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By Rick Rieder
Rick Rieder and the team outline how to think about portfolios as we enter 2023.
1 or more years of additional interest-rate duration in ‘23 vs. ‘22, to be grown over time: As central banks slow, or pause, their tightening cycles, in sympathy with slowing economic growth and inflation.
2 years of locked-up returns in fixed income assets, at a generational inflection point in yields: A decline in inflation volatility suggests a decline in interest rate volatility too, both from extreme levels.
3 -handle inflation by the end of 2023, driving a decline in rate volatility: Oil’s falling price means it is becoming a deflationary impulse, and leading indicators for housing suggest a correction is in motion (the highest-beta and largest components of CPI, respectively).
4 more months (or less) of data/policy uncertainty, after which the Fed can pause: The market has fully priced in another 100 basis points (bps) of hikes over the next four months.
5 years of runway potential for fixed income to generate outsized returns: The higher we climb up the discount rate mountain, the more vertical is created on the other side.
6% to 6.5% of portfolio carry potential (including anticipated curve rolldown): Without needing to take on much duration, credit, convexity or illiquidity risks.
7% carry (including rolldown) potential in U.S. Investment-Grade: Based on historical returns, at similar entry yields.
8 or a high-single-digit number of significant defaults in 2023: We have probably left the 1% default rate in high yield behind us, but we don’t anticipate seeing 2009’s 13% either.
9% nominal GDP may be behind us, but we won’t dip much below 4% NDGP (while the 7 years before the pandemic averaged 3%): The strong labor market will keep real growth from collapsing, even as inflation slows.
10% potential return on mortgages, if yields just went back to the 83rd percentile from over the last 10 years (from the 98th percentile, currently): Supported by shelter inflation that is slowing, but a housing market that is not going into a bust.
11% carry (including rolldown) potential in U.S. High Yield, for those able to venture into the right places: Keeping in mind that defaults will probably rise off record lows, making selectivity critical.
12 months of carry in fixed income hasn’t been this exciting in many, many years!
…and a bunch of equity gamma, funded by a portion of that fixed income carry, to capture the potential for right-tail risk.
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Investing involves risks, including possible loss of principal. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index.
Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic, or other developments. These risks may be heightened for investments in emerging markets. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks may be heightened for investments in emerging markets.
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This post originally appeared on the iShares Market Insights.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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