Branstad: Hi, everyone. Thanks for joining us. I'm Jeff Branstad, a portfolio manager with Thrivent Asset Management. And this is Steve Lowe, our chief investment strategist.
Today, we're going to talk a little bit about what happened in 2022 and what our outlook is for 2023. So, Steve, it was a pretty rough year last year. What stands out for you about 2022?
Lowe: Yeah, it was an extremely tough year. So, what really stands out is both fixed income and equities had historically poor returns. And if you look at records that go back to about 1872, which is as far as you can do both equity and fixed income well, and it’s the only year in that 150-year time span that fixed income and equity have both returned -10% or worse – actually both kind of upper teens negative.
If you look at mixed assets – the classic portfolio is at 60% equity, 40% fixed income – it was one of the worst on records. What drove that for both markets was inflation and higher rates and a very aggressive Fed. I mean, they raised rates by over 4% – 425 basis points to be precise. And unlike the 1970s when you had a similar high inflation environment, the income you got from fixed income was very small to start. It didn't really help to buffer negative price returns at all. The point is that there was very little diversification benefit from fixed income last year, actually just the opposite.
Branstad: So, how about equities? Can you kind of talk a little bit about how they performed?
Lowe: Yes, certainly. The low was about down 25% for the S&P 500. If you look at that historically, it's a bit shy of where you typically are on average in a recession and closer kind of to a standard bear market. S&P finished the year about down -19%. NASDAQ was the worst, as its more impacted by rates. That was down about 33%. And small caps [were down] 22% or so.
The one standout was commodities. It's one of the only mainstream asset classes that was positive: oil, natural gas, food. And the other thing that stands out at the year is very volatile returns. I mean, you had – which is very standard in a bear market – strong rallies. You had rallies in the spring of 11%, in the summer of 17%, and in the fall of 12%. And that's very normal, that type of volatility in a bear market. And the other thing that stands out is there wasn't really a sharp drop at any one time in equities; it was a very severe series of drops. It was kind of a slow, grinding market.
Branstad: So, Steve, what can we expect going forward?
Lowe: Yeah, I think our base case is that a recession is more likely than not. Probably the earliest is the end of the second quarter, but more likely third quarter or fourth quarter timeframe. Our expectation that it's mild and not that different than kind of a slow growth environment.
There is a path to a short landing. And how you get there [would be by] inflation slowing due to the Fed rate hikes, but the jobs market [would ease], maybe openings start falling because there are a large number of job openings still and you don't get this large spike in unemployment. So under that scenario, the Fed pauses with a rate hike somewhere around the beginning of the second quarter or end of the first quarter at about 5%. And then they’d just hold it for a while. Holding at a high level, in a way, can forge a path to a soft landing. In other words, inflation tails off. The risk of that, however, is that they overshoot. On the way into this environment, they thought inflation was transitory. Well, it wasn't. It was very persistent. So, they made a mistake there. And the concern of the markets is they're going to make a mistake on the other side by being overcorrecting and holding rates too high.
I think cuts are possible, if not probable, toward the second half of the year. If you look at equities, I think we test lows and probably reset new lows, but then rally in the second half as markets start looking more forward to the end of this slow growth environment and a recovery. Long-term rates would decline with lower inflation. The Treasury curve [would continue] to flatten for a while and then it eventually should steepen as the Fed starts cutting rates or the market believes that the Fed will cut rates, because that'll bring down short rates. And then credit most likely runs into a little more issues as the economy slows, particularly the lower part of it, like high yield or leveraged loans; you might see defaults rise a bit and credit spreads increase.
Branstad: That's great information, Steve. Thank you very much. And thank you all for joining us. Bye.