After a couple of distinctly rocky years in financial markets, can we look forward to better times in 2023? As inflation continues to be the dominant determinant of markets and the Fed strikes a hawkish posture, is there any possibility we will avoid a recession? Bernstein Research's Senior US Economist and Strategist, Eric Winograd, joins The Pulse to dissect the competing headwinds.
This transcript has been generated by an A.I. tool. Please excuse any typos.
00:04 - 00:16
Hi, I'm Stacie Jacobsen, National Director of our Client Engagement team and your new host of the Pulse podcast, where we bring you insights on the economy, global markets, and discuss all the complexities of wealth management.
00:23 - 01:08
Today we're kicking off the new year with our macro outlook for 2023. Now, of course, given the headline events of the past few years, any economic forecast must be delivered with a healthy dose of reserve. Almost no one could have foreseen the full impact of the COVID pandemic at the end of 2019. Yet that was clearly the dominant economic event of the following year. Few could have predicted the global impact of the Russian invasion on Ukraine at the end of 2021. Yet that proved to be the dominant event of last year. Even so, we would be derelict in our duty if we decided not to make any predictions. So forecasts must be made, however tentative, to make use of the Donald Rumsfeld dictum. You must deal with the known knowns and the known unknowns and the unknown unknowns will have to take care of themselves.
01:09 - 01:59
For the United States and for all developed economies, in 2023, inflation and slower growth will be the key issues. In mid-December, the U.S. Bureau of Labor Statistics reported that consumer inflation had risen a less than expected 0.1% in November, and 12 month inflation fell 0.6 percent from the October reading to 7.1%. This is 200 basis points lower than the peak of 9.1% in June. Now, this seems to suggest that the recent cycle of Federal Reserve hikes totaling no fewer than 400 basis points in 2022 is beginning to bear fruit. Nonetheless, it hiked another 50 basis points in December, and the minutes from that meeting give little hope that the cycle is done. Reporting that, quote, No participants anticipated that it would be appropriate to begin reducing the federal funds target in 2023.
01:59 - 02:36
Now, look, there is good reason for the Fed's caution. Much of the decrease in November inflation was due to lower energy prices, which tend to be more volatile anyway. Service inflation remains elevated and this is a source of concern as services account for two thirds of the US economy and tends to be stickier. Housing is particularly worrisome. Shelter inflation continues to reset at higher levels, though home prices reached an apex in June 2022. There tends to be a lag of at least 15 months between peak home price and peak shelter inflation. There may be another three quarters before the Fed can be sure that tightening is having an effect.
02:37 - 03:06
The December nonfarm payroll released on January six, contained little that would shift Chairman Powell's trajectory. The payroll grew by 223,000, while unemployment ticked down from 0.1% to three and a half percent. So while we expect inflation to slow over 2023, there will likely be no substantial release from the higher rates. Corporate earnings will be depressed by around 5% in our view, and perhaps up to 15% in the worst case.
03:06 - 04:01
Now, of course, there is a chance that inflation will ease rapidly and the Fed can stop tightening sooner than expected. But that's really optimistic. Europe will feel the same pressures as the U.S., only more so. While there is a chance the U.S. will avoid recession in 2023, this is much less likely for Europe. China looks as though it may be reopening, though one can never be sure. Well, this is actually really good news for the world economy in many respects and should, for example, boost energy stocks. It is also likely to add to already considerable inflationary pressures. So tying this all together, what does it actually mean for asset allocation and returns Those exposed to the equity markets, which is most of us will need to tap into reserves of patience and resolve if indeed the US does drift into recession in the first half of 2023. Stock market returns will likely tread water until the landscape becomes clearer.
04:01 - 04:31
In most recent recessions, the Fed has stepped in to ease the pain the so-called Fed puts. But that is the one thing the Fed just can't do this time around. We do think that the time will come when inflation has receded sufficiently for the Fed to think of easing again. But predicting the timing of this would require a very special type of crystal ball. So it is also worth noting that our fixed income team warns that it is just easier to get inflation from 8% to 5% than it is to get it from 5% to 2%.
04:32 - 05:25
All right. Let's talk about international exposure. What do we do about it? Look, it tends to be a good idea for U.S. investors to be diversified on a global level. But the 9% rally in the US dollar worsened declines in the non-U.S. stocks in 2022. However, if the Fed begins to hike less aggressively, more central banks in the rest of the world catch up, then a strong dollar could become less of a factor. And moreover, European stocks are now just looking oversold. One of the most painful aspects of 2022 was the fact that fixed income markets flat out failed to provide offsetting gains to the equity investors. Rather, bonds fell in lockstep with stocks. This was a historical anomaly similar to 2008, in that both stocks and bonds delivered losses. Bernstein's own senior investment strategist, Roosevelt Bowman, tells us more from a recent Outlook 2023 video.
05:25 - 06:04
Our base case assumes that the Fed may be close to the end of its hiking cycle, and a recession lies in store. But we remain cautious about taking interest rate or duration risk. The bar for the Fed to begin cutting rates is extremely high, and we don't believe we're close enough yet to justify more aggressive positioning toward a longer duration in the taxable bond space. We're focusing in the 3 to 5 year area of the yield curve and the municipal bond space. We're avoiding the short end of the curve where the relative returns are poor. How your credit is more of a mixed bag with different parts of the market showing more opportunity than others. We also see notable risk adjusted returns in areas of the securitized credit markets.
06:05 - 06:20
Mortgage backed securities and credit risk transfer securities offer relatively high yields and strong fundamentals, which can mitigate both inflationary and recessionary risks. Ultimately, this year has taught bond investors that when markets are more volatile and returns are more modest.
06:20 - 06:23
Good advice becomes even more important to gain an edge.
06:24 - 06:43
That was Bernstein, senior investment strategist Roosevelt Bowman. And you can see our full video of our 2023 outlook in the link of this episode's description. We'll take a break for just a minute and be back with AllianceBernstein, senior economist and strategist Eric Winograd to get his take on all things macro. Stay with us.
06:46 - 07:13
Hi, I'm Clare Golla, host of Inspired Investing, a podcast for those engaged in the nonprofit philanthropy and broader social sector. Be sure to tune in this month as we address major changes and massive data gaps across the sector with Cathleen Clerkin of Candide, an organization that gives people the information they need to create change and do good in the world. You can find inspired investing at Apple Podcasts, Spotify, or wherever you listen to podcasts.
07:17 - 07:29
Thanks again for joining us for the first episode of the new Pulse podcast from Bernstein Private Wealth Management. We have with us today senior economist and strategist at AllianceBernstein, Eric Winograd. Thanks for being with us, Eric.
07:29 - 07:30
Thank you for having me.
07:30 - 07:37
All right. I'm going to get right back into it and ask you to be my crystal ball. For how long do you think the Fed will continue to a rate hike and by how much?
07:37 - 07:58
So we move into the new year, close to, we believe, the end of the tightening cycle that started last year with the caveat that things could change based on the incoming data. Our general expectation is that the Fed has one or two more rate hikes totaling either 50 or 75 basis points left and that they should be done raising rates by the end of the first quarter.
07:58 - 08:01
All right. So where will that leave us? Where are we going to settle?
08:01 - 08:23
That will leave the policy rate sitting right around 5%. If they raise rates by a total of 50, it leaves you just below 5%. If they end up doing 75 just above. I'll tell you that from a macroeconomic perspective, that's a rounding error. It doesn't really make very much difference to the economy if we're a little bit below five or a little bit above. The point is that they're going to settle in right around 5%, we expect.
08:23 - 08:33
Now, the Wall Street Journal has reported that two thirds of economist at 23 large banks think that we're going to enter into a recession in 2023. What are your thoughts?
08:33 - 09:05
The first thing I would say is I bet that of those what did you say, 23 economists. There are probably 23, maybe 25, maybe 30 different definitions of a recession. It's sort of an eye of the beholder thing because there is no one answer to or there is no one definition for what a recession is. So let me tell you what we actually expect, which is for growth in the US this year to be close to zero, maybe a little bit above, maybe a little bit below, but around zero for the year as a whole. We also expect the labor market to weaken, which means that unemployment should rise.
09:05 - 09:43
Now, to me that's consistent with the idea of a mild recession. To me, really, the labor market is the driving variable there. I would guess that most other economists would also consider that to be a recession. So I think that's consistent with the consensus view. But you'll certainly find some who will get hung up on, you know, multiple consecutive quarters of negative GDP growth or a particular magnitude of unemployment increase. And I just don't think that semantic debate is particularly useful. I think it's better to really focus on what we expect, which, as I said, is zero growth and some weakening of the labor market. But if you have to categorize me and if you want to put me in a box, put me in the mild recession box.
09:43 - 09:53
Mild recession box, your. So if we do indeed enter into recession in 2023, do you think that the Fed will alter course and begin lowering rates?
09:54 - 10:24
I think the answer depends very much on the magnitude of the weakness of the labor market. Remember that we're talking here about a prospective weakening of the labor market. We haven't seen any weakening yet. The unemployment rate is still three and a half percent. And the monthly payrolls report is adding jobs at roughly a 200,000 per month rate, which is more than twice the number of new entrants to the labor force. So it's a little premature to talk about how much the labor market will weaken before it has even started weakening.
10:24 - 11:01
That said, the Fed also expects the labor market to weaken and they have told us that even if the labor market weakens and even if GDP is not particularly robust this year, although they're a little more optimistic than I am, that they don't intend to cut rates over the course of the year. So if you listen to the Fed, the answer to your question is no. My own answer is by the end of the year, I suspect that if the labor market weakens and we're in something that looks like a recession, they'll be talking about rate cuts and whether they actually deliver them in 2023 or not till 2024. We'll see. But I expect that to be the dominant narrative in markets as the year draws to a close.
11:02 - 11:11
I'm going to shift a little bit to the markets now. Last year, stocks lost somewhere in the region of 19%. Are they now beginning to look oversold to you as well?
11:12 - 12:05
Not really. I mean, I think the economic outlook and the rate hikes that we saw last year warrant a rerating of the stock market. We started this discussion talking about the possibility of a recession. And in a typical recession, stocks go down something like 30%. So just from the growth perspective alone, the change in this year relative to where we were a few years ago warrants a decline in stock prices. You combine that with an aggressive rate tightening cycle, the likes of which we haven't seen since the 1980s. And I think it's easy enough to say that the decline in stock prices reflects the changing economic and market landscape. So I think that the decline we should also observe that the decline came on the heels of a massive rally coming out of the COVID pandemic. So I don't have a particular issue with the decline in stocks. If anything, given our economic outlook, I think that earnings expectations may still be a little bit too high.
12:05 - 12:20
There's been some tough news here. Other countries and regions are worse off than the US. So why do you think Europe is particularly vulnerable to a longer and deeper recession to. US. And what does that really mean for the U.S. investors on their global exposure?
12:21 - 13:04
Yeah, I do think Europe is a little bit more vulnerable for one clear and obvious reason, which is that their dependence on natural gas imports is much higher than ours, and large portions of their natural gas come from Russia, come from Ukraine. But obviously geopolitical conflict has limited those supplies. If you had asked me a few months ago, I would have said that they were all but guaranteed to have a significant recession. But what we've seen over the last few months has been that the winter in Europe has been unusually mild, and European governments did an excellent job of stockpiling natural gas ahead of the winter. And as a result, the economic damage from limited gas supplies over the last few months has been more limited. And that doesn't make things look great.
13:04 - 13:50
And remember that the European Central Bank is still raising rates, and the growth outlook there is still pretty negative, but it's better than it was a few weeks or a few months ago. We're looking for growth, as I said, in the US of around zero in Europe, probably between negative half a percent and -4% over the course of this year. So it's still a relatively mild recession, but not quite so mild as what we see in the U.S. And of course, the U.K., I think is even worse off because of the way in which past increases in gas prices pass through to consumers there. Regulated gas prices mean that they face these changes in sort of a lump sum form, and that's caused a significant hit to household finances that I think it will be difficult for the economy there to withstand.
13:50 - 14:01
If I could summarize all of the great information that you just gave us and put it into my own words, I would say that the macro landscape is improved compared to 2022. Is that fair?
14:01 - 14:23
Yeah, I would say it's more balanced, right? 2022 The entirety of the macro landscape was dominated by inflation and by rate hikes as we move into 2023. I think we will, over the course of this year, have a more balanced outlook that allows for policymakers to consider the growth consequences of raising interest rates rather than just doing it because they have to get inflation under control.
14:23 - 14:30
Got it. So while inflation may take a backseat, a slow growth picture may become a key determinant of the returns in the market.
14:31 - 15:24
Yeah, I think that's right. Over the course of the year, inflation should recede as the foremost concern and we should have this more balanced view between growth and inflation. And the challenge, as you point out, is that the growth outlook isn't exactly robust either. You know, we view 2023 as sort of a transitional year, right. A transition away from the focus on inflation that we saw this year. We expect that by 2024, the growth picture will have deteriorated enough and inflation will have come down enough that policymakers will be focused on supporting growth. But that still leaves 2023 for this sort of transition from a focus on inflation to a focus on growth. And that transition is going to be bumpy. It's not going to be only in one direction. There are going to be periods where inflation comes down more quickly and markets get very optimistic and there are going to be periods where it comes down more slowly and the ride gets a little bit bumpier. So as I said, I think the best way to look at this year is as a transitional one.
15:25 - 15:28
All right. Transitional one. That'll be our key word here.
15:28 - 15:33
Are there any risks that you're focused on besides the usual inflation and growth?
15:33 - 15:59
You know, one risk that we want to flag that we think investors need to be aware of is the probability, I would say, of a disorderly debate in Washington around raising the debt ceiling. This is an issue that resurfaces periodically and will need to be addressed probably over the summer this year. You'll recall that in past episodes, the political parties have had a difficult time coming up with an agreement to increase the debt ceiling without sort of a public back and forth.
16:00 - 16:39
If you go back to 2011, in fact, the process was so messy that it ended up with the U.S. getting a sovereign downgrade from one of the ratings agencies, from triple-A to Double-A plus. Now, it didn't have economic effects and the market effects were relatively short lived. But we think that that process this year is likely to be, if anything, even messier than what happened in 2011. If you look at the challenges that the Republicans faced in electing a speaker of the House and then combine that with a much more controversial topic, which is government spending, we think the odds are very good that at some point over the summer that is going to move to the forefront of issues that the market needs to deal with.
16:39 - 16:47
Eric, you said that you're in that mild recession box. What might happen that would take you out of that box and into a deeper recession?
16:47 - 17:10
It's a great question and probably one that's more important than the question about our absolute forecast. So, you know, you don't only have to look back a year or two to recognize that forecasts can go wrong very quickly. A lot happened in 2022 that we didn't expect, starting with the continuation of the zero COVID policy in China. The Russia invasion of Ukraine and so on. So forecasts are only as good as the assumptions that underlie them.
17:10 - 17:51
When we look at this year, the things that strike us as most likely to make the situation. Worst one is if we're wrong and everyone else is wrong and inflation simply doesn't come down, there's good reason to expect that it will come down, Whether it's commodity prices that have declined or healing into global supply chains or faltering house prices. But nonetheless, there is some possibility that it won't. And if it doesn't, the Fed will have to continue raising interest rates, and the peak in rates might not be 5% or even 6% or even 7%. We don't think that's a very likely scenario. But we certainly don't want to disregard it altogether. And that would certainly lead to a much more negative economic and market outcome if the banks are not healthy.
17:52 - 18:12
If the banks have taken untoward risk, then you end up with a situation that could spiral its or through the financial sector and from there to the real economy. You know, the financial sector is the place that monetary policy hits Main Street, if you will. That's the that's the transmission mechanism. And as we saw during the financial crisis ten, 12 years ago now.
18:12 - 18:52
And so we've spent a lot of time looking at the health of the financial sector. And we're generally comfortable that the excesses that defined that previous crisis don't exist today. And the risk management has been better. That regulatory policy has been far better. Capitalization and liquidity ratios are much healthier. So we don't worry too much that the banks are in a position to add fuel to the fire, if you will, in the event of a slowdown. But it's always possible that there is some pocket of leverage that we can't see, that there is some bubble somewhere that spirals into a broader slowdown. And that's something we'll continue to monitor. As I said, though, the good news is, at least as a starting point, is that we don't see evidence of that ex-ante.
18:52 - 19:04
Now, you had mentioned 2022, and I think it's fair to say that the year didn't quite turn out as many expected in the beginning of 2022. So do you think we have a better chance of getting it right this year?
19:04 - 19:35
I do think we have a better chance of getting it right this year. Or to put it differently. If we're wrong, it won't likely be by as much as we were last year. The range of potential outcomes seems much narrower, and that's true for a couple of reasons. One is that at this time last year, most economists, myself included, understood that we would have a period of elevated inflation. But we also expected that inflation would then start to come down as the year ended. But that was an expectation, right? It was based on forecasts. It was based on very limited evidence available at the time.
19:35 - 20:10
At the challenge of looking too far forward is that you have to do it with less information than you would like. You contrast that to now when we say that we have increasing confidence that inflation will come down. The reason is because we started to see that process play out. We're talking about a near-term decline in inflation rather than one that starts six or nine months from now. Goods prices have already started to come down. House prices have already started to come down. And over time, that will pull inflation down as well. So we're more confident that we won't get that major issue wrong this year by the same degree that we did last year.
20:10 - 20:13
Well, that's all very helpful and I think a positive outlook for us.
20:13 - 20:15
Glad to provide something positive.
20:15 - 20:19
Eric, thanks again for being here and giving us your perspective. We really appreciate it.
20:19 - 20:21
My pleasure. Happy New Year, everybody.
20:21 - 20:23
And thanks to everyone for tuning in.
20:23 - 20:34
You'll hear from us again on January 31st when we'll be back talking about a subject with no shortage of discussion swirling around it crypto. If you have questions about crypto and how could you not?
20:34 - 20:44
You won't want to miss it. Don't forget to subscribe to the pulse wherever you get your podcasts to ensure you never miss a beat. I'm your host, Stacie Jacobsen. Wishing you a great rest of the week.
- Stacie Jacobsen
- National Director—Wealth Strategies Group