In 2022, the market suffered a hangover after almost 12 years of fiscal and monetary accommodation on the backend of the financial crisis of 2008-09 and Covid-19 in 2020. What brought the party to its end was the emergence of inflation and the Federal Reserve’s response to it via increased short-term interest rates and quantitative tightening. As we enter 2023, let’s look at the current market environment and what investors should be thinking about.
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Uncertainty Will Continue
While the Federal Reserve made progress in its fight against inflation towards the end of 2022, most of the progress was made with commodities inflation. The concern now revolves around services inflation and the historically tight labor market, which is straining companies across the economy. Additionally, geopolitical events, such as the ongoing Russia/Ukraine conflict and China’s inconsistent Covid-19 response policy, continue to add uncertainty around supply chains.
Have a Bias Towards Quality Companies/Bonds
Considering these ongoing challenges, investors should have a bias toward quality in 2023. On the stock side, look towards companies providing goods and services people need day in and day out. These types of companies often have greater pricing power and can pass inflationary pressures on to consumers. Additionally, focus on companies with strong balance sheets, consistent free cash flow/profit generation, and those that pay dividends.
On the bond side, have a bias towards bonds with shorter maturities and borrowers with excellent credit ratings. The shorter maturities will give you less exposure to a potential resurgence in inflation, and the high credit quality will help you avoid defaults and loss of principal. For example, look at 1–3-year US Treasuries that are currently yielding between 4-4.75%, with 1-year Treasuries yielding more than the 3-year at the moment.
Your Goals and Time Horizon Matter
While uncertainty is likely to remain in 2023, let your personal financial goals and time horizon determine your approach. For example, if you have more than 10 years until retirement, you have the ability to take more risks. If you are closer to retirement or in retirement, look to lean more defensive in the face of potential uncertainty.
Over the past 95 years, approximately 97% of 10-year time periods resulted in positive market returns. Additionally, approximately 90% of 5-year periods, 84% of 3-year periods, and 73% of 1-year periods resulted in positive market returns. So be respectful of the short-term but try to stay diversified and maintain the appropriate amount of risk exposure as the long-term odds are in your favor.
Everyone’s financial situation is different. Be sure to consult with a Certified Financial Planner before you make any investment decisions.
