Market compass video series

Market news is everywhere — but what does it all mean for you, and how should you react?
Market Compass helps keep you in the know but also looks ahead to what may be down the road. In this video series, our investment strategists share their thoughts on the latest market and economic developments, and offer investing tips you can use as you work toward your long-term financial goals.
Check back each month for a new Market Compass. If you have any questions, reach out to your financial advisor.
Markets are up for the year, but major indexes have been more volatile lately. Where are the opportunities in today’s market? Angelo Kourkafas outlines three actions to consider.
Hello, everyone, and welcome to the August edition of Market Compass. We are more than halfway through the year. And the one word that seems to capture the economic and market activity is resilience. Despite strong headwinds of high borrowing costs, still elevated inflation, and geopolitical uncertainty, the US economy has fared much better than expected. The same goes for corporate profits and equity markets, which we're not going to complain about.
Even though major indices have been more volatile recently, large cap stocks are up more than 20% from last year's lows and are not far from their all-time highs. So what justifies the move higher in stocks? We think the improvement in inflation, a strong labor market, and expectations for an end to the Federal Reserve's rate hiking cycle have moved us away from any worst case scenarios. But hefty gains taken together with flat earnings growth for the S&P 500 this year mean that valuations have increased, and investors need to be more selective going forward.
Historically, August and September have been less favorable for stocks, with volatility tending to pick up. However, this shouldn't be a reason to stop working towards your long-term goals. With that in mind, here are three opportunities we see in today's markets based on the macroeconomic conditions we expect for the rest of the year. The first, diversify into lagging segments of the equity market that carry lower valuations.
Until recently, market leadership has been very narrow, with just a handful of mega-cap technology stocks accounting for the majority of this year's gains. Beyond the largest seven S&P 500 companies by market cap, gains have been more modest not only within the S&P 500 itself, but across other indices and asset classes. These include value-style investments, small caps, and international equities, which trade at a larger than average discount.
From a sector perspective, so far this year, only 3 of the 11 sectors have been able to outperform the S&P 500 index, while some defensive sectors have posted losses year to date. We think participation could broaden, and therefore recommend investors rebalance as appropriate. The second opportunity we see is the dollar cost average to take advantage of the potential for higher volatility. We think the path has widened for the economy to avoid a recession, but some downside risks to growth remain.
Historically, a strong first half of the year has been associated with further gains for the remainder of the year, but with deeper pullbacks. To avoid trying to time the market and also take advantage of the potential for volatility, we recommend investors dollar cost average by investing systematically at regular intervals. Dollar cost averaging can spread out your purchases and help you buy more shares when prices pull back.
The third opportunity is to complement, in our view, CDs and other cash-like investments with longer term bonds. Yields are historically attractive across the curve, providing great opportunities for investors to generate income in certificates of deposit, as well as longer term bonds. We think this is a good time for investors to complement their CDs and short-term bonds with longer duration bonds that have higher interest rate sensitivity.
These bonds offer the opportunity to lock in historically high yields for a longer period. They also may appreciate if yields start to move lower as economic growth softens and the Fed starts cutting rates possibly in 2024.
To highlight this exact point, let's look at some historical data going back to 1980. Over the past seven rate hiking cycles, 10-year yields have declined by 1% on average six months after the Fed's last rate hike. This highlights that the end of tightening can be a positive catalyst for government bonds, which experienced a historic decline last year.
To sum up, we think that the evolution of growth and inflation provides a solid foundation for stocks to remain in a sustainable uptrend, but with higher volatility in the months ahead. Yet, market gains over the past several months should not be a reason to stay on the sidelines as we still see opportunities in parts of the equity market, including the defensive sectors. And within fixed income, we see an opportunity to position for potentially lower yields next year. With that, thank you for joining us. We hope to see you again next month.
There's an old saying that markets climb a wall of worry, which would be an appropriate characterization a performance so far this year. Those worries have been centered on a potential recession, and that climb has taken the form of an 18% year-to-date rally in the S&P 500.
So we came into 2023 expecting a mild brief recession to emerge, and the good news is that hasn't happened. As the strength of the consumer has kept a contraction at bay that does not however mean a recession is canceled. As our evaluation of underlying economic trends and signals suggest to us that a slowdown is still a likely outcome.
With the economy setting the foundation upon which market performance is built and with markets likely to remain focused on the recession or no recession debate, here's our take on four key questions. First question, given the calls for recession, why isn't one materialized?
Second, is the timetable simply pushed back, or can we avoid a recession altogether? Third, what would a recession look like if one were to materialize? And four, what are the implications for the financial markets and investors?
So let's circle back. Question one. Given the calls for recession, why hasn't one materialized so far this year? Well, it really starts with consumer spending. Consumer spending accounts for 70% of GDP in the US, and that area has been particularly resilient. In fact, in the first quarter of this year while the economy was growing at a little bit better than 2%, consumer spending was growing at better than 4%.
So this has been supported by a very tight, very healthy labor market that's remained significantly stronger than we had anticipated in the first half of 2023. And this includes a half century low in the unemployment rate, as well as elevated wage growth. Of note, services spending has been the standout as consumers have returned to more normal spending habits following the pandemic. Keep in mind after the pandemic, a lot of the spending was oriented on goods we're now seeing that shift back to more normal spending on services.
So the second question, is the timetable simply push back, or can we avoid a recession altogether? The resiliency of the economy is most certainly welcome, nobody's going to complain about a recession not emerging. But a look under the economic hood, signals to us that a slowdown is still a likely outcome. The strength in consumer spending has to a degree masked weakness in other areas of the economy, most notably manufacturing, business spending, and housing.
We think the economy will slow as we move through the back half of the year driven principally by slower consumer spending. Key employment indicators, like initial jobless claims have shown some deterioration, monthly payroll growth has also slowed, and wage gains are moderating. In addition to that, accumulated household savings, so the amount of savings we have on top of our income, which topped more than $2 trillion following the pandemic has been drawn down more recently. A little less dry powder for consumers to spend.
We don't think consumers will have to go into full hibernation. But as the labor market conditions soften, we think the source of strength for the economy so far in 2023 will lose a bit of steam. We're mindful that the Fed has embarked on historically aggressive tightening campaign in the last year raising its policy rate by more than 5% in an effort to quell high inflation.
Monetary policy tightening traditionally acts with a lag taking some time to fully filter its way through the economy. And we think the full effects of the Fed's rate hikes are still working their way through the system and will ultimately result in a slower economy ahead.
So to be clear, a recession is not inevitable. And the path toward a soft landing for the economy, in which the Fed brings inflation down without clobbering the economy completely is still a very viable path. But we're careful not to dismiss underlying signals that have traditionally heralded a slowdown.
So then three, what would a recession look like? Well, this is where the news gets much better. Our view coming into the year was that any recession that did emerge was going to be mild and short based in part on our view that the health of the labor market, and the consumer heading into this phase would be helpful. In part because there were no major economic bubbles or systemic imbalances that would produce a more severe outcome.
Good examples of these two would be 2008-2009 where the housing bubble popped caused a lot of consumer deleveraging that drove a more severe downturn. Whereas in 2000-2001, consumers were a bit more resilient through that phase and we saw a more shallow downturn in the economy.
So in our view, the slowdown will take the form of what we would call a rolling recession. Meaning that various areas of the economy will slow and recover at different times. We've already seen a meaningful downturn in manufacturing, and housing market activity, and in business investment. And in fact, we're seeing early signs that production is stabilizing, and the latest reads on the housing market are indicating a bit of a rebound.
As input and labor costs moderate, we expect to see some resiliency in business spending as well. This could transpire at a time that consumer spending is softening. Meaning that the overall GDP levels may not fall dramatically, even though underlying components of the economy are experiencing recessionary conditions.
Question four then. So what are the implications for financial markets and for investors? There are reasons for investors to be optimistic about the markets even as the economy is slowing. It's critical to remember that markets are forward looking, historically stocks on average have declined around 30% during recessionary bear markets.
We think last year's 26% decline between January and October already anticipated some of this mild recession that we think could take shape. Looking back at Bear Markets since 1948, each started before a recession occurred. And markets began their recovery before the economy rebounded.
To be clear, we don't think markets will ignore emerging evidence of a slowdown, but we don't believe that will drive a return back to the lows and the stock market of last October. We think greater volatility and a mild pullback could emerge as we progress through the back half of this year. But we think that should be viewed as an opportunity by investors, not a warning sign of a more prolonged or severe sell off.
Interestingly, we think the slowdown in the economy can actually have a silver lining for the markets. As consumer spending softens, that should help the downward path for inflation, and in turn, allow the Fed to back away from restrictive interest rate policy. Thus, we think a market pullback spurred by signs of economic weakness can be mitigated by the prospects of less aggressive Fed tightening and potentially lower interest rates next year.
Looking at the comparison between earnings yield on stocks and the yield on bonds or higher interest rates, we've seen that relationship has trended toward levels very similar to prior stock market recoveries that began in 2009 and in 2018. This there's no guarantee that the coast is clear, but we believe that despite the risks of recession, investors can have confidence that a durable bull market will ultimately take shape.
Hello, everyone, and welcome to the June Market Compass. It's hard to believe we're now squarely in the middle of 2023, looking out to the second half of the year. Now what I thought I'd do first is recap some of the themes that have played out in markets so far. And then I'll talk about three themes for the back half of the year, including, number one, a cooling in economic growth and inflation, number two, the Federal Reserve potentially stepping to the sidelines on rate hikes, and number three, the opportunities we see forming in both equities and bonds.
So first, two trends to highlight in equity and bond markets this year. Number one, while equity markets have moved higher, leadership has been narrow. As you can see from this chart, while the S&P 500 overall is up over 13% this year, only three sectors-- technology, communication services, and consumer discretionary-- have outperformed the broader index.
Now, these three sectors are up over 25% year to date, while the remaining eight sectors are up modestly, flat, or even down for the year. Now while it's certainly welcome to see positive returns this year, in our view, broader leadership is a healthier sign for markets. And we would actually expect this to occur as we head into the back half of 2023.
Now second, unlike stock market returns, bond market returns have been somewhat more muted thus far. Rates continue to move higher, pushing bond prices lower.
In fact, the Barclays us Aggregate Bond index is up just about 2% this year. As you can see from this chart, two year and 10 year US Treasury yields have moved higher in the past few months, as expectations for Federal Reserve rate hikes continue to climb as well.
Now this has put some pressure on bond returns near term. But we would expect yields to be peaking in the months ahead. We'll discuss this more in our themes for the second half.
So given this backdrop in equity and bond markets, what are the key themes we see for the back half of 2023? We'll highlight three.
First, we continue to see signs that the US economy may continue to soften, and potentially a mild recession may emerge in the back half of the year. However, we still do not expect any downturn to be deep or prolonged. And in fact, we may ultimately see this downturn manifest as a slowing in growth to below trend levels of about 1 and 1/2% here in the US.
Now we also believe that inflation will continue to moderate as the year progresses. Keep in mind, both the consumer price index and producer price index inflation metrics for the month of May have come in lower than expectations, especially on a headline basis. And we've seen now the 11th consecutive lower reading since inflation peaked back in June of 2022.
Now our view is that inflation should continue to moderate, likely heading towards about 3% on a headline basis by year end. And what factors do we look at that support this view?
Well, here are a few forward looking indicators to highlight. First, ISM prices paid indexes for both manufacturing and services have moved lower. Next, global supply chain pressure indexes have eased and actually are now back to pre-pandemic levels. Home and rental price appreciation has moderated, which tends to show up with a lag in the inflation metrics.
And finally, labor markets have been solid. But some early signs of cooling have emerged, including rising jobless claims and a lower total number of job openings.
Now the second theme for the back half of this year is that the Federal Reserve will likely pause its interest rate hiking cycle. As you can see from this chart, the Fed's estimate of its terminal or peak Fed funds rate has climbed higher since early March of 2022.
The latest set of estimates by the Fed indicate that the peak Fed funds rate may now be close to 5.6%, which implies about two more rate hikes from here. However, we believe the Fed will be data dependent. They will pay close attention to the incoming economic and inflation data.
And if those data don't warrant two additional rate hikes, they may not implement these. But more broadly, we do believe that overall the Fed is nearing the end of its tightening campaign.
Now while rate cuts are not likely this year, a pause in rate hikes will be welcomed by markets, especially if this is because inflation has moved closer to that 2% target range.
Finally, the third theme for the second half of 2023, the opportunities we see forming in both stocks and bonds. Now in equities, we would look for broader participation in leadership, particularly as investors look towards 2024.
We think that could bring lower inflation, lower interest rates, and better earning trends overall. Leadership could include small cap stocks, cyclical sectors, such as industrials, materials, consumer discretionary, alongside the AI and technology themes.
Now in bonds, we see an opportunity to complement some of the short duration bonds and cash like instruments with longer duration bonds, particularly in the investment grade space. Now keep in mind that the peak in treasury yields typically occurs one to two months prior to the peak in the Fed funds rate.
This could imply that peak yields are likely, perhaps in the weeks ahead. This would present an opportunity for longer duration assets, as investors can not only capture better yields, but also have the potential for price appreciation as the Fed pauses and ultimately pivots lower.
So with that, hopefully, we've given you some good food for thought on the themes and opportunities for the second half of 2023. And we'll see you back here for the July market compass.
Hello everyone, thank you for joining us for the May edition of Market Compass. Today we’re looking at the Federal Reserve and the bank’s interest rate policy.
As we think about what drives investment performance over the long term, it’s economic growth, corporate earnings, and interest rates. The latter has been at the forefront over the past year as the Fed has hiked rates aggressively to tame inflation. But after having done a lot in a short amount of time, we are potentially at a turning point.
In early May, the Federal Reserve raised interest rates by a quarter point, bringing its policy rate to slightly above 5 percent. To put into perspective how sharply rates have adjusted higher, up until March of last year, the Fed’s policy rate was near zero. So, we have seen a 5 percent rise, which makes this tightening cycle the most aggressive in 40 years. But we have some reasons to believe that the May hike might be the last.
To begin with, the Fed softened the language in its statement, omitting a line that said, “Some additional policy firming may be appropriate.” Given how policymakers prefer to communicate, we view this as a strong signal that the Fed is indeed preparing to step to the sidelines.
Of course, any change hinges on the path of inflation. And we’ve seen some progress on that front. The most recent CPI reading showed that consumer prices slowed to below 5 percent in April for the first time in two years, which we think gives some room for the Fed to pause. Historically, the Fed has never ended its rate hikes before its policy rate exceeded the rate of inflation. But with headline inflation now at 4.9 percent and the fed funds rate slightly above 5 percent, a June pause would not break that precedent.
Also, with the recent stress in the banking system, banks are less likely willing to lend. And this could weigh on economic activity and inflation, in a way doing some of the Fed’s work for it.
As an investor, you might be wondering what comes next. We believe the Fed will keep interest rates steady in the months ahead. But a pause doesn’t mean rate cuts are coming soon. Inflation is still way above target, and the economy has proved to be resilient, supported by low unemployment.
As we get closer to the end of the year, we could see discussions about rate cuts starting to emerge. By then, we expect some economic softness and a more meaningful improvement in inflation. Historically, once inflation peaks, the pace and duration of declines have largely matched the pace and duration of the prior increases. That was even the case in the 1970s and 1980s. Given that so far we are following the same pattern, we think there is a good chance that inflation could fall to around 3 percent by the end of the year, which would be a significant accomplishment for the Fed.
What does all this mean for investors? For over the past 40 years, a Fed pause has been a positive catalyst for balanced portfolios that include stocks and bonds. Historically, after the final interest rate hike, policymakers held rates steady for about six months on average before cutting them to stimulate the economy. From the last Fed hike to the first rate cut, stocks performed strongly in five of the last seven cases, while they declined only modestly the other two.
Investment-grade bonds also experienced above-average returns, as yields peaked a couple of months before the last rate hike. With the May policy decision likely marking the end of tightening, we believe that we have seen the peak in the 10-year yield, which rose as high as 4 and a quarter percent last year.
Today’s high interest rates are not going to last forever, given the gradual shift in Fed policy. We think investors where appropriate could consider locking in the historically high yields in short-term fixed income.
But we also see an opportunity to add longer-term quality bonds. These bonds not only secure higher income for longer, but also may appreciate if yields eventually start to move lower if the economy slows and the Fed begins cutting interest rates down the road.
We believe you can expect more volatility in the months ahead as the economy slows. But we also think balanced portfolios can continue to rebound following last year’s decline. Keeping a long-term perspective is important, especially when equities are still some ways off their highs. A Fed interest rate pause won’t be a cure-all, but we believe it will be an important step toward a more sustainable recovery.
With that, thank you for joining us for this month’s Market Compass. We hope to see you again next month.
Hi, everybody. Thanks for joining us on this month's Market Compass video. So as we take a look back, after a very strong 2021, that ultimately gave way to a very challenging 2022, where we saw both stock and bond markets decline pretty heavily, 2023 has, so far, been a more muted mixture of both of those conditions. And although stocks and bonds have logged gains so far this year, the list of challenges for the market is seemingly growing longer of late.
In particular, the recent banking crisis, rising geopolitical tensions, and chatter of an approaching recession, are starting to top that list of investor worries. We think each of those are credible uncertainties that shouldn't be dismissed. In particular, we think the most acute phase of the banking turmoil has passed, but the lingering effects will continue to show up, in the form of tighter lending standards, which curb access to credit for both consumers and for businesses.
This, in turn, is likely to add to the economic headwinds that are fueling those concerns about a recession. And while we think it will culminate in a mild economic slowdown this year, we do think that there are some opportunities for the economy to weather the storm.
And then, third, as geopolitical tensions continue to rise, we expect conflicts and emerging political alliances to spur bouts of market volatility ahead, as they've tended to do over history.
Keep in mind, though, political and geopolitical risks have typically been short-term instigators of market swings, not long-term drivers of performance. So the road ahead in 2023 is hardly clear of potholes. But while headlines are likely to focus on the risks, we think current and upcoming conditions warrant a more positive outlook.
So for this month, let's focus on three reasons for optimism. Reason number one, we think the Fed is going to call it quits on rate hikes. Now, inflation high inflation, in fact, in 2022, is was what led us to this stage of aggressive and sharp rate hikes from the Fed. And the good news is, while inflation is still too high for comfort, it is well off of its peak, and we expect it to continue to trend lower.
We think the Fed may look to put one more quarter point rate hike under its belt in its May meeting, but then we expect the Fed to move to the sidelines and hold rates steady for an extended period of time in 2023, as the Central Bank evaluates the impacts on inflation and economic activity.
Now, let's be clear, this won't solve all the market's problems, but we do think that the end of monetary policy tightening, or rate hikes, is a very necessary condition for a new bull market to emerge.
In fact, over the last 40 years, stocks and bonds both, on average, have logged gains following the last rate hike in a Fed hiking cycle.
Reason number two for optimism. While recessions aren't good, this one won't come as a surprise. Now, what do I mean by that? So I recognize recessions, and the talk of an upcoming recession, doesn't exactly inspire a lot of confidence in investors. But here's the good news, markets have been anticipating an economic downturn for some time. We do think we will see some form of a mild recession emerge in 2023. But again, here's some reason for optimism, the labor market, which tends to be the primary driver of consumer spending, consumer spending being the primary driver of the US economy, the labor market's in rather healthy shape. And in fact, what we think is, the healthy conditions of the labor market entering this downturn will actually help the economy weather the storm a little bit better.
So we can look at the unemployment rate, which currently sits at a, nearly a, 50-year low of 3 and 1/2 percent. We see job growth that's continuing. We see unemployment claims remain cyclically low.
All of this tells us that, while the labor market is not going to be bulletproof through this downturn, we do think that the rather healthy starting point for the labor market will help consumers weather the storm a little better.
Now, the economy then forms the foundation for corporate profits. And the good news here is that, while we do think corporate profits are likely to decelerate as we move forward, companies have already anticipated some of this economic slowdown, which should help support a turnaround in corporate earnings in coming quarters.
Now, we suspect this will probably be a source of market anxiety, as we move forward, and companies seek to navigate these uncertain waters. But broadly, we expect a rebound and a recovery in corporate profits to start to emerge later this year, that will form a good foundation for market performance as we move forward over time.
Markets are typically forward looking. Again, this is good news. So while we might see the economic slowdown take shape as we move through this year, markets are going to start to look ahead to an ultimate recovery.
Historically, the stock market has bottomed and begun its rebound well before recession comes to an end.
Now, reason number three to be optimistic. Bears don't live forever, and this one in particular, is starting to mature. Now, what do I mean by that? Well, the current bear market, which started at the beginning of 2022, is now more than 15 months old. It puts it almost right at about the average length of a bear market downturn. And while bear markets don't have expiration dates, we do think that this one is moving into the latter stages. And the good news here is that, typically, when we reach this point in a bear market, average market returns looking ahead are quite positive. In fact, markets have averaged about a 16% return in the one year after the average bear market length. And better than a 25% return two years ahead.
So what that tells investors is that, even though we're likely to see some rough conditions ahead as we move through 2023, there's still a reason to be optimistic as we expect market recovery to take shape as we move through the rest of this year.
The potential for continued volatility ahead, it's natural if you're feeling a bit worried. During times of uncertainty, one of the things that helps me the most, and that we often recommend to clients, is to focus on the things within your control. When it comes to saving for retirement, or really any goal for that matter, three factors that directly influence your ability to achieve your goal, are how much you save, how long you save and how much your investments earn.
The first two factors, how much you save and for how long, are largely within your control. And while you don't control what your investments earn, you do control your asset allocation, which determines your return potential. Having a strategy to achieve your goal is also within your control.
Your strategy should define what you want to achieve, and by when, estimate how much you need to reach your goal, and identify steps to help you get there.
And while you can't predict how life will unfold, you can prepare for the possibilities by having an adequate emergency fund, maintaining adequate insurance coverage, and appropriately diversifying your investment portfolio.
Having a strategy, and working with a financial advisor, can also help with another item that's within your control. And that is how you react to the inevitable ups and downs of the market. Your financial advisor can help you review and update your strategy, as needed, when in different scenarios to help you prepare for the what ifs, and navigate through the markets, and life's potential ups and downs. So be sure to reach out to them.
Up next, for the market will be the May Fed meeting on May 3. As well as the latest monthly reads on inflation and employment. So those important bedrock conditions for the economy that will help inform the markets as we move forward.
The combination of each of these reports will be of particular influence to the markets as investors evaluate these trends through the lens of the outlook for the economy.
We think investors should anticipate renewed market volatility as we head into the summer, particularly as rates remain elevated in the face of additional evidence showing a more sluggish economy. We do not, however, think stocks will have to give back all of the gains since the October low. And we'd recommend leaning into bouts of market weakness in anticipation of a more sustainable recovery that we believe will take shape as we progress through 2023 and into 2024.
Hello everyone, and welcome to the March edition of Market Compass. It certainly has been an eventful month in markets. And today, I thought I'd go through two key drivers of markets in recent weeks. First, we can review the status of the unfolding banking upheaval and the implications there. And second, we can discuss the March Federal Reserve meeting and rate hiking decision, as well as our broader take on markets.
So first and foremost, most recently, while there has been a bit more stability in the banking sector, uncertainty remains, and confidence is fragile, notably with the UBS acquisition of Credit Suisse, that has provided an important support to a systemically important bank in Switzerland.
And here in the US, while deposit outflows have stabilized, there remains some distress in the regional banking sector, including with banks like First Republic and Pac West Bank. Now a couple of points we'd note here.
First, while the recent turmoil in the US regional banks and the acquisition of Credit Suisse may evoke memories of the financial crisis of 2008, we continue to see two very different environments. Large banks in the US are much better capitalized today. They also have more diversified sources of revenue, including capital markets, investment banking, and wealth management.
They're regularly monitored by Dodd-Frank regulations, including periodic stress testing. So while volatility may persist near term, and this crisis of confidence may take some time to ease, we do not yet see the scope for systemic disruption in the global banking system.
Now secondly, there also may be a bit of a silver lining to some of this global banking turmoil. If lending standards do tighten and some consumer spending does erode, this does put less ongoing pressure on services inflation, which perhaps also supports the Federal Reserve moving to the sidelines earlier than initially expected.
And speaking of the Fed, at this past March meeting, we did hear from Fed Chair Jerome Powell on two very important fronts. First, the actions they've taken to support the banking crisis, and second, their ongoing interest rate hiking cycle to combat inflation.
Now this meeting was unique, in that the Fed spent time to highlight its role as a liquidity provider to the banking system, not just focus on its inflation battle. Chair Powell noted that the Federal Reserve remains ready to continue to use its liquidity tools to support the banking sector as needed, through means like offering emergency lending and increasing the flow of dollars.
Now while it did acknowledge that recent turmoil in the banking sector may lead to tighter credit conditions and a slowdown in economic activity, it continues to see the US banking system as, quote, sound and resilient.
Now it's also important to remember that the Fed and global central bank actions recently do come at a more rapid pace than what we've seen really in any time in recent history, including the great financial crisis in 2008. Now, the Fed of course, also focused on its ongoing inflation battle, raising interest rates by 0.25%, in line with market expectations. This brings the federal funds rate to around 5%. Now notably, the Fed also released a new summary of economic projections and best estimate of rate hikes going forward.
As the Fed projections indicate, they see economic growth softening, headline and core inflation likely headed lower, and interest rate hikes that are closer to an end. In fact, the 5.1% estimate for 2023 implies perhaps just one more rate hike remaining.
Now what are the market implications of the banking crisis and this Fed rate hike decision? Well, in both equity and bond markets, we have seen more defensive posturing over the past month. Sectors such as consumer staples and health care, which are traditional defensive areas, have outperformed alongside quality growth and parts of technology, which also tend to do well when yields are moving lower.
Now we see this trend persisting near term, as this confidence in the banking sector may take some time to fully return. Similarly, in the bond market, we have seen Treasury yields move lower, as investors flock to traditional safe haven assets. Both the two year and the 10 year Treasury yield are well below recent highs.
Now over time, we do think yields will stabilize, although perhaps the highs in yields are behind us. But nonetheless, while investors more recently have gravitated towards short term bonds-- think about CDs or one or two year treasuries-- and perhaps rightfully so, as yield opportunities are favorable relative to any time in recent history, we do see opportunities forming, however, to complement these, potentially with longer duration bonds, particularly in the investment grade space.
Now keep in mind, these bonds not only lock in better yields for longer, but also have the opportunity for price appreciation, especially if the Fed does pause and over time move interest rates lower.
With this part of the year often referred to as retirement season, I want to take a minute to talk about cash. Interest rates are higher than they've been in years. And with the markets having a rough 2022 and early start to 2023, there's been a lot of focus on cash and shorter term investments, like CDs. Given the current environment, it could be tempting to either move or to even keep money in cash.
So the question becomes, should I be keeping my money in cash or CDs, or should it be invested in something else? Now certainly, cash plays a crucial role as part of your overall financial strategy. But it's important to hold the appropriate amount in order to achieve your goals.
But to answer this question, we need to first understand the role of cash and how much makes sense. And then we can determine if this money should actually be invested.
In general, cash can serve several purposes. It should be there to provide for your ongoing living expenses, as well as maybe to pay down debt. In addition, we recommend having between three to six months of living expenses in cash for your emergency fund. Finally, cash can also be used for short term savings goals.
But if the cash isn't needed for those items, if you have your emergency fund and your living expenses covered, then any excess cash should really be targeted for reinvestment within the portfolio to support your goals. Notably, by knowing you have those other needs covered, this can provide you with a confidence to allocate this excess cash towards your goals.
So before you decide to move any funds to cash or reinvest into another CD, take these steps. First, what is the purpose of the money, and what role is it playing relative to the goals you have? Do you have your spending and emergency cash needs covered? And if so, is this really excess cash that should be invested?
If the answer is yes, this would be where we could look for opportunities to invest and make progress towards your long term goals. Not only could the current environment present some opportunities, with this being retirement season, you can still make contributions for 2022 to your IRAs before the April 18 tax deadline, as well as fund your 2023 contributions.
Holding cash is important. But cash is not the solution for money that's really intended for long term goals like retirement. And while there are risks to investing, there are also risks in not investing, and that's not reaching your goals.
Importantly, taking the time to understand the purpose of your cash and its role can help you determine where you should invest it. So reach out to your financial advisor. See if you have your short term and emergency needs covered, and ensure you're taking the appropriate steps to reach your goals.
So overall, while it does take time for a crisis of confidence to ease, we continue to believe that there are not yet signs of wide scale contagion or systemic risk in the US banking system. In our view, a modest economic downturn continues to remain the base case scenario. And markets over the past 15 months or so have reflected some or even much of this outcome.
We do see opportunities forming, both in the equity and bond space, in the months ahead, and beyond the more recent defensive posturing. We recommend investors work with advisors to continue to use market volatility to rebalance, diversify, and add quality investments at better prices ahead of a potentially more sustainable rebound to come.
So with that, I thank you, and I hope to see you back here for the April Market Compass.
Thank you for tuning in to the February edition of Market Compass, where we share our thoughts on the latest economic and market developments. This month, we're going to use a global lens to discuss how the world economy is progressing, what are the key trends that we are monitoring, and what it all means for you.
Last year saw some unique challenges and economic headwinds, many of which were global in nature. High inflation around the world forced central banks to raise rates aggressively while the war in Ukraine and renewed lockdowns in China weighed on global economic activity.
Geopolitical uncertainty remains high, and the effects of the rise in borrowing costs that we have seen will continue to be felt this year. But the outlook for global growth has improved in recent months.
So what's changed? To begin with, confidence in Europe has started to recover as an unseasonably warm winter helped avert a much-feared energy crisis. Natural gas prices shot up when Russia cut off its natural gas supply to the region, but they've now returned back to where they were before the Ukraine invasion.
Related to this point, the European economy was expected to contract last quarter but instead, showed slightly positive growth. And as with the US and Canada, the European unemployment rate remains at historic lows, supporting incomes and consumer spending.
The other positive development is China's reopening. After battling a COVID-19 resurgence, the country pivoted away from its zero-COVID policy. In light of the pivot, we are expecting China to experience what most of the Western world saw in 2021. The reopening should release pent-up demand while government is supporting growth. Because of this, China is the only major country where growth is expected to accelerate from last year.
Of course, risks do remain. For example, we could see an escalation in the war in Ukraine. But overall, it appears that the global economy has avoided some of the worst-case scenarios
A big piece of the investment puzzle over the past 12 months has been inflation and Central Banks' response to it. Eurozone inflation appears to have peaked, but core inflation, which excludes food and energy, remains sticky and is higher than it is in the US. Because of this, the European Central Bank has more work to do in our view. And we believe it will stop hiking rates after the Federal Reserve does. As a result, we expect the difference between US and European policy rates to narrow going forward, which could be less favorable for the US dollar.
Speaking of the dollar, last year, it was exceptionally strong against other major currencies, rising to a 20-year high. It has begun to soften, but still remains above its two prior peaks in 2016 and 2020. The question is, what could make the dollar weaken even further this year? In our view, a Fed pause and a reacceleration in global growth by year end could be the two catalysts.
Historically, international equities tend to perform well when the dollar is weaker against other currencies and vice-versa. US investments typically outperform when the dollar is stronger. Even a modest shift lower in the dollar could be a catalyst for better international equity performance. And we've already started to see early signs of this playing out.
Equity markets are not ignoring the better news coming out of Europe and China. You might be surprised to learn that international equities outperformed US equities last year, even though both were down significantly. Over the past six months, that outperformance was more noticeable, especially when you look at emerging markets and Chinese equities.
But despite the rally, international equities still trade at a near-record discount relative to US equities. That historical discount has averaged about 11%. As of mid-February, the discount is about 30%. This to us suggests that there is more room for global indices to catch up and make up some of the lost ground over the past decade.
This leads us to our last point. International diversification still makes sense in our view. Leadership often rotates. And bare markets, like the one we are experiencing, tend to trigger those rotations. Technology and other growth sectors of the economy have supported US outperformance over the past 12 years. But high interest rates could favor sectors that trade at lower valuations and pay dividends. These type of companies have a higher representation in international indexes.
It's nearly impossible to predict exactly when leaders might turn into laggards and vice-versa. But diversifying your portfolio across asset classes and regions can help spread out risk and give you a chance to participate in whatever region is outperforming at any given time.
With that, thank you for tuning in. We will continue to share our insights on the financial markets and what that means for your portfolio. So look for another video next month.
What’s on the horizon for the economy, inflation, interest rates and the stock market? And how should investors react? Investment Strategists Craig Fehr and Scott Thoma offer some perspective as well as ideas you can discuss with your financial advisor today.
Thanks for tuning in to the January edition of the Market Compass video, a new video series in which we cover some of the most important and relevant topics to the financial markets and what that means for the outlook for performance ahead and ultimately what that means for you as an investor as you help navigate these markets toward what's most important to you and your financial goals. So with that, given that we've turned the page on 2022 into 2023, let's use that transition to talk about the year that was and, importantly, what that sets us up for in the year ahead.
So if we think back to 2022, obviously a year many investors would prefer to forget, a challenging year with declines in both stocks and in bonds, which is rather abnormal. They're really speaking to the unique environment that we were in, in which inflation was rising rapidly for a whole host of conditions. Post-pandemic reopening, war around the world, geopolitical tensions, supply chain bottlenecks, all produced elevated inflation, which ultimately weighed on interest rates and the financial markets.
So as we have that as a backdrop, what can we expect for 2023? Let's talk about five key questions for the year ahead. First question being, what's the outlook for the economy this year? The economy really forms the foundation upon which financial market performance is built, and our view here is that the economy is poised to slow. We had a rather healthy end to 2022 in terms of economic growth. As we look ahead this year, we think some of the core components of the economy, particularly consumer spending, which makes up the bulk of GDP in the United States, is poised to slow. It's going to show some of the effects of restrictive monetary policy from the past year as well some natural progression in what we're seeing of the underpinnings of the economy.
We know from data more recently that retail sales are starting to slow. Investment, particularly capital investment from businesses, is starting to slow. We're seeing some emerging cracks in the labor market. The housing market is starting to roll over.
I recognize this doesn't necessarily paint the most positive picture, but what we think it's ultimately going to produce is a mild slowdown or recession in the economy. And I'll just point out, a recession at this stage is not inevitable or a foregone conclusion, but instead, as we look at some of the momentum coming out of the economy, we think investors should prepare for a slowdown there.
Now, I'll draw one important distinction. We do think that the point that the labor market is entering the slowdown at is critically supportive and positive for what the outlook for any slowdown might look like. Put a different way, we're seeing rather tight labor market conditions even as we're seeing the economy start to slow. Specifically, unemployment is at a 50-year low. Job growth on a monthly basis continues to be rather healthy, and if we look at the number of job openings relative to unemployment, that's at a historic low as well. So all that tells us that there's some cushion for the consumer as we enter this period of slower growth or even a slight, modest decline for growth in the economy ahead.
Second question, then, would be will inflation, which obviously was a key influence on the economy and markets last year, subside or remain high? And our view here is that inflation is on a more positive trend, meaning it's on a downward trend, as we progress. We saw inflation peak last year. Since then, we've seen several months of declines and inflation pressures. Now, keep in mind, inflation is still at an absolute level, still quite high, but the trend is moving in a much more favorable direction.
We see goods inflation. So the price we pay for the goods that we buy is continuing to come down quite dramatically. Services inflation remains a little sticky, a little high, but even the shelter component — so the contribution from housing — is starting to roll over and become less of an upward influence. So all told, we think that inflation, which was the primary focus for the markets last year, is going to continue to move in a favorable direction.
So then the third question, then, which is connected to inflation is, will interest rates keep going up? And our view here is that we have a much more favorable outlook in 2023 than we saw in 2022. Keep in mind, last year we saw interest rates rise at a historically rapid clip. That was because the Fed was pushing up short-term rates to combat inflation, and higher inflation was bleeding through into longer-term rates moving higher. We don't expect a repeat of that in 2023, and, in fact, we do think that interest rates can stabilize, which will help support more positive performance in the bond market in the year ahead.
Question four, then, would be — the question on every investor's mind — when will the stock market rebound? And our view here is, again, more favorable. We think that relative to the declines we saw last year, which were driven by the reaction from the Fed, much more restrictive policy and some challenges to the economy, we think that as we look ahead in 2023, there's an outlook for more favorable performance ahead for equities.
Now, keep in mind, if we compare that to the first point we made, which is we do think an economic slowdown is coming, importantly, stocks moved to price in some form of a mild recession already with the decline that we saw in 2022, which means, as we move forward, even as economic conditions perhaps deteriorate, we've already seen markets move ahead of that, and we would expect markets to rebound in advance of any bottoming in the economy. So at this stage, we do expect a much more positive performance from equities in the year ahead.
So with that, the fifth question, what do investors do about all this? And I would say there's a couple of things to keep in mind. One perspective is that, while we've obviously seen a lot of challenges in the market, 2022 was a historically challenging year for investment returns, bad returns are often followed by better returns historically, and, in fact, bad markets, in our opinion, make for good opportunities. And we think that will be the case in 2023, recognizing there's going to be ongoing volatility, particularly early in the year as the recessionary pressures continue to take shape, but ultimately, we think that a new, renewed bull market, a more sustainable bull market, will start to take shape as we progress through 2023, which means as an investor, you want to review your situation, look at your tolerance for risk, consider if your goals have changed, and if so, make the appropriate adjustments to ensure that your portfolio remains on track to support your long-term goals.
And then a couple of more specific actions to take, things like rebalancing, making sure that your long-term allocations for your portfolio that are designed to achieve your goals and match your comfort with risk continue to be recalibrated to stay on track. And then, lastly, consider a systematic investing strategy, one in which you're putting money to work regularly and systematically so that you can take advantage of the rallies, like we've seen early in 2023, as well as some of the pullbacks that are inevitable as we see volatility materialize over the course of this year.
So that's our outlook where broadly, we would say, 2023 is poised to be a more favorable year than 2022. So as an investor, we want to make sure that we're keeping our portfolios and our investment decisions aligned with our long-term goals. Speaking of long-term goals, now let's have a minute with our Client Needs Research Leader Scott Thoma.
Craig noted that this is an opportunity to review your goals with your financial advisor, see if you're on track, and if adjustments need to be made, which is a great start, but we also recommend reviewing your budget to see how much flexibility you have with your spending and see if there might be opportunities to fortify your emergency fund if you don't have one. These steps can help you better prepare for the unexpected and provide some security and stability should we have some near-term economic weakness.
And speaking of security, the SECURE 2.0 bill was just passed in Washington, which has several important changes that could benefit you, including increasing the age you need to begin taking required minimum distributions from retirement accounts, increasing it to 73 in 2023, higher retirement contribution limits for certain individuals, additional Roth options, and the ability to roll over 529 assets to a Roth IRA for the beneficiary. Now, I note that aside from the increase in RMD age, most of these provisions don't take effect until 2024 and beyond, but these additional savings opportunities highlight the importance of not letting the current environment cause you to lose focus on investing for your long-term goals.
You can refer to our home page at EdwardJones.com for more information on SECURE 2.0. Ultimately, we do believe 2023 could be a more favorable year for investors, so we recommend reaching out to your financial advisor, who can help you navigate the ups and downs, look for opportunities, and help keep your focus on what's most important to you.
Clearly, there's a lot for investors to digest and pay attention to, and we suspect markets are going to remain tightly focused on labor market conditions and inflation trends and ultimately what lies ahead for Fed policy as a guide toward what we can expect from the economy and the financial markets over the course of this year. Thanks for tuning in to the January Market Compass video. Tune back in next month, where we'll continue to provide our fresh insights and takes on what we think lies ahead for the financial markets and strategies that you can take as an investor to ensure you're navigating these markets toward your long-term financial goals.