Multi-Asset Strategies Outlook
Investing Discretion is the Better Part of Valor
“Discretion is the better part of valor” in current usage means it’s better to be cautious than to take unnecessary risks. In our view, that’s crucial advice when risk assets are rallying hard, but we believe an economic and corporate earnings recession is on the horizon.
It’s easy to look at rising stock prices earlier this year and think that things must be looking up. But some context can transform our view. Rather than seeing the beginning of a new bull market, we think the economic backdrop means this is a classic bear market rally. And if we’re right, then it may be better to be cautious than courageous.
Recession Remains the Most Likely Outcome
The yield curve has been inverted since late 2022, and inverted yield curves have been a strong predictor of recessions over the last 50 years. If that historical relationship holds, we’re looking at a recession before 2023 is out. Housing and manufacturing data are also slumping, two other strong recession indicators.
Market Pricing in a ‘Short and Shallow’ Recession
The recent rally in stocks suggests the market expects the coming recession to be short in duration and shallow in depth. That’s in direct contrast to those economists and Wall Street prognosticators who are still expecting a recession that is “long and painful.”
We’re Skeptical About a Fed Pause or Pivot Anytime Soon
In the wake of recent bank failures, the market is betting heavily that the Federal Reserve (Fed) will pivot to rate cuts before the year is out. We think Fed Chair Jerome Powell remains focused on snuffing out any signs of inflation. If the bank crisis spreads, then the Fed will be in a tough position. But lacking a systemic crisis, we don’t see the central bank cutting rates before declaring victory over inflation.
Cautious Economic Outlook Influences Our Portfolio Positioning
Because we believe we face an economic and earnings recession, we’re cautious on stocks. In our view, earnings expectations for U.S. equities are too optimistic given the anticipated economic downturn. Instead, we find bond yields attractive, though our economic view means we favor high-quality over high-yield bonds.
Rising rates, slowing growth and still-high valuations weaken the outlook for stocks. As a result, we see further downside risk for equities, especially considering the rally over the last several months. At the same time, higher short-term rates make cash much more attractive. Longer-term bond yields are also appealing relative to equities. But with the yield curve inverted and inflation still not decisively knocked out, we prefer cash over bonds. Within bonds, our economic view means we favor high-quality over high-yield bonds.
With economic growth and earnings expectations for U.S. equities coming down, we see the ongoing stock market rebound as a bear market rally. Instead, we’re more sanguine on stocks outside the U.S. We think these markets offer more attractive relative valuations and risk/reward after earlier underperformance. Our quantitative view finds that momentum and macroeconomic variables are strongly positive outside the U.S.
As with stocks of developed non-U.S. markets, emerging market equities (EME) are attractive relative to U.S. markets on our metrics. In part, the rationale is based on our cautious outlook for U.S. equities. At the same time, EME valuations are historically cheap after a poor performance in 2022. In addition, China’s economy is reopening after years of its zero-COVID policy at a time when commodity prices are strong, and the U.S. dollar is weakening. This development has led to a sea change in investor sentiment on EME, where investor inflows are soaring. That positive momentum is another reason we are now shifting to an EME overweight.
U.S. Equity Size & Style
Positioning by size is an opportunity we’ll be evaluating carefully as economic and market conditions evolve in 2023. That’s because small-cap growth and value are trading at significant discounts to their average valuations. In addition, the valuation spread versus large-cap stocks is the widest in decades. Also, small caps have tended to lead large-company stocks exiting recessions. So, we can see the qualitative arguments for small over large at some point this year, but will be waiting for our quantitative model to confirm the timing.
One of our longest-running positions is overweighting value versus growth stocks. The rationale for this trade remains much the same over time. For example, valuation metrics continue to favor value even after a punishing year for growth stocks. We also prefer value-oriented stocks because they tend to populate more defensive sectors and produce more predictable earnings. Regardless of growth or value, our managers are emphasizing high quality stocks, defined by healthy balance sheets, high return on invested capital and high recurring revenues.
With higher yield levels, our duration positioning is gradually moving toward more overweight U.S. exposure. Country duration positioning favors the U.S., France and Finland against China and Japan. Given heightened recession risk, we are defensively positioned within credit exposures, favoring higher-quality and senior, shorter-duration securitized bonds. However, we continue to believe select holdings, such as municipal bonds and EU corporates, remain favorably positioned for an eventual market recovery.
A further economic slowdown would not favor real estate investment trusts (REITs). Indeed, our models are now negative on REITs versus stocks, bonds and cash. REITs’ recent rebound means that valuations aren’t quite as attractive as they had been. As a result, we remain underweight REITs in favor of broader U.S. equity exposure. China’s reopening and better growth in select emerging economies present opportunities outside the U.S. that we’ll be monitoring carefully.
View Glossary Definitions
A form of securitized debt that represents ownership in pools of mortgage loans and their payments.
Asset-backed securities (ABS)
A form of securitized debt (defined below), ABS are structured like mortgage-backed securities (MBS, defined below). But instead of mortgage loans or interest in mortgage loans, the underlying assets may include such items as auto loans, home equity loans, student loans, small business loans, and credit card debt. The value of an ABS is affected by changes in the market's perception of the assets backing the security, the creditworthiness of the servicing agent for the loan pool, the originator of the loans, or the financial institution providing any credit enhancement.
BB and BBB credit rating
Securities and issuers rated AAA to BBB are considered/perceived “investment-grade”; those rated below BBB are considered/perceived non-investment-grade or more speculative.
Entity responsible for oversight of a nation’s monetary system, including policies and interest rates.
Collateralized loan obligations (CLOs)
A form of securitized debt, typically backed by pools of corporate loans and their payments.
Commodities are raw materials or primary agricultural products that can be bought or sold on an exchange or market. Examples include grains such as corn, foods such as coffee, and metals such as copper.
Consumer Price Index (CPI)
CPI is the most commonly used statistic to measure inflation in the U.S. economy. Sometimes referred to as headline CPI, it reflects price changes from the consumer's perspective. It's a U.S. government (Bureau of Labor Statistics) index derived from detailed consumer spending information. Changes in CPI measure price changes in a market basket of consumer goods and services such as gas, food, clothing, and cars. Core CPI excludes food and energy prices, which tend to be volatile.
Corporate securities (corporate bonds and notes)
Debt instruments issued by corporations, as distinct from those issued by governments, government agencies, or municipalities. Corporate securities typically have the following features: 1) they are taxable, 2) they tend to have more credit (default) risk than government or municipal securities, so they tend to have higher yields than comparable-maturity securities in those sectors; and 3) they are traded on major exchanges, with prices published in newspapers.
Correlation measures the relationship between two investments--the higher the correlation, the more likely they are to move in the same direction for a given set of economic or market events. So if two securities are highly correlated, they will move in the same direction the vast majority of the time. Negatively correlated investments do the opposite--as one security rises, the other falls, and vice versa. No correlation means there is no relationship between the movement of two securities--the performance of one security has no bearing on the performance of the other. Correlation is an important concept for portfolio diversification--combining assets with low or negative correlations can improve risk-adjusted performance over time by providing a diversity of payouts under the same financial conditions.
Credit quality reflects the financial strength of the issuer of a security, and the ability of that issuer to provide timely payment of interest and principal to investors in the issuer's securities. Common measurements of credit quality include the credit ratings provided by credit rating agencies such as Standard & Poor's and Moody's. Credit quality and credit quality perceptions are a key component of the daily market pricing of fixed-income securities, along with maturity, inflation expectations and interest rate levels.
Measurements of credit quality (defined below) provided by credit rating agencies (defined below). Those provided by Standard & Poor's typically are the most widely quoted and distributed, and range from AAA (highest quality; perceived as least likely to default) down to D (in default). Securities and issuers rated AAA to BBB are considered/perceived to be "investment-grade"; those below BBB are considered/perceived to be non-investment-grade or more speculative.
A debt instrument, including bonds, certificates of deposit or preferred stocks.
Duration is an important indicator of potential price volatility and interest rate risk in fixed income investments. It measures the price sensitivity of a fixed income investment to changes in interest rates. The longer the duration, the more a fixed income investment's price will change when interest rates change. Duration also reflects the effect caused by receiving fixed income cash flows sooner instead of later. Fixed income investments structured to potentially pay more to investors earlier (such as high-yield, mortgage, and callable securities) typically have shorter durations than those that return most of their capital at maturity (such as zero-coupon or low-yielding noncallable Treasury securities), assuming that they have similar maturities.
The eurozone is sometimes referred to as the euro area and represents the member states that participate in the economic and monetary union (EMU) with the European Union (EU). The eurozone currently consists of: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.
Federal funds rate (aka fed funds rate)
The federal funds rate is an overnight interest rate banks charge each other for loans. More specifically, it's the interest rate charged by banks with excess reserves at a Federal Reserve district bank to banks needing overnight loans to meet reserve requirements. It's an interest rate that's mentioned frequently within the context of the Federal Reserve's interest rate policies. The Federal Reserve's Open Market Committee (defined below) sets a target for the federal funds rate (which is a key benchmark for all short-term interest rates, especially in the money markets), which it then supports/strives for with its open market operations (buying or selling government securities).
Federal Reserve (Fed)
The Fed is the U.S. central bank, responsible for monetary policies affecting the U.S. financial system and the economy.
Investment "fundamentals," in the context of investment analysis, are typically those factors used in determining value that are more economic (growth, interest rates, inflation, employment) and/or financial (income, expenses, assets, credit quality) in nature, as opposed to "technicals," which are based more on market price (into which fundamental factors are considered to have been "priced in"), trend, and volume factors (such as supply and demand), and momentum. Technical factors can often override fundamentals in near-term investor and market behavior, but, in theory, investments with strong fundamental supports should maintain their value and perform relatively well over long time periods.
Gross domestic product
Gross domestic product (or GDP) is a measure of the total economic output in goods and services for an economy.
High-yield bonds are fixed income securities with lower credit quality and lower credit ratings. High-yield securities are those rated below BBB- by Standard & Poor's.
Inflation, sometimes referred to as headline inflation, reflects rising prices for consumer goods and services, or equivalently, a declining value of money. Core inflation excludes food and energy prices, which tend to be volatile. It is the opposite of deflation (see Deflation).
Debt securities that offer returns adjusted for inflation; a feature designed to eliminate the inflation risk.
Investment-grade corporate bond or credit
A debt security with a relatively low risk of default issued and sold by a corporation to investors.
Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's price.
Mortgage-backed securities (MBS)
A form of securitized debt (defined below) that represents ownership in pools of mortgage loans and their payments. Most MBS are structured as "pass-throughs"--the monthly payments of principal and interest on the mortgages in the pool are collected by the financial entity that is servicing the mortgages and are "passed through" monthly to investors. The monthly and principal payments are key differences between MBS and other bonds such as Treasuries, which pay interest every six months and return the whole principal at maturity. Most MBS are issued or guaranteed by the U.S. government, a government-sponsored enterprise (GSE), or by a private lending institution.
These are long-term municipal securities (defined below) with maturities of 10 years or longer.
Municipal securities (munis)
Debt securities typically issued by or on behalf of U.S. state and local governments, their agencies or authorities to raise money for a variety of public purposes, including financing for state and local governments as well as financing for specific projects and public facilities. In addition to their specific set of issuers, the defining characteristic of munis is their tax status. The interest income earned on most munis is exempt from federal income taxes. Interest payments are also generally exempt from state taxes if the bond owner resides within the state that issued the security. The same rule applies to local taxes. Another interesting characteristic of munis: Individuals, rather than institutions, make up the largest investor base. In part because of these characteristics, munis tend to have certain performance attributes, including higher after-tax returns than other fixed income securities of comparable maturity and credit quality and low volatility relative to other fixed-income sectors. The two main types of munis are general obligation bonds (GOs) and revenue bonds. GOs are munis secured by the full faith and credit of the issuer and usually supported by the issuer's taxing power. Revenue bonds are secured by the charges tied to the use of the facilities financed by the bonds.
For most bonds and other fixed-income securities, nominal yield is simply the yield you see listed online or in newspapers. Most nominal fixed-income yields include some extra yield, an "inflation premium," that is typically priced/added into the yields to help offset the effects of inflation (see Inflation). Real yields (see Real yield), such as those for TIPS (see TIPS), don't have the inflation premium. As a result, nominal yields are typically higher than TIPS yields and other real yields.
Non-agency commercial mortgage-backed securities (CMBS)
MBS that represent ownership in pools of commercial real estate loans used to finance the construction and improvement of income-producing properties. Non-agency CMBS are not guaranteed by the U.S. government or a government-sponsored enterprise.
Price to earnings ratio (P/E)
The price of a stock divided by its annual earnings per share. These earnings can be historical (the most recent 12 months) or forward-looking (an estimate of the next 12 months). A P/E ratio allows analysts to compare stocks on the basis of how much an investor is paying (in terms of price) for a dollar of recent or expected earnings. Higher P/E ratios imply that a stock's earnings are valued more highly, usually on the basis of higher expected earnings growth in the future or higher quality of earnings.
Nationally recognized statistical rating organizations assign quality ratings to reflect forward-looking opinions on the creditworthiness of loan issuers.
Real estate investment trusts (REITs)
Real estate investment trusts (REITs) are securities that trade like stocks and invest in real estate through properties or mortgages.
Russell 1000® Growth Index
Measures the performance of those Russell 1000 Index companies (the 1,000 largest publicly traded U.S. companies, based on total market capitalization) with higher price-to-book ratios and higher forecasted growth values.
Russell 1000® Value Index
Measures the performance of those Russell 1000 Index companies (the 1,000 largest publicly traded U.S. companies, based on total market capitalization) with lower price-to-book ratios and lower forecasted growth values.
S&P 500® Growth Index
A style-concentrated index designed to track the performance of stocks that exhibit the strongest growth characteristics by using a style-attractiveness weighting scheme.
S&P 500® Index
The S&P 500® Index is composed of 500 selected common stocks most of which are listed on the New York Stock Exchange. It is not an investment product available for purchase.
S&P 500® Value Index
The S&P 500 Value Index is a style-concentrated index that measures stocks in the S&P 500 using three factors: the ratios of book value, earnings, and sales to price. It is not an investment product available for purchase.
Debt resulting from the process of aggregating debt instruments into a pool of similar debts, then issuing new securities backed by the pool (securitizing the debt). Asset-backed and mortgage-backed securities (ABS and MBS, defined further above) and collateralized mortgage obligations (CMOs, defined above) are common forms of securitized debt. The credit quality (defined above) of securitized debt can vary significantly, depending on the underwriting standards of the original debt issuers, the credit quality of the issuers, economic or financial conditions that might affect payments, the existence of credit backing or guarantees, etc.
A security that has a higher priority compared to another in the event of liquidation.
A country's own government-issued debt, priced in its native currency, that can be sold to investors in other countries to raise needed funds. For example, U.S. Treasury debt is U.S. sovereign debt, and would be referred to as sovereign debt when bought by foreign investors. Conversely, debt issued by foreign governments and priced in their currencies would be sovereign debt to U.S. investors.
Spreads (aka "interest-rate spreads", "maturity spreads," "yield spreads" or "credit spreads")
In fixed income parlance, spreads are simply measured differences or gaps that exists between two interest rates or yields that are being compared with each other. Spreads typically exist and are measured between fixed income securities of the same credit quality (defined above), but different maturities, or of the same maturity, but different credit quality. Changes in spreads typically reflect changes in relative value, with "spread widening" usually indicating relative price depreciation of the securities whose yields are increasing most, and "spread tightening" indicating relative price appreciation of the securities whose yields are declining most (or remaining relatively fixed while other yields are rising to meet them). Value-oriented investors typically seek to buy when spreads are relatively wide and sell after spreads tighten.
Spread sectors (aka "spread products," "spread securities")
In fixed income parlance, these are typically non-Treasury securities that usually trade in the fixed income markets at higher yields than same-maturity U.S. Treasury securities. The yield difference between Treasuries and non-Treasuries is called the "spread" (defined further above), hence the name "spread sectors" for non-Treasuries. These sectors--such as corporate-issued securities and mortgage-backed securities (MBS, defined above)--typically trade at higher yields (spreads) than Treasuries because they usually have relatively lower credit quality (defined above) and more credit/default risk (defined above), and/or they have more prepayment risk (defined above).
Stagflation describes slowing economic growth combined with high inflation.
An unsecured loan or bond that ranks below more senior loans in terms of claims on assets or earnings.
Treasury inflation-protected securities (TIPS)
TIPS are a special type of U.S. Treasury security designed to address a fundamental, long-standing fixed-income market issue: that the fixed interest payments and principal values at maturity of most fixed-income securities don't adjust for inflation. TIPS interest payments and principal values do. The adjustments include upward or downward changes to both principal and coupon interest based on inflation. TIPS are inflation-indexed; that is, tied to the U.S. government's Consumer Price Index (CPI). At maturity, TIPS are guaranteed by the U.S. government to return at least their initial $1,000 principal value, or that principal value adjusted for inflation, whichever amount is greater. In addition, as their principal values are adjusted for inflation, their interest payments also adjust.
A treasury note is a debt security issued by the U.S. government with a fixed interest rate and maturity ranging from one to 10 years.
The yield (defined below) of a Treasury security (most often refers to U.S. Treasury securities issued by the U.S. government).
A quantitative estimate of a company or asset’s value.
For bonds and other fixed-income securities, yield is a rate of return on those securities. There are several types of yields and yield calculations. "Yield to maturity" is a common calculation for fixed-income securities, which takes into account total annual interest payments, the purchase price, the redemption value, and the amount of time remaining until maturity.
A line graph showing the yields of fixed income securities from a single sector (such as Treasuries or municipals), but from a range of different maturities (typically three months to 30 years), at a single point in time (often at month-, quarter- or year-end). Maturities are plotted on the x-axis of the graph, and yields are plotted on the y-axis. The resulting line is a key bond market benchmark and a leading economic indicator.
References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
International investing involves special risk considerations, including economic and political conditions, inflation rates and currency fluctuations.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
Historically, small- and/or mid-cap stocks have been more volatile than the stock of larger, more-established companies. Smaller companies may have limited resources, product lines and markets, and their securities may trade less frequently and in more limited volumes than the securities of larger companies.
Diversification does not assure a profit nor does it protect against loss of principal.
Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.
Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.