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OUR VIEW

A look ahead: First quarter 2023 outlook

10/12/2021

01/24/2023

10/12/2021

The road ahead
  • We believe interest rates and bond yields will remain at a higher level, but we don’t expect them to surge significantly higher. Also, longer-term yields likely have peaked, reflecting growing concerns over a slowing economy and recession risks. After years of providing meager yields, fixed income has begun offering higher yields for investors.
  • Higher bond yields are indeed somewhat of an alternative to equities in the short-term, given the continuing uncertain environment for higher risk assets. However, equity valuation is much more reasonable relative to historical metrics. Earnings results are always important for stocks, but in the current environment, they take on even more significance.
  • An uncertain earnings environment is a key reason to maintain a cautious stance on equities to start 2023. Also, it seems likely a new cyclical leadership change is now developing as value and small cap segments could lead the overall market. While caution is warranted, volatility is likely to become increasingly two-sided with the potential for large downdrafts but also strong rallies. As the year progresses closer to 2024, we expect markets to increasingly look forward to the prospect of stabilizing growth. Investors should be prepared to position their portfolios for a possible market recovery, as markets can gap up just as intensely as they moved down.
Related content:

Capital Markets Perspective (PDF)

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Asset allocation views: Current outlook

Tactical vs. peers position

 

Equity vs. Fixed Income

There have been just 3 occasions upon which the S&P 500® index experienced an annual return worse than 2022’s nearly 20% decline (1974, 2002, 2008). Each of those years saw significant rallies over the year that followed (1975, 31.5%; 2003, 26.4%; and 2009, 23.5%). Moreover, S&P 500 returns are positive approximately 80% of the time in the full year following any down year.

The Federal Reserve (Fed) has slowed the pace of the Fed Funds hikes, but the tightening cycle has yet to reach its climax and the risk of a Fed-induced recession continues to rise.

Inflation has cooled, but with the Fed looking to achieve and maintain a restrictive environment, it is likely that markets will continue to experience above-average volatility.

Presently, Thrivent retains a small equity bias relative to fixed income.

Equities

Equities

 

U.S. vs. Int'l.

We are modestly underweight international in both developed and emerging markets.

We favor domestic over international in the intermediate-to-long term for a variety of reasons, including peak globalization and the increase in reshoring by U.S. companies, a higher degree of innovation domestically, greater demographic challenges internationally, structural issues in Europe and a more favorable climate for businesses (e.g. regulation) domestically.

China’s reopening after almost three years of travel restrictions and lock-downs to varying degrees, the related boost to international economies, and a recently weakening dollar’s relief to emerging markets are occurring in a favorable relative valuation environment for foreign markets.

 

Market Cap

We are overweight both small and mid (smid) caps, with a bigger overweight to mid caps. When they outperform large caps significantly, small and mid tend to do so simultaneously.

Small cap valuations are quite low both on an absolute basis and relative to large caps. Additionally, sentiment is generally low, which often favors small caps.

Small caps will likely need to see economic prospects stop deteriorating and a risk appetite return to equity markets before a more sustained period of outperformance can occur versus large caps.

Despite the relative valuation, small caps are at risk of underperformance should more than a modest recession occur.

Fixed-income

 

Duration

We believe that, as inflation is significantly higher than 2% and employment and the economy remain strong, the Fed will remain in tightening mode, with short-term rates rising with Fed Funds.

Longer-term rates, however, likely have peaked absent an unexpected inflation surge. We expect long-term rates to be steady to down, reflecting concerns over the economy and falling inflation.

 

Yield Curve

An inversion of multiple Treasury yield curves occurred in 2022. This an ominous signal that a recession is forthcoming.

We believe the Fed will continue its tight policy to reverse inflation. This would cause the curve to continue inverting. The bulk of the increase in rates will be on the short end, while long-term interest rates should hover near neutral or even fall a bit.

 

Credit Quality1

In 2022, credit returns were sharply negative due to higher interest rates and wider credit spreads.

In 2023, we expect credit markets to be increasingly driven by concerns over a slowing economy and the possibility of a recession due to tightening financial conditions.

If the economy significantly slows, credit spreads have meaningful downside with defaults likely rising in lower-quality credit.

We intend to tactically lower credit risk should the probability of a recession increase further than our expectations. If spreads increase to around average recessionary levels, we intend to start adding back credit risk.

1 Credit Quality ratings are determined by credit rating agencies Moody’s Investor Services, Inc. or Standard & Poor’s Financial Services, LLC.

The Senior Investment Team is discussing the asset classes, sectors and portfolios they oversee at a macroeconomic level. The views expressed are as of the date given unless otherwise noted and may change as market or other conditions change, and may differ from views expressed by other Thrivent Asset Management, LLC associates. Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or recommendations of any particular security, strategy or product.

Past performance is not necessarily indicative of future results.

Related insights

Market Update [PODCAST]

12/01/2023

The U.S. housing market [PODCAST]

The U.S. housing market [PODCAST]

The U.S. housing market [PODCAST]

Do high mortgage rates mean trouble is brewing, or will high demand continue to drive prices? Bottom line, we do not foresee a significant correction in home prices, but we do think investors would be well served to understand market conditions.

Do high mortgage rates mean trouble is brewing, or will high demand continue to drive prices? Bottom line, we do not foresee a significant correction in home prices, but we do think investors would be well served to understand market conditions.

12/01/2023

November 2023 Market Update

11/07/2023

Rising rates take their toll

Rising rates take their toll

Rising rates take their toll

The long period of rising U.S. policy rates is likely near its end. But the toll that higher rates extract from economic growth has a lagged effect, and we believe the impact will become steadily more apparent as we head into 2024.

The long period of rising U.S. policy rates is likely near its end. But the toll that higher rates extract from economic growth has a lagged effect, and we believe the impact will become steadily more apparent as we head into 2024.

11/07/2023