys. I'm your host, Katie Gatti Tassin. Before we dive into this week's episode, I wanna disclaim that nobody has a crystal ball, not even BlackRock, despite being the world's largest asset manager, with $10 trillion under management as of January 2022. We will link their full 2023 outlook in the show notes of this episode, for those who would like to peruse on their own. But I've got a very special guest here today to help me break it down.
Kristy Akullian: Hi, I'm Kristy Akullian, and I am the director of investment strategy at iShares at BlackRock.
Katie: That being said, this is not investment advice. It should not be taken as such. It's merely an exploration of BlackRock data for what they think is coming in 2023. To start, I wanna read you the opening takeaway for their breakdown with some editorializing of my own, as it boils down to three key themes. All right, this is a long quote, so stick with me. “The investing regime we have long known has changed. Over the past 15 years, accommodative Central Bank monetary policy”—so think zero interest rate policy—“had shaped asset allocation, encouraging investors to add risk in search of yield. The prolonged period of low, stable rates resulted in a fundamental shift away from fixed income and towards high-growth equities.”
A little aside from me: It's kind of the reason that you see people touting 100% S&P 500 portfolios with nary a bond in sight. All right, back to the quote. “We believe that the regime of lower rates for longer has transitioned to a regime of higher rates for longer, bringing with it profound implications for portfolio construction. The post-pandemic inflationary shock brought a rapid rise in US interest rates, with the Fed funds rate moving from 0.25% to 4% in a span of just nine months, punishing equities and fixed income alike. In 2022, a portfolio comprising 60% equities and 40% bonds returned -16.8% through the end of October 1st, the worst annualized performance since 1937. The rapid normalization of monetary policy has brought about a reset across asset classes that has created incredible opportunities, particularly in fixed income markets.” So this means bond markets. “Today an investor can potentially earn over 5% coupon in a low-duration, high-quality fixed-income bond, underscoring the enhanced role that bonds can play in an investor's overall portfolio. Higher yields and fixed income also means that investors do not need their equity allocations to work as hard, and within their equity allocations they can focus on earnings resiliency in the face of an uncertain economic environment.” End quote.
Okay. I know that was a lot. That was a lot of fancy investor-speak, and I have some of my own thoughts that we're gonna dig into, but I did ask Kristy to give me her best attempt at summarizing that in her own words in a sentence or two.
Kristy Akullian: It's a good place to start. Just to level-set and to go back a little bit, the way that I think about it is that 2021, in terms of market returns and investing, was really an outlier. 2022 was awful, and 2023 is gonna be complicated. So what we're looking at, and kind of the themes that we have identified in the mid-year, or sorry, the year-ahead outlook that we just published, what we're trying to do is be a lot more nimble in terms of the risks that we're gonna take, because we don't think that the whole year is gonna look the same.
So we call it a one-year-ahead look ahead, a one-year-ahead guide. Really, I think you can think about it in terms of quarters or in halves. We're really continuously watching to see what macro factors change, because we think there's some big stuff ahead of us. You know, the biggest one of the things ahead of us that I think is a risk is recession. At BlackRock we are calling for a recession next year. I think that where we saw the Federal Reserve for their December FOMC [Federal Open Market Committee] meeting, it sounds like they are too. So really what we're thinking about is how to construct a portfolio that is both almost recession-proof and inflation-proof. 'Cause those are the two things that we think we're gonna be living with in 2023.
Katie: We'll be right back after a message from the sponsors of today's episode.
The biggest story in finance and personal finance this year? The Fed. This first central theme, that we need to rethink the role of bonds in our portfolios, stems from this idea that based on what the Federal Reserve has all but declared it's trying to do, a recession is looking like a near-guarantee. So a little background. The Fed tries to make borrowing money more expensive when inflation is high to essentially get people to spend less. They want fewer dollars chasing the goods available. Now, this approach has been criticized by me and others, because in a lot of ways it seems like they're trying to force unemployment, and that tends to more negatively impact people who skew lower to middle income. But as we've discussed before, it's a rock and a high inflation print hard place, because inflation also hurts wage workers. I published a blog post about this last month. We'll link it in the show notes. It's called “The Pain of a Forced Recession.” It's a ranty deep dive into the irrationality of labor markets. It's a little more sassy and cynical than usual, and kind of light on the solutions. So consider yourself warned.
But anyway, where do bonds come into this? Well, when the Fed funds rate rises, so do bond yields. BlackRock's research is projecting that it's very unlikely that we'll see inflation return to pre-pandemic levels in 2023, and as a result, they have two major takeaways. Number one: Put your cash to work through ultra-short-duration securities. And number two: Bonds are back. For example, in 2021, and to this report's point, for much of the last like 10 to 15 years, you would earn 0.2% yield on a US six-month T-bill. In 2022, it yielded four and a half percent. If that is your risk-free rate of return, why would an investor who's trying to reliably generate income from their investments opt for all equities? How the turn tables, right? A lot of the criticism of the 4% rule—which is the guideline that determines a safe withdrawal rate for retirees, that says you should be able to withdraw 4% of a 60/40 portfolio annually and never deplete it 96-ish percent of the time—hinged on a zero interest rate environment. The criticism claimed that in a world where fixed income yielded nothing, the 4% rule was dead. Well, maybe not anymore. Does this mean you should blow up your entire portfolio? Well, maybe, but maybe not. Here's Kristy’s take.
Kristy Akullian: So we kind of have this joke internally that, you know, it's been a thing that people have been talking about in markets for a long time. It was called TINA: “There is no alternative.” And so TINA was sort of the name of the game for the last 15 years. We're saying TINA's out and BARB is in. “BARB” meaning bonds are back. So that's kind of the tagline for how we're thinking about the year ahead, and even, you know, multiple years ahead. So I guess the TINA world was really characterized by this need to add a whole bunch of risk in a portfolio to get a decent return. So the world as it looked like in the past, sort of pre-pandemic, pre-interest rate hikes, meant that most things went up and they went up in tandem, but bonds didn't offer that much in terms of yields. So bonds were in this incredible 40-year bull market, which means the price went up, but the yields went down. So bonds just really weren't a very viable option in most investors' portfolio. So when we spoke to investors—in particular, you know, kind of back to that 54-year-old that you were talking about earlier, and especially on the retirement end of the spectrum—a lot of investors held bonds almost as a necessary evil. They thought of 'em as a hedge in their portfolio for when stocks went down, bonds were supposed to go up.
You know, 2022 was really, really difficult for a lot of investors because everything went down together. But where we are now, bonds have gone down so far that the yields are really attractive, and I think that that can be attractive even for a 24-year-old. Instead of just thinking about it in terms of age breakdown, I would think about it in terms of risk profiles. So, you know, not every 24-year-old wants to add a whole bunch of risk. Not all of their investment is necessarily gonna be super long-term in nature. I think what's attractive about bonds right now is that you can get something much closer to a guaranteed return. It's not gonna be the 30% that we saw in the stock market last year, but it might be 5%.
And so if you're thinking about, you know, as a 24-year-old, are you investing just for retirement, or are you investing to buy a house down the line? Do you have near-term investment goals? I think that bonds can fit really nicely into that sort of an allocation and a way to reach those goals.
Katie: We'll be right back after a message from the sponsors of today's episode.
So there you have it. Here's my take: I am not going to sell equities at a loss to rebalance, but I may consider what I'm going to call “buy side rebalancing” in some of my accounts that are designated for short- to medium-term goals, where new cash that I add will bolster the bond allocation in my portfolio. So that's something I'll probably try to revisit when I do my annual asset allocation check-in at the end of this month.
Theme two is pricing the damage. So to quote the report, “stock prices are a function of earnings, interest rates, and risk sentiment.” End quote. For the last decade, because of the interest rate environment, growth stocks—so think FAANG—have soared, because it was cheap to borrow money and make big bets for the future. But in a more defensive environment like the one we're in now, the report points to sectors like healthcare—which, okay, I have some moral qualms with that one—and energy. The idea is that it's time to focus on the quote “real economy.” So industrial production, durable goods, aka, get your head out of the metaverse’s ass and back into real life.
One thing that jumped out at me in the report was this emphasis on value segments of the market, as represented by the Russell 1000 value and small-cap equities. So I asked Kristy if she thinks the “value premium,” which is the overperformance of traditionally undervalued equities, is back.
Kristy Akullian: I would say the tagline for that one, if we're gonna boil things down into the simple tagline, is that stocks are mostly expensive. So the higher, you know, overarching theme of what we've looked at is valuations across the entire stock markets, before we slice and dice it into the values versus growth components and the capitalization differences. What we see at kind of the broad stock market level, so looking at the S&P 500 as sort of our benchmark, is that over the last year and a half we've seen that valuations—and for this we're just looking at price to earnings ratios—valuations have come back down to about the 10-year average. So where they've been. Call that 17, 18 times earnings. But what stands out to us is we don't think we're in an average economic environment. If we're heading into a recession, stocks should be much cheaper than average. So that, you know, at the kind of the headline level, they still look pretty expensive, and they don't seem, you know, like a huge opportunity in our mind at current prices.
But digging in a little bit more, we do see opportunity within value, and there's a few reasons for that. So yes, you know, I think that value gets a bad rap, especially for the younger generations who haven't actually been alive while it performed well. Part of that is just because value tends to perform well when interest rates are high and rising, and when inflation is high. And we haven't had both of those scenarios for the last 15, 20 years. So yes, value has not been a recent strong performer, but it has been pretty good this year. So if you think about what types of stocks make up the value side of the equation within a broader index, it tends to give you exposure to sort of the more…the real economy. So these are older, more mature companies.
The antithesis of that is thinking about tech and growth stocks. So growth stocks in particular are really, really geared towards, are sensitive to the consumer, and where we're starting to see cracks, and kind of what signals to us that we might be heading into our recession relatively soon, is that we're starting to see cracks in the consumer balance sheet. All of 2021, what we talked about was that, especially in the US, consumers were in this really great position because they built up a huge amount of savings during Covid. You know, we don't need to relive the Covid days, but we know there wasn't a whole lot to spend money on, and a lot of people benefited from stimulus checks. So we saw the consumer, you know, in a really good place, even just in the last couple months.
So towards the end here of 2022, we've seen a lot of that draw down. That used to be sort of dry powder that could be put into the stock market, and kind of push that higher. But we've seen the savings rate draw down, and we've seen the consumer debt tick up. So if we start to see cracks in the consumer and in terms of how they can spend, and sort of personal income as well, those are the types of stocks, growth stocks, that are gonna be really hurt by that. So value is a little bit more positioned in terms of where we see strength within the economy, and also we just seem to, it just does look much more reasonably priced. So value stocks look like they're expecting a recession. Growth stocks do not.
Katie: What went mostly unnoticed in the last decade and then came back with a vengeance? Inflation. Our last and final theme: living with inflation. Yay. The Fed has an inflation target of 2% per year, right? So on that note, actually, I wanna share an interesting perspective on inflation being a good thing from my friend Nick Maggiulli. He writes, “No currency should be able to buy the same basket of goods over very long time spans through hoarding. If you wanna retain the purchasing power of your money, it should participate in society via investment.”
Now I had never heard this perspective before, so I thought it was worth sharing. But anyway, BlackRock is predicting further easing of supply chain constraints, which would push the cost of goods down.
Kristy Akullian: It's one of the more complicated areas of the financial markets just to understand, because the mechanics of it really matter. So Treasury Inflation-Protected Securities are bonds that the US government issues, and what happens is that the value of par—so the amount that you get back at the end of that bond—adjusts up and down with inflation, or just adjusts up with inflation. So what that really means is that the opportunity in the time when you would want to think about buying a TIPS is if expectations in the market for inflation are lower than they end up actually being. So if you think that the market is pricing a really rapid return to low or zero or 2% inflation, then you wouldn't wanna hold TIPS. If you think that the market underappreciates the inflation that's coming ahead of us, TIPS would outperform regular bonds. The value of them would tick higher as inflation does. So they really do move in lockstep with inflation. There's a TIPS ETF and it has the great ticker of just being TIPS. So we would call that an explicit inflation hedge. Also kind of within that bucket and within that theme of thinking about inflation, and sort of living with it for longer, there's other ways to position a portfolio for that as well.
Katie: The report states that the other element to consider is infrastructure spending. The Infrastructure and Jobs Act directed $1.2 trillion to US infrastructure spending, comprising some 4,300 projects in 2023.
Kristy Akullian: Historically, if we look at sort of the performance in different periods of higher inflation, infrastructure stocks tend to perform better than the overall stock market. So it's an area of opportunity. Part of that is because some of those longer-term contracts within utilities and with other infrastructure projects have built-in mechanisms so that when inflation is higher over the course of the 10 or 20 years that that project is underway, the pricing actually ticks higher. So they have sort of this implicit inflation hedge in them as well. And then also on the infrastructure stocks front, you know, not only would it benefit from higher than currently expected inflation, which is our view, and our base case, that the market is overly optimistic that inflation is going away soon. It seems like we cannot get away from that transitory narrative. I think outside of that, there are other tailwinds for infrastructure as well, and a lot of that is just politics and spending. So if you look at the Inflation Reduction Act, there's millions and millions of dollars that are allocated to infrastructure projects. So some of those infrastructure stocks should benefit as well.
Katie: So to summarize, a few key investment opportunities may be arising in 2023. For some, it'll make sense to just stay the course, not change a thing. For others, depending on where you are in your investing lifespan, your risk tolerance, and your current level of diversification, it might make sense to adjust your portfolio accordingly. The reemergence of bonds as an asset class worth holding, the projected overperformance of value stocks in a higher interest rate and inflationary environment, and continued inflation presenting an interesting opportunity in TIPS are the three core messages that we are taking into consideration in 2023.
All right y'all, that is all for this week. I will see you next week, same time, same place, on The Money with Katie Show. Our show is a production of Morning Brew and is produced by Henah Velez and me, Katie Gatti Tassin, with our audio engineering and sound design from Nick Torres. Devin Emery is our chief content officer, and additional fact checking comes from the lovely Kate Brandt.