SUMMARY
The combined impact of sharply higher rates, reduced lending by the Fed in credit markets, and a future economic slowdown suggest we should seek to focus on earning high-quality income from our investments, rather than pivot to high risk/return opportunities too soon.
- In this period replete with New Year’s resolutions, markets have a tendency to focus on what can change for the better. We believe 2022’s 19% loss in global equities and 16% loss in global bonds significantly revalued and boosted future return opportunities when measured over a year or more.
- Early positive market performance in a given year does not correlate with full year returns, however. The cost of debt and equity capital is rising, not falling. Our EPS estimates are around -12% relative to market consensus.
- With December’s positive job growth supporting markets, there is likely to be a reckoning. Equity markets have not bottomed before a recession has occurred. The track record of the yield curve (90% of recessions correctly predicted since 1960) is certainly better than the track record of economists.
- Liquidity constraints in the fixed income markets are having meaningful knock-on effects on domestic equity return requirements for those investors willing and able to take longer-term risks. We also expect that over-leveraged businesses that require significant new capital, or that operate dated business models, may face real financing challenges. One major retailer has already announced a risk of default this week.
- Elevated current yields reflect the opportunity cost to bet on speculative investments. Due to both sharply reduced liquidity and higher cost, riskier credit especially may soon see both wider credit spreads as well as higher overall default rates, suggesting we wait before adding to portfolios.
- Higher minimum required rates of return for equity and debt present a headwind for equity and debt markets.
- Early positive performance in Europe and China provides indicators of future value as uncertainties abate.
