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OUR VIEW

A look ahead: Third quarter 2022 outlook

10/12/2021

07/13/2022

10/12/2021

Given this market environment, here are our views on economic and market prospects:

Volatility. We expect volatility to remain high until there is greater clarity on inflation and the economy.

Inflation. There are tentative signs that inflation may be peaking. We expect inflation to peak in the second half of this year. A wild card is commodity prices, which are somewhat hostage to geopolitical risks.

Recession. Estimated probabilities of a recession are increasing but vary, with most estimates in a range of about a 30% to 60% probability, which appears reasonable. If the economy does tip into a recession, it’s likely to be moderate given the underlying strength of both consumers and companies.

Equity markets. Valuations and market prices have reached levels that are more attractive to long-term investors. Historically, once the market hits bear market levels (down 20%) average performance of the next 12 months has been 16%, with a 17% chance of a loss.

Interest rates. Interest rates have fallen from peak levels as markets have started pricing in Fed rate cuts next year in response to recession risks. In the near-term, we expect interest rates to trade within a range below peak levels seen in June.

Yields. Yields in the corporate and municipal bond market look significantly more attractive, particularly if inflation continues to soften over time and rates fall.

Real estate. With mortgages rates up, the housing market should continue to cool off. Longer-term, strong demand and a shortage of housing should support the market.

Related content:

Capital Markets Perspective (PDF)

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Asset allocation views: Current outlook

Tactical vs. strategic position

 

Equity vs. Fixed Income

  • Thrivent’s viewpoint is a maintained overweight to equity. Given a sufficient bear market rally, we may moderately reduce equity, but would still remain overweight. 
  • What makes this period unique is that while the S&P 500® reached bear market declines, so too has nearly every other asset class. 
  • The Fed’s attempts to combat inflation resulted in simultaneous significant declines in stocks and bonds, which in turn led to negative returns for typical mixed-asset portfolios that were similar to the brief February/March 2020 Covid market crisis.

Equities

Equities

 

U.S. vs. Int'l.

  • Thrivent’s viewpoint is a maintained overweight to domestic equity and neutral-to-underweight in international equity. 
  • Within international, we remain modestly overweight in developed markets versus emerging markets. Longer-term secular trends include China’s slowing growth rate due to an aging population, falling birth rate, and high debt. 
  • Europe shares many of China’s demographic challenges but also faces immediate headwinds like excessive inflation, war in nearby Ukraine and the associated geopolitical risks with Russia, and ECB tightening into a slowing economy. 

 

Market Cap

  • Thrivent’s viewpoint is a maintained overweight to domestic equity across market caps as a result of being overweight in domestic equity as a whole. Furthermore, small-cap valuations are very low both on a relative and absolute basis. 
  • Our internal tactical model for small versus large-caps is grounded on the idea that investor fear is often overblown, and small-caps tend to outperform with the abatement of that fear. 
  • As a rule of thumb, large-caps tend to outperform in an environment with slowing growth. However, despite the economy appearing to enter such an environment, investor fear is building.
  • The stage is being set for small-caps to outperform large-caps, but patience and caution may be warranted.

Fixed-income

 

Duration

  • We believe the Fed will continue to tighten, and this will put upward pressure toward higher short-term interest rate in Q3. However, as the Fed tightens, we think economic growth could come under pressure. This should cap or even lower longterm interest rates. 
  • Our Funds tend to be positioned close to neutral duration with respect to longerterm interest rates, but somewhat short the interest rates the Fed controls with its tightening: two-year and under.

 

Yield Curve

  • Unlike last quarter, a flattening of the yield curve was not a theme during the second quarter. 
  • A common yield curve that investors look at is the spread between 2-year and 10- year Treasury yields. This curve started 2022 at +78 basis points and ended the first quarter nearly at zero basis points. 
  • An inverted yield curve is generally considered a harbinger of recession. Right now, we are not looking at the yield curve predicting recession, but that doesn’t mean a recession can’t occur.
  • Through the next quarter, we expect the Fed to continue to raise short term interest rates and cause the yield curve to invert and signal a recession.

 

Credit Quality1

  • Looking ahead, we expect inflation, Federal Reserve rate hike expectations and a slowing economy to be the main factors driving markets. 
  • Corporate spreads have increased to modestly above long-term averages and medians, but have downside if the economy tips into a recession. 
  • Corporate earnings estimates have started to decline, but balance sheets remain strong. 
  • We are positioned roughly neutral credit risk within broad fixed-income portfolios after reducing credit risk moderately.

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.

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