A cloudy outlook with a silver lining
2022 is a year investors hope will not repeat anytime soon. The turmoil of 2022 followed 2021’s economic reopening and easy money—with big gains for stock investors. By contrast, 2022 was a year of inflation, rising interest rates, war, and big losses for both stock and bond investors.
We don’t think that 2023 will be a repeat of 2022, but it won’t be easy street either. A cloudy outlook for growth and inflation will likely keep volatility high, but there is a silver lining as we expect the outlook to be much clearer by the end of the year. And financial markets like clarity.
Looking ahead, we expect economic growth to slowly grind lower through at least mid-year as the economy normalizes after the pandemic reopening boom and the lagged effects of higher interest rates make themselves felt by weighing down demand. We expect inflation to ease as the year progresses and we may even see the Federal Reserve cut rates by the end of the year.
An environment of slow growth and perhaps recession combined with slowing inflation tends to be good for bonds as interest rates typically decline, pushing bond prices higher. Declining interest rates are often good for stock valuations as well. However, if earnings estimates prove to be too optimistic due to recession, stocks may struggle to record gains.
While the near-term outlook is cloudy, the long-term outlook has improved significantly over the past year. Compared to a year ago, long-term expected returns are notably higher for both stocks and bonds. The punchline is that the 10 to 15-year expected annual return for a balanced portfolio is about 8% compared to 5% a year ago, which provides long-term investors with reason to remain patient as near-term issues resolve.
