Investing Strategy
The last 12 months were challenging for stock and bond markets, and Capital Group’s portfolio teams don’t anticipate a less challenging environment in the near future. High inflation, a weak economic environment and continuing geopolitical risks emphasize the need for investment discipline. But where should investors look for opportunities?
Here are five key outlook themes to help advisors prepare for client conversations about risk, opportunity and portfolio construction in early 2023.
The last 12 months were challenging for stock and bond markets, and Capital Group’s portfolio teams don’t anticipate a less challenging environment in the near future. High inflation, a weak economic environment and continuing geopolitical risks emphasize the need for investment discipline. But where should investors look for opportunities?
Here are five key outlook themes to help advisors prepare for client conversations about risk, opportunity and portfolio construction in early 2023. For more information on Capital Group’s outlook for 2023, see our 2023 outlook report and our deeper dives on the investment outlook for the U.S., international and fixed income markets.
Many of the world’s leading economies appear to be heading for an economic downturn. Europe is likely already in a recessionary period, while China’s growth has substantially decelerated, exacerbated by COVID-19 lockdowns. In the United States, elevated inflation levels and increased interest rates have taken their toll on domestic growth. Capital Group economist Jared Franz expects the U.S. economy to contract by about 2% in 2023 — worse than the post-tech and telecom bubble recession of the early 2000s, but not nearly as bad as the 2008–09 financial crisis.
One thing all past recessions and bear markets have in common is they eventually ended and set the stage for the next period of growth. Capturing a full market recovery can have a meaningful impact on investment returns, as highlighted in the charts below. Often, the market’s strongest gains have occurred immediately after a downturn.
Stocks led the economy down during this latest cycle, with nearly all major equity markets entering bear market territory by mid-2022. If history is a guide, stocks could rebound about six months before the economy does. Therefore, waiting on the sidelines for an economic turnaround could be a missed opportunity if equities bounce back before the economy shows its recovery.
Stocks have tended to recover before the economy does
2022 was one of the worst years for bond market returns on record. Substantial losses have led many investors to question the long-standing principal that bonds offer relative safety when stocks decline. Could bonds offer some relief from volatile equity markets in 2023?
Stocks and bonds rarely decline in tandem. In fact, calendar year 2022 was the only period on record over the past 45 years where this phenomenon occurred. Bonds are once again expected to offer diversification benefits and relief from volatile equity markets as recession concerns come into focus.
Reports of lower inflation coupled with growth concerns could allow the U.S. Federal Reserve to slow down its rate hikes. “I believe we are close to that point,” says Pramod Atluri, Capital Group fixed income portfolio manager. “Once the Fed pivots from its ultra-hawkish monetary policy stance, high-quality bonds should again offer relative stability and greater income.”
Stocks and bonds rarely decline in tandem
While dividends accounted for just 16% of total returns for the S&P 500 Index in the 2010s, historically they have contributed an average of 38%. Companies that have paid steady and above-market dividends can be found across various sectors including financials, energy, materials and health care. Higher dividend yields may cushion the fall during market corrections, offering a measure of downside protection when volatility is on the rise.
“With growth slowing, the cost of capital rising and valuations for less profitable tech companies declining, I expect dividends to be a more significant and stable contributor to total returns,” says Capital Group equity portfolio manager Caroline Randall.
Dividends play an important role in equity returns
Historically, it has paid to invest in fixed income prior to the final Fed rate hike during rising rate environments. With the Fed expected to end its hawkish stance in mid-2023, maintaining an allocation to bonds may be sensible for some investors.
Over the last 40 years, there have been six rate-hiking cycles. Purchasing bonds regularly for a year starting six months prior to the last rate hike in each of those cycles would have returned a range of 3.3% to 10.2% in the first 12 months. Longer term, that year-long investment would have provided a 5-year annualized total return ranging from 5.9% to 15.6%. Of course, past results are not predictive of future returns.
“As active managers we aim to purchase bonds with good prospects using fundamental research while also accounting for macroeconomic conditions,” says Atluri. “Markets move fast. I’d rather be early than late when it comes to positioning the portfolios I manage.”
It may pay to invest prior to a final rate hike
In recent years, there is no doubt that investors have been frustrated with the persistent lagging returns of international equities. A strong U.S. dollar, weak economies in Europe and Japan, and various obstacles in emerging markets have created a cloudy near-term outlook.
However, investors should remember that there is a difference between top-down macroeconomic views and the fundamental, bottom-up prospects for individual companies. Company fundamentals are driving returns outside the United States, placing added importance on individual stock picking. Therefore, an active investment approach may be beneficial for international equity exposure.
Company-specific factors drive international equity returns
In 2023, you can expect several familiar headwinds, including a rocky geopolitical landscape, elevated inflation, rising yields and hawkish central bank policy. However, there are reasons to be optimistic, including an abundance of possibilities for selective investing rooted in bottom-up, fundamental research.
As you review your clients’ portfolios for potential areas of opportunity, consider scheduling a portfolio consultation with a Capital Group specialist today.
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This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.
For financial professionals only. Not for use with the public.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.
All Capital Group trademarks mentioned are owned by The Capital Group Companies, Inc., an affiliated company or fund. All other company and product names mentioned are the property of their respective companies.
Use of this website is intended for U.S. residents only.
American Funds Distributors, Inc.
This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.
For financial professionals only. Not for use with the public.