Market compass video series

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.