Market Outlook: So...What's Next?!

This portfolio mix is generally relied upon as a relatively conservative allocation because stocks and bonds do not typically fall together, as demonstrated in the chart below. In fact, it is quite rare for bonds to be negative at all, let alone as significantly as the asset category was last year. Having both asset groups trend strongly negative together created significant losses for even conservatively minded investors in 2022. Stock assets remain highly valued ahead of what appears to be an impending recessionary environment, which historically is not good for future stock price returns. While the 2022 bond performance was discouraging for more risk adverse investors, it should not be assumed that 2023 will repeat negative performance with bonds following stocks into the recessionary abyss. The starting conditions of this year are far different from that of 2022.

Last year began with the global economy still strongly expanding, thanks to most countries reopening from the COVID-related shutdowns and historic levels of stimulus programs (direct payments, low interest rates, corporate support, etc.) that fed economic activity. As the year carried on, economic weakness became more evident. Manufacturing and non-manufacturing (service economy) data - previously showing the strongest expansion this century - quickly rolled over into contractionary readings (reading below 50 on the ISM indices seen in the graphic below). Both sides of the economy, manufacturing and services, have not been in contraction together - outside of the peak COVID crisis months - since the last major negative economic event in 2008, now known as “the Great Financial Crisis.” While contractionary readings do not guarantee a recession is imminent, these are just the latest red flags for the United States and wider global economy.

The expanding economy of early 2022 ran headfirst into the wall of still snarled and dysfunctional global supply chains that were themselves attempting to recover from the effects of government ordered COVID shutdowns. Historically high consumer demand stoking economic stimulus, combined with a shutdown of production (supply), led to bursting higher inflation at levels not seen in over 40-years. In response, central banks around the world, which had not been expecting to raise rates for years into the future, suddenly found themselves embarking on the fastest rate hiking regime on record. (Even faster than the inflation fighting efforts under Federal Reserve Chairman Paul Volcker in the late 1970s and early 1980s.) That period of time under Volcker did notably end at much higher rates than the current experience is expected to, but the rate of change for interest rates is much greater now. That rate of change has already caused significant disruption in real estate markets where sales volumes and prices have fallen off a cliff, as home buyers have been shocked by significantly higher related payments. This shock has occurred even though compared to history, the current nominal rate of a 30-year mortgage is rather average. When the cost of money rises quickly, so does the risk that something will break, as evidenced by these current challenges.

Bonds as an asset category had a terrible 2022 due to the surprisingly high level of inflation, and the related central bank rate hiking actions designed to combat it. Rates moving higher is bad for bond valuations and vice versa (think of a how a teeter totter functions on a playground). Since rates have already been aggressively elevated, and most inflation readings are currently showing signs of peaking, it can be reasonably estimated that the risk to bonds is far lower now than it was in early 2022.

The above means that the potential risk of high inflation and central bank rate increases is largely known and priced into bond assets at this point. But, if the U.S. and/or global economy is heading into a recession, downward pressure will continue to be put on stock valuations. Investors should be able to be more confident that their bond assets will serve as the defensive hedge typical of historical markets, while the stock market will likely head lower in 2023.

CWM Risk-Adjusted Models: It should be expected that markets will continue to be volatile as the world combats 40-year high inflationary pressures and major geopolitical events go unresolved. Based on established disciplines, your CWM team believes that maintaining defensive positioning while awaiting a potentially more favorable future risk-taking investment environment is still the most prudent course. Future allocation changes will be made as relevant datapoints change.

CWM Accumulator Models: Your CWM team believes there is a high potential for continued market volatility and perhaps even further sharp market valuation drops in the near-term (0 – 2 years). A significant benefit of choosing this more passive investment style is the strategy’s longer-term focus (5+ years) and the ability to ignore day-to-day news, so long as discipline is maintained.

A key component of investment discipline is the responsibility of investors to continue to make portfolio contributions in line with their financial plans (assuming they are able). New contributions are particularly important in scary market environments, where often the best future return (buy low) opportunities exist.

For more great articles and information, please visit the News section of our website. If you are interested in a deeper dive into the current market data, have questions, or would like to schedule an appointment with a CWM advisor please contact us or call the office at (425) 778-6160.

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A chart to think about. I often think about the time with extended family, the time with your own kids, and the time spent alone as we age, and it drives a lot of my intentional behaviors and practices with my own family.

* The market indexes discussed are unmanaged and generally considered representative of their respective markets. Individuals cannot directly invest in unmanaged indexes. Past performance does not guarantee future results. The return and principal value of investments will fluctuate as market conditions change. When sold, investments may be worth more or less than their original cost. No investment strategy can guarantee profit or protect against loss.