Multi-Asset Strategies Outlook

Q4 2022

long green bar separator

Multi-colored piles of spices.

Bear Market Rally Is a Cautionary Tale

The market rallied hard from its June low before rolling over again in late August. Unfortunately, bear market rallies are quite common. Before the market bottomed out at -48% in 2002, it had six separate rallies of 10% to 20% each along the way during the two-year downturn.

Similarly, during the 2007-2008 financial crisis, before the market bottomed out at -58% it rallied no fewer than five times ranging from 8% to 25%. Rather than focus on short-term market moves, we argue for focusing on economic fundamentals and sticking to your long term investing targets.

Ultimately, it’s the underlying economic data that matter. That’s because the health of our economy drives corporate earnings and ultimately, stock prices. Our own read of the economic fundamentals — particularly the more forward-looking housing and manufacturing data — suggests more trouble ahead. Indeed, the most widely followed measure of manufacturing activity recently hit its lowest level in two years.

Stock Valuations Remain Elevated

Rather than suggest the sell-off in equities has reached a bottom, prominent valuation metrics argue equities remain expensive. One of the most well-regarded valuation measures is the cyclically adjusted price-to-earnings (P/E) ratio or CAPE, which is based on 10 years’ worth of earnings data to smooth out profit fluctuations. The CAPE ratio is above 30 as of this writing. By comparison, the longer-term average is around 15.

It’s a similar story for the Buffett indicator, a simple ratio of the total stock market capitalization to the size of the U.S. economy. Today, the Buffett ratio stands at 1.67, where 1 would imply fair value and a number less than 1 would suggest stocks are attractive.

In terms of realized earnings on the S&P 500{sup}®{/sup} Index, if you strip out the energy sector, earnings growth was negative for the 12 months ended June 30, 2022. Slowing economic growth and corporate earnings at a time when the Federal Reserve (Fed) is raising rates and stocks aren’t cheap makes us cautious about equities.

We’re Not Out of the Woods on Inflation and Rates

Inflation took a breather in July — rising 8.5% for the trailing 12 months versus 9.1% in June. This decline encouraged stock and bond markets that the Fed may be about to pivot or slow its pace of rate hikes. And it’s possible we’ve reached the peak in inflation. But it’s hard to see how rising wages and rents won’t keep upward pressure on inflation for the foreseeable future. So, whether inflation settles at 9%, 8% or some other number, it’s still likely to be radically far from the Fed’s flexible average inflation target of 2%.

Asset Class

Slowing economic growth and corporate earnings when the Fed is raising rates and stocks aren’t cheap make us cautious about equities. In addition, we’ve argued that inflation is likely to remain elevated. Our analysis shows that U.S. large-cap equities meaningfully underperform their long-term averages during periods of sustained high inflation. As a result, we favor an actively managed fixed-income allocation with the ability to select among inflation-adjusted and short-term bonds as appropriate.

U.S. Fixed Income & Cash favored over U.S. Equity.

Equity Region

Our regional equity models have been tilting toward non-U.S. developed equities for some time. What we consider U.S. equities’ summer bear market rally into economic weakness further increased the relative appeal of stocks outside the U.S. It’s true that Europe faces stiff economic challenges of its own, but we believe these realities are better reflected in existing stock prices overseas. Of course, geopolitical and economic conditions vary sharply by country, arguing for active security selection.

Non-U.S. Developed Markets favored over U.S.

Emerging markets equities (EME) look increasingly attractive relative to U.S. equities, which rallied even as earnings and the economy slowed. In addition, our analysis under different inflation regimes shows that EME historically does well in periods of high inflation. Of course, this sort of historical analysis is complicated by the fact that this asset class has gradually shifted over time from commodity-exporting to commodity-importing economies. Regardless, this is another asset class tailor-made for active security selection that we believe adds value over passive approaches.

Emerging Markets favored over U.S.

U.S. Equity Size & Style

We have moved back to neutral weighting by size after favoring small stocks for several months. Our rationale was that small-company stocks offered attractive relative valuations after having lagged large-cap firms. But it’s hard to justify that ongoing overweight because small-cap stocks tend to be more sensitive to changes in economic conditions. In contrast, larger companies typically have more ways of maintaining profitability during a slowdown.

Large Cap and Small Cap favored equally

Our preference for value stocks has been one of our longest-running and most profitable positions to date. However, our preference for value stocks is waning — the economic slowdown in the U.S. could argue for companies with more durable earnings growth. For now, our risk and valuation readings continue to favor value. Of course, the inflation and interest rate outlook complicate matters. We think there’s an argument for high-quality stocks regardless of style — those with sustainable free cash flows, strong balance sheets and high returns on invested capital will likely hold up best.

Value favored over Growth.

Fixed Income

We continue to actively manage our fixed-income allocation for the competing forces of slowing growth and rising inflation. Inflation-protected securities are attractive given the likelihood of sustained high inflation. But given the risk of recession, the team is favoring higher-quality, less-credit-sensitive investment-grade over high-yield bonds. We expect heightened yield volatility as the Fed continues to tighten monetary policy this year.

U.S. and Non-U.S. favored equally.

Alternatives

We value real estate investment trusts (REITs) as strong strategic portfolio diversifiers. It’s a broad, diverse sector with global exposure that offers relatively uncorrelated returns with equities. At present, however, REITs face some challenges. Rising bond yields and mortgage rates cloud the outlook for the real estate sector at the same time the economy is slowing. In contrast, REITs have tended to perform well in strong economies. On balance, then, we are underweight REITs for now.

Core Assets favored over REITs
Richard Weiss
Richard Weiss

Chief Investment Officer

Multi-Asset Strategies

Q4 2022 Investment Outlook Resources

Agency mortgages

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.

Central bank

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

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

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

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.

Credit ratings

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.

Debt security

A debt instrument, including bonds, certificates of deposit or preferred stocks.

Duration

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.

Eurozone

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 Reserve (Fed)

The Fed is the U.S. central bank, responsible for monetary policies affecting the U.S. financial system and the economy.

Fundamentals/fundamental analysis

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.

General obligation (GO) bonds

One of the biggest sectors in the municipal securities (defined below) market. Typically, these bonds are secured by the full faith and credit pledge (defined above) of the issuer and usually supported by the issuer's taxing power (tax revenues provide the means by which most interest payments are made). GO bonds can be issued by states, counties, cities, towns and regional districts to fund a variety of public projects, including construction of and improvements to schools, highways, and water and sewer systems.

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

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.

Hybrid securities

Financial securities that combine two or more instruments, typically providing both debt and equity characteristics.

Inflation

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).

Inflation-protected securities

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.

Leveraged buyout (LBO)

The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition.

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.

Municipal bonds

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.

Nominal yield

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.

Quality

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® 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.

Securitized debt

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.

Senior-secured securities

A security that has a higher priority compared to another in the event of liquidation.

Sovereign debt

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).

Subordinated security

An unsecured loan or bond that ranks below more senior loans in terms of claims on assets or earnings.

Stagflation

Stagflation describes slowing economic growth combined with high inflation.

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.

Treasury yield

The yield (defined below) of a Treasury security (most often refers to U.S. Treasury securities issued by the U.S. government).

Valuation

A quantitative estimate of a company or asset’s value.

U.S. Treasury securities

Debt securities issued by the U.S. Treasury and backed by the direct "full faith and credit" pledge of the U.S. government. Treasury securities include bills (maturing in one year or less), notes (maturing in two to 10 years) and bonds (maturing in more than 10 years). They are generally considered among the highest quality and most liquid securities in the world.

Yield

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.

Yield curve

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.