2023’s already been a wild ride and numerous risks will likely result in a very uneven market for the rest of this year. Michael Arone, CFA, Chief Investment Strategist, US SPDR Business, and Matthew Bartolini, CFA, CAIA, Head of SPDR Americas Research, revisit their 2023 investment themes and offer strategies to help mitigate near-term volatility and seek long-term returns.
Our 2023 ETF Market Outlook provides more detail on the themes discussed — with tickers.
Matt Bartolini: Hi everyone. Welcome to the Market Outlook Update at the end of the first quarter of 2023. My name is Matthew Bartolini. I'm the Head of SPDR Americas Research, State Street Global Advisors, and I'm joined by Michael Arone, our Chief Investment Strategist for the SPDR Business in the Americas.
Now the markets have been quite crazy in this start the year. We've obviously had positive gains in both stocks and bonds, but the path has not been linear as volatility has both spiked in equity and rates. And we've also had another crisis to deal with in March, this time a banking crisis. So Mike, we've already encountered, you know, a quarter of 2023. What does it look ahead in terms of the risks that investors need to consider for the rest of the year and more specifically for perhaps the next few months?
Mike Arone: So, Matt, I think there are four main risks as we head to the second quarter and beyond in 2023. I think first and foremost, you mentioned the banking crisis. Certainly I think that the government, the Fed, and even the banking industry did a good job in terms of ring fencing that. But going forward, I think it's going to move from a liquidity challenge to one that's about credit creation. And I think credit creation is going to get staggered a little bit. And as a result, that's going to slow economic growth.
The second thing is that real interest rates, rates are above inflation now, and that's drawing away assets from demand deposits into kind of more conservative investments. And I know you do a lot of work on the flows, and so a lot of money market funds have ballooned in terms of their assets, and that's drawing money away from risk assets. And that's likely to continue as interest rates remain high.
The third thing is, is that the Fed funds rate is above every single yield across the maturity spectrum. And so that suggests that the Fed may have over tightened in terms of this tightening cycle, and that could lead to a recession later on this year.
And I'd say fourth and final, as a result of that ring fencing, the banking industry crisis or the challenges that we see there, is that all the money that the government spent in order to support those uninsured deposits, that's likely to bring the debt ceiling conversation forward — probably from what we were expecting in the June-July timeframe to perhaps as early as May. So I think those four risks could continue to result in a very uneven market for the rest of this year, which is why we titled the outlook The Great Balancing Act. So given that now, what do you think investors should do about it as we move into the second quarter of 2023?
Matt Bartolini: Yeah, and I think there's probably even a fifth risk there around just earnings fundamentals and earnings volatility, particularly given how we're likely to see Q1 2023 earnings results be negative and that would be the second consecutive quarter of negative earnings results in the S&P 500, which would be a technical earnings recession.
So I think in light of all of these risks in the marketplace, I think it still warrants the focus on high quality areas of the US equity market that also trade at inexpensive valuations, because even though the markets are being faced with all of these risks, valuations, particularly in US equities, are stretched relative to history. So focusing on inexpensive, high quality areas of the market, you know, as Warren Buffett said, “Either in stocks or stocks, you always want to find high quality, inexpensive areas.” And I think that warrants consideration given all of the amount of these risks. But also there's an aspect of looking overseas, too, because overseas there is stronger relative earnings sentiment, there are more constructive valuations, and returns have been better. So you had those three sort of quantitative signals of momentum, sentiment, and valuations indicating an overweight to non-US equities, again, warrants that consideration.
But within bonds, I think it's just, you know, don't try to be a hero in this type of marketplace. You said it yourself, the Fed funds is above every part of the maturity curve. That means ultra-short-term rates are elevated, particularly in the 1 to 3 year corporate bond market. You can get a five and a half percent yield with two years of duration. Spreads are in line with historical averages and that five and a half percent yield is on par with the earnings yield of the S&P 500. So your sort of potential cash flow for bonds relative to stocks is similar, but it's 88% less volatility. So sort of don't try to be a hero. Take what the market is giving you with that ultra-short, defensive 1 to 3 year space.
In terms of the yield generation, I think that is something we put in our outlook of balancing that yield and duration on the hunt for total return in bonds. And the last part is, you know, within high yield, if spreads start to go up to around 500 and 520 basis points in line with averages, and then it does warrant a little bit of nibbling in terms of allocating to high yield or senior loans just because the yield is so high. So again, trying to balance those risks, trying to seek out areas of return, but mitigate some of the near-term volatility, both fundamentally and macro.
Mike Arone: Great. So today we've talked about the fact that the first quarter has been quite volatile for both stocks and bonds, despite the positive returns. We've highlighted five additional risks as we head to the second quarter and for the balance of 2023. And that's provided some useful insights on how to position portfolios. For more information, please visit our website.
Basis Point (bps) A unit of measure for interest rates, investment performance, pricing of investment services and other percentages in finance. One basis point is equal to one-hundredth of 1 percent, or 0.01%.
Duration A commonly used measure, expressed in years, that measures the sensitivity of the price of a bond or a fixed-income portfolio to changes in interest rates or interest-rate expectations. The greater the duration, the greater the sensitivity to interest rates changes, and vice versa. Specifically, the specific duration figure indicates, on a percentage basis, by how much a portfolio of bonds will rise or fall when interest rates shift by 1 percentage point.
Federal Funds Rate, or Federal Funds Target Rate The overnight interest rate charged by depositary institutions on funds held at the Federal Reserve. The fed funds rate is set by the Fed’s policy-making body, the Federal Open Market Committee, or FOMC.
S&P 500® Index A popular benchmark for U.S. large-cap equities that includes 500 companies from leading industries and captures approximately 80% coverage of available market capitalization.
Yield The income produced by an investment, typically calculated as the interest received annually divided by the price of the investment. Yield comes from interest-bearing securities, such as bonds and dividend-paying stocks.
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The views expressed in this material are the views of Michael Arone and Matthew Bartolini through March 29, 2023, and are subject to change based on market and other conditions. This material contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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