2023 Outlook: Return to Normal?

2023 Outlook: Return to Normal?

Mike Ordonez:            Welcome to Thornburg Investment Management’s 2023 outlook webcast.  My name is Mike Ordonez and I’m the Director of Client Portfolio Management here at Thornburg.  Today we’re gonna discuss how to navigate the investment waters of 2023 following what has been a very volatile year.  Persistently high inflation, a hawkish fed, ongoing geopolitical risks, and the continued risk of recession have dominated the headlines, and we will set the stage on those topics and hopefully more.  Uh, a few housekeeping items before we get started.  At this time, all participants are in listen-only mode.  However, you can ask questions at any time by submitting them directly through the WebEx portal, uh, or emailing us at questions@thornburg.com, that’s questions@thornburg.com.  Just to remind you, the webcast is being recorded and replay is gonna be available in the next few days.  For those on the call today who not may be, uh, may be less familiar with Thornburg, we are an investment management firm based out of Santa Fe, New Mexico overseeing approximately $40 billion of assets across a suite of actively managed equity, fixed income and multi-asset solutions.  I’m thrilled today to be joined with my colleagues, Ben Kirby and Jeff Klinghoffer, co-heads of investments for Thornburg.  In addition, Ben and Jeff are portfolio managers on some of our most popular investment solutions here at Thornburg, and there’s obviously lots to discuss.  So guys, thank you very much for, for having, uh, the time today.

Mike Ordonez:            Let’s get into, uh, the topic of the webcast which is a return to normal.  And really, talk about how your experience in 2022 is informing your position for this year.  Jeff, maybe why don’t we start with that and, and how 2022 went.

Jeff Klingelhofer:        Sure.  And I think you mention a lot of the things in 2022, right?  To me, 2022 was much less about the discreet time period.  Yes, it’s the last year.  But really the question today is whether it is the exit of what has been a, a decade, a decade and a half of one of the greatest social experiments in, in, in, in, in human history, right.  It, the, it’s not just the economic implications, the, the extreme, uh, support of not only markets but ex-, extraordinarily accommodative monetary policy and very, very easy fiscal policy.  But the implications that it has on the socioeconomic aspects that we’re seeing today, right, around labor and economic, uh, labor market conditions in particular.  As we look forward, right, what we, what we are leaving potentially in the rear-view mirror is the question of whether inflation is or is not transitory.  To me, transitory was never a defined, definite timeline, right.  It certainly exceeded the time expectations of central banks around the world and investors around the world.  But what we are seeing today is many of the non-structural nature, non-structural aspects of inflation begin to come down.  A lot of the supply-side constraints are easing, and we’re seeing goods inflation fall.  And as we look forward into 2023, the most important question that investors need to be able to answer and, and, and opine on to build portfolios successfully is where inflation heads from here.  But we’re also seeing is a lot of the structural impediments, significantly tight labor markets, prop up inflation.  And as we look forward, one of the ways that I’m thinking about that within the context of, of portfolios, its implications is, right, the correlations of equities versus fixed income, the starting place, uh, of both of those asset classes that will have profound implications for assets, asset allocators and, and money in motion into 2023.

Mike Ordonez:            I’d love to touch on correlation, but then maybe before we go there, you know, 2022 was the hardest, uh, year since the global financial crisis in 2008.  You know, uh, Jeff has just talked about cheap money.  In, in your markets, what, what do you, what are you seeing, uh, that 2023 is gonna help, uh, for that 2022 is gonna help you understand what’s going on in 2023?

Ben Kirby:      Sure, thanks, Michael.  So I think that COVID created an unusual business cycle, right, so we had an unusual slowdown, then an unusual bounce back, and now we’re, we’re having maybe a more normal business cycle with an more, more normal fed tightening and a slowdown economically.  Um, certainly 2022 was an unusually bad year from a multi-asset standpoint.  Um, equity’s down, you know, almost 20 percent but the multi-asset portfolio on a 60/40 basis was down as much as it was, uh, going back to the 1930s.  Um, so stocks have gone, uh, over the last year, from being over-valued, kind of in the top 1 percent of over-valuation, uh, to fairly valued, and I think bonds have gone from being over-valued to, to maybe even attractively-valued today.  So the setup as we looked at 2023, uh, certainly from a valuation standpoint and from, uh, already having a lot of the, uh, wood chopped, uh, from a, a monetary standpoint, is certainly a better place than we were 1 year ago.

Mike Ordonez:            Well, you guys both touched on it so let’s, let’s go right there and that’s the 60/40 portfolio and the correlations really of, of bonds and equities.  Um, do you think that this year, obviously last year a stagflationary environment creates a perfect environment where you have seen, uh, bonds and equities move in the same direction.  Do you think that’s the, that’s the base case for this year or, or, or hopefully will we see, hopefully will we see some alleviation, at least in one market?

Jeff Klingelhofer:        Yeah, starting place matters a lot, and I already touched a little bit on just inflation being the central, uh, tenancy, the central question that we have to answer as investors, right.  And so really the question that immediately I come to in, in trying to answer where correlations between fixed income and equity go is, is where does inflation go.  And, and really you have kind of two, two base case or two potential outcomes.  Right.  My base cases were past peak inflation but that doesn’t mean we’re going back to, to normal.  It doesn’t mean we’re going back to 2 percent.  There are significant structural impediments from the inflationary backdrop, wages and, and services, uh, being the, the primary ones which suggest to me that the fed will likely be on pause much longer than the market currently expects.  But the starting place within fixed income is notably better, right.  Central banks gave us no alternative other than to chase risk assets.  The starting place of U.S. Treasuries let alone global treasuries, right, or, or, or global risk-free assets at near zero levels, the correlation was almost certainly going to be positive as we experienced into 2022, or 2022.  As we looked at 2023, the 10-year treasury sitting mid-3s, all of a sudden if we head into a deep recession, I do expect that fixed income shields portfolios relative to equities.  But on a base case, right, if, if inflation remains relatively high, I think you can expect roughly a kind of a coupon year within, within inflation potentially some positive, uh, returns within the equity side.

Mike O:           And your thoughts on, on correlations?

Ben Kirby:      Yeah, so, uh, the risk-free rate is the foundation for equity valuation, so when the risk-free rate goes up, all else equal, equity valuations need to come down.  Um, what’s interesting today as Jeff pointed out is that bonds have interesting yields and so they, they offer, um, equities a bit of a run for their money in many cases, right?  So high-yield bonds yielding 9 percent, that’s competitive with the long-term return of stocks, uh, and of course, uh, the risk-free rate, um, also an interesting level, higher than the dividend yield on, on equities.  So that’s a, a significant change versus 1 year ago.  Uh, I agree that the possibility of inverse correlations is higher this year than it was last year and we should all welcome that.  As investors, we want diversification, we want assets to go in different directions and give us an ability to, to have a more all-weather, uh, performance in our overall portfolios.

Mike O:           Great.  Jeff, you’ve touched on it now but, uh, central to everybody’s mind for 2023 is the inflation, uh, picture.  Um, obviously we’re nowhere near, uh, central bank targets of 2 percent, um, and hopefully what we’ve seen at the end of 2022 and the beginning of this year, um, is some alleviation of that pressure.  But curious as to your thoughts on, on where we stand with inflation today and how we, we, we end the year.

Jeff Klingelhofer:        Okay.  Looking forward to me, it’s pretty clear.  Inflation is now on a downward trajectory.  The question becomes, much as when it was on an upward trajectory, where does it peak.  Today the question is where does it trough.  And I believe the markets are still focusing and believing that we’re going back to the, the, the world of normal, 2 percent or maybe even slightly under, and I don’t think we’re going back there.  But I would also ask maybe a flip side of the question is do we have to, right?  What is normal inflation.  And my argument would be is that not all inflation is created equal, right.  Goods inflation is particularly distortionary.  It makes it incredibly hard for, for me and you and companies to plan.  But services inflation, on the other side, right, has the potential to lift up purchasing power.  It can be much, uh, broader in nature and ultimately positive, uh, from the, the, the perspective of a central bank.  And so as I look forward, I think much of the supply-side constraints are easy and we’re gonna continue to see goods inflation come down.  We’ll probably enter an era of 3 to 4 percent sustained inflation, but that’s still above target inflation will be driven by services inflation.  So I think we’re getting closer to normal, but I wouldn’t expect a complete reversion to normal, and as a result, I think central banks are, again, they’re likely to stay on hold much longer than the market expects.

Mike O:           Ben do you agree with that, can see some hopefully some alleviation this year?

Ben K: Yeah, like I think inflations come in kind of four, four waves.  You’ve had, you had the COVID supply-chain constraints, uh, you’ve had, uh, a lot of, uh, money printing.  Then you had the Russian invasion.  So those are kind of the, the, the three aspects of inflation that I think are a bit more transitory and can, and can come back.  The fourth aspect that Jeff is talking about is a very tight labor market, and, you know, unemployment at 3-1/2 percent, wages still growing, labor force participation is down, um, over, over this time period.  A lot of people chose to retire early in COVID and, uh, there’s also lower participation among, uh, working-age, uh, people as well.  So the labor market is tight.  That part of inflation can be a lot more structural whereas the other three are all kind of, uh, pulling back at this point.

Mike O:           Um, that’s interesting.  So, okay.  Why don’t we move over to probably one of the worst kept secrets of, of, of all analysts on Wall Street is, is really recession expectations for 2023.  Um, you hear the, the IMF speaking last week, certainly very strongly at how, uh, the recession probability because of the three big economies, European Union, the U.S. and China all slowing down simultaneously.  Um, it seems to be more than consensus that we are gonna be in a recession at this point, at, at some point this year.  Um, maybe Ben, I’ll start with you.  What, what do you, what do you think about, um, the, what do you think about that idea and, uh, and, and, and, yeah, when everybody, when everybody believes one thing, is that, is that an opportunity for investors?

Ben K: It’s absolutely consensus.  It’s, it’s unbelievable.  I think that people expect a global recession, uh, maybe in, maybe in Q2 but certainly by Q3, and it’ll probably last a couple quarters.  Um, so that’s, that’s, uh, very uniform.  What that means for risk assets is expectations that we’re gonna have a bad first half and, and, and a good second half, right, and then we’re gonna end the next, in 2023, about where we are right now, maybe up a little bit.  Um, so that, that’s the path that it feels like 85 percent of people expect.  Um, my expectation is, is that’s certainly a, a reasonable possibility, but the base case is probably that we don’t end the S&P at 4,000, it’s probably that we end, higher probability of 4,500 or 3,500, um, because the current expectation is kind of averaging a few extreme events.  So, 4,500, what would that be?  That would be, uh, a soft landing and earnings continue to grow.  We look out to 2024, earnings are 250, you know, that’s, that, that’s a very justifiable level over time.  Uh, similarly, uh, on the other side, if we have a harder landing and inflation is, is harder to tame, then we’re gonna have, um, a worse outcome for the economy and for risk assets.

Mike O:           Jeff, what are your thoughts? One-third of the, uh, expectation that one-third of the economy is gonna be in slowdown, uh, what, what are your thoughts on recession?

Jeff K: Okay.  I think it’s, it’s undeniable.  We’re slowing down.  There, that to me, that’s not a question.  The question is whether you, you, you dip into outright negative GDP prints, right?  And we already have, to be fair.  We have to keep in mind, we’re slowing down from an incredibly strong point, right.  So the U.S. economy in particular is driven by the U.S. consumer, and the U.S. consumer has had the lowest default, uh, delinquency ratios pretty much in the entirety of, of economic history.  So the starting place is just phenomenally, phenomenally strong.  Are we slowing?  Yes.  Does that mean that we must tip into recession?  Not necessarily, but we’re keeping a very, very close eye on a number of metrics.  And particularly, consumers today especially in the lower income cohorts have already spent through all of their COVID stimulus.  They’re dis-saving it in order to continue to, in order to continue to, to, to, to, uh, work with their, their purchasing habits, right.  And so I do believe that we’re likely to head into a mild recession but again it’s, it’s base case.  So the market’s probably already priced much of that.  Really from a probability standpoint, we need to think about the two scenarios that Ben mentioned, right, either the, the, the, the notably, uh, prolonged recovery or deeper recession.  And right now one of the fears that we’re watching is just the market is pricing for base case probably pretty well but it is mispricing for the higher probability that the slowdown ends up in an outright deeper recession than we expect.

Mike O:           Okay.  So to that point, I mean, really the early 2022, the fed really was the major factor in getting us into this, into this bear market and that’s probably one of the more important questions hanging over investors’ minds is how does central bank, how, how does everything we’ve talked about right now infer central bank policy?  Um, maybe, maybe Ben, you want, you want to start with that and then, and then we’ll go to Jeff, uh, maybe, maybe focus on the fed.

Ben K: So the fed is definitely hiking aggressively into a slowdown, and that’s not common in history so I think we’re all worried that they’re gonna hike too much and they’re gonna tip us into more of a recession than is necessary.  So I think what the market would love to see is for the fed to slow down and, and for the fed to sort of let the long and variable aspects of monetary policy play out and let’s see how all the, the tightening affects, uh, the real economy for a few quarters and then we can reassess.  The risk is that the fed has been embarrassed, right.  So the fed was really really wrong last year, really really wrong the previous year and they stayed loose for way too long.  So the risk is that they’re embarrassed and they have gone from three mandates to focusing on one mandate and that’s inflation.  So I think, I think the market is, is fairly unified, that we’d like to see that, that pause.  We’re not clear, um, if the fed is gonna do what they say which is remain very hawkish.

Mike O:           Jeff?

Jeff K: Okay.  I, I agree, it’s, it’s a very difficult, uh, conundrum that the fed has found itself in.  But just pursuant to your opening question, a return to normalcy, right.  We have to remind ourselves that the last decade and a half wasn’t normal.  We stimulated economies around the globe with extraordinary monetary and fiscal stimulus and yet we got no inflation out of it.  Every economic textbook I’ve ever read says that’s not the likely outcome.  And so we aren’t necessarily exiting today into normal.  The question is whether we’re exiting from a very non-normal environment, and that non-normal environment would be fed funds rate notably higher than where it has been over the last decade.  So what is most apparent to me is when you listen to central bank speeches, they are telling you they’re playing for a downturn.  They believe too that one is coming.  It’s consensus with inside the fed and they don’t care.  That’s what they need to see.  And so the only way that I think that they’re likely to be in motion, uh, with, with cutting rates is a very, very deep recession where inflation really does fall off a cliff.  I think there’s actually still significant risk that maybe inflation is still, right, it’s off its peak, but if we hang out with inflation at 6, 7 percent or even 5 percent, that’s likely to cause the fed to double down on its inflation fight.  They can’t risk having ingrained sustained high inflation as, as consumer expectations.  And so if anything, I think the risk is actually, uh, tilted to the other side, that inflation doesn’t come down nearly as fast as we expect and central banks after a short pause end up having to hike again.

Mike O:           Well, let’s, let’s come back to that.  That’s, that’s interesting to think about what that rate path looks like if that’s the case.  Um, let’s, let’s talk about fixed income.  I’m gonna read you something.  Since 1976, the broader bond market measured by the ag has been negative four times, three of the years where we were actually negative, 1994, ’99 and 2021.  The reserve, the, the return was in the 2 to negative 3 percent range.  In 2022, the Agg was down 13 percent.  So how much further does the fed need to go, uh, and what clues should we get about fed pivoting?

Jeff K: I think in answering that question, we have to rewind the clock all the way back to the ’80s, right?  We’ve been on a one-way train lowering yields broadly within fixed income.  And that has led to I think return, base case return expectations that are just, they were unsustainable from the start.  And so we had a great reset in 2022 and, and now of course the question is, is it over or do we continue resetting.  And what I would look for in a, in a pivot in particular is it all comes down to labor market conditions.  As Ben talked about, the fed actually has three mandates.  We don’t talk about the third one but it’s incredibly, incredibly important.  We always talk about inflation, right, price stability.  We always talk about maximum employment.  We never talk about the third mandate which I believe is a little bit of a social stability mandate.  Technically it’s moderate long-term interest rates.  But as I’m looking at where the fed may pivot, it all comes down to inflation has to be contained.  At this point, I think we actually already meet that.  Inflation is contained, it’s just contained at too high of a level.  So the, the, the third mandate, right, around social stability perhaps intersects very well with labor market conditions and whether the fed is compression the wage gap.  So my belief of what we really need to focus on in, in looking for a fed pivot is getting inflation down to probably 3-ish, 3 to 4 percent and where that non-return to normal, lacking of going to 2 percent, is remaining relatively strong from the services side, continuing to see wage, uh, wages compressed.  So to me, all eyes have to be on the labor market.

Mike O:           Um, maybe, maybe just one more follow up on fixed income.  You see a better sense of the 10-year going lower than 3 percent then resuming its march upward?

Jeff K: No, I don’t.  Um, I, our base case expectation is the fair value of, of the U.S. Treasury today.  It’s kind of in the upper 3 to very low 4, right.  To me that’s a very sustainable level.  I still remain hopeful that we avoid, uh, an outright deep recession and, and, and without that deep recession, I don’t see how we get a 10-year treasury down at 3 percent.  I could absolutely see a case where it marches higher from where it is today.  We also have to keep in mind the rate volatility over 2022 has just been extraordinary.  And so 10, 15 basis point moves are kind of a common daily occurrence and that’s not, that should not be a common daily occurrence.

Mike O:           I don’t to get you too existential, but, but, uh, as a fixed income portfolio manager, what, what part, uh, what role does a, does fixed income play in 2023 in a client’s portfolio?

Jeff K: I think it plays the classic definition of fixed income, right.  It has the ability to provide negative correlation with other risk assets, aka equities.  The income component of fixed income today is tremendously interesting, right.  Core portfolios are easily ticking off 5 or 6 percent yields.  That to me is a very good setup.  Additionally, and, and most importantly I think what a lot of, a lot of asset allocators learned throughout 2022 is fixed income didn’t serve that negative correlation and, and really, that was a challenge.  And no – very few fixed income, probably no fixed income portfolios are truly able to overcome that, but there’s a bifurcation between the ones that were reach for yield at all cost, uh, all cases, right, that really had a challenging 2023.  So we need to remind ourselves that when you’re allocating to fixed income, it should behave like fixed income.  It should have a defensive nature, right.  So despite the fact that portfolios weren’t up this year, ideally good fixed income managers were down a whole heck of a lot less than ag and whole heck of a lot less than the competitors.

Ben K: Thanks, Jeff.  Uh, Ben, let’s go, let’s go to equities and spend some time there.  You know, if you think about the MSCI ACWI, or All Country World Index losing about a fifth of its value in 2022, uh, that’s about an $18 trillion route.  Um, that’s the worst performance in 14 years, uh, you know, last seen, again at the GFC.  Um, equity volatility really was exogenous external events, um, that overwhelmed those fundamental factors.  You touched on it but an appreciation for fundamentals may be front and center in 2023, is that correct?

Ben K: I think fundamentals are always, uh, always in vogue.  So look, stocks down 20 percent in a year that inflation was, was in the high single digits.  The, the real destruction of wealth was even more than $18 trillion, right?  The actual purchasing power of your, of your, of your stocks.  Um, the other way to think about it is stocks down 20 percent, but actually at least for the S&P 500, earnings grew, uh, about 10 percent last year.  So the valuation D rate in stocks is about 30 percent.  So again, starting place matters a lot.  Um, we’re kinda back to average valuations in equities, but at 30 percent D rate.  Uh, a lot of companies that grow faster, uh, it was, it was terrible year for fast-growth companies, right.  And we actually talked about that in the outlook last year.  We said stay away from those money-losing high-growth companies, that’s gonna be a dangerous place.  A lot of those stocks are down 70, 80 percent this year.  What’s interesting though, they’re down 78, you know, 70 or 80 percent but they still grew, uh, kinda through that, that time period.  So the valuation might be down 90 percent in some of those stocks.  So again, the setup is, is a lot more favorable for both value and growth because the D rate has been really significant.

Mike O: One of the things we talked about last outlook was really focus on business resiliency and a company’s ability to weather storms like we saw.  Is that kind of the same message for 2023?

Ben K: Absolutely, and you know, one, one bullish aspect of stocks even if we get some higher inflation, equities do tend to do better in an inflationary environment.  We saw it this year.  Many companies, a surprising number of companies, were able to pass on, uh, higher inflationary costs to the end consumer and consumers, uh, sort of paid the higher bill.  Um, so there were a few, you know, notable cases where that didn’t work, but in many cases equities were relatively resilient to inflation from an earnings standpoint.  So, you know, as we think about that, that multi-asset portfolio, that’s another consideration for maintaining some equity exposure in that portfolio.  If inflation, as Jeff is talking about, stays relatively high and we don’t have as much expectation for capital appreciation from the fixed income side, own some stocks that can, that can have pricing power.

Mike O:           So, so this is a perfect way to end our prepared questions and then go to, go, open it up to the audience.  But I think I’ll, I’ll end it, um, it sounds like both of you are constructive for, for each asset class.  And if I think back to what we discussed, a 60/40 portfolio, when you talk about now you have bond yields at 5 percent, you have equity valuations that are severely depressed over the, off of the highs, it’s actually not a terrible idea, uh, or a terrible you’re doing yourself a disservice if you’re not, if you’re, if you’ve forgotten about that 60/40 portfolio.  Is that, is that the right way to think about it, Jeff?

Jeff K: I think it is, but again, I mean, to a, as a portfolio manager, you also, you always have to think about in terms of probabilities, right.  So we’re always asked what your base case is.  And absolutely have a base case.  But I have a left tail and I have a right tail.  And I think for both Ben and I as, as we chat, right, the left tail risk, the, the potential deeper recession, the, the reality the consumer is weakening, right.  We are weakening as an economy.  That’s not questionable.  But again, it’s from an incredibly strong starting place.  Right?  So, while our base case remains relatively constructive from the setup here, given what already happened in 2022, in constructing a portfolio I think the 60/40 portfolio is absolutely back and it’s absolutely back because traditionally you want a 60/40 portfolio because you have ballast and you have that ability to have ballast.  And that’s both within the equity side as well as the fixed income side, right?  There’s, there’s actually still a lot of very high yielding, very interesting equity-like return opportunities within the world of fixed income.  But those don’t serve that ballast and vice versa.  As Ben talked about, the, the focus on potentially very defensive companies also exists in the world of equities.  And so I think it’s not as simple as just a pure 60 equity portfolio.  I also think you have to think about how they interplay and that’s at the actual asset class, or actual, uh, fundamental credit or company level.  But the startup today, or setup today is notably better than it has been.

Mike O:           Ben, you want to, anything to follow up on that or should we, shall we get into some client questions?

Ben K: So Jeff and I probably agree too much on, on many things but, uh, this is definitely one where I think the idea of a barbell makes a lot of sense.  High quality fixed income has interesting yield today and it’s gonna be resilient, um, in the face of an economic slowdown.  On the other side, there are, uh, interesting valuations in equities, especially international equities that we can talk about later.  So kinda having that barbell I think gives you the ability to, to participate in a variety of environments that might not be exactly the base case.

Mike O:           Let’s go into some client questions, and I have one here, uh, on economic data that I think is, is, is pertinent to, to actually this part of the conversation is, is there anything that you guys are looking at, whether it be positive or negative, in the context of judging a recession, um, that, that you’re watching closely, something that, that maybe is not on the radar of everybody or is?

Jeff K: I’ll go back to, to what I said a little bit earlier.  I think watching just consumer conditions and the labor market, to me really is the most important because the question you have to get right in 2023 is where inflation goes and, and what is the fed and other central banks’ reaction to inflation.  Right.  Central banks and the fed in particular has told us they are playing for a slowdown in the labor markets.  We haven’t seen it yet.  We haven’t seen it.  And so a pre-condition to the fed not continuing to march higher is getting that actual slowdown.  Now, it’s probably on its way, but how deep and, and how far does that fall, right.  So to me it’s all about the, the, the, the consumer, it’s all about in particularly that lower income cohort of consumer ’cause they’re already showing signs of weakness.  So when do they potentially peak in terms of delinquencies or do they continue to, to, to move higher.  So watching, uh, remits as they come in within the world of securitize is probably my best, uh, recommendation of, of, of where to look.  It’s a monthly read, it comes in in real time and it’s, it provides a ton of insight into the strength of the consumer and, and a read through to potential inflationary conditions.

Mike O:           Ben, anything that you’re looking at or –

Ben K: Sure, so credit spreads matter a lot, uh, global short rates matter a lot.  I think that those are pretty common, pay attention to those.  The yield curve is inverted, um, that’s a single metric but it’s actually a fairly powerful metric so be watching the shape of the yield curve.  The other thing to be watching more from a market standpoint is we, we didn’t have a huge contagion event in 2022, right.  So it was a, it was a bad market, uh, but we didn’t have, uh, we didn’t have an EM Sovereign defaulting.  We didn’t have European, uh, peripheral spreads blowing out.  We didn’t have a bank defaulting.  Um, so I think, I think paying attention to, to, to some of those potential contagion risks, uh, we were able to, to essentially pop a tech bubble, uh, and a lot of those stocks have deflated a lot.  Crypto is down a lot.  So we were able to deflate some of those areas of excess in the market.  But I think we have to keep our eyes on, uh, any, any areas of a potential contagion, um, spreading that would cause, uh, uh, you know, wider spread pain.

Mike O:           So, uh, certainly there is contagion in the energy market in Europe, and that’s the next question.  But it’s really, several factors are keeping Europe in a better position than they were last year, milder temperatures, reduced heating demand, high storage rate.  Ben, why don’t you answer for us, um, is Europe okay for now with the ongoing energy crisis or, or is there something to worry about?

Ben K: So the energy crisis is not completely over but that’s a bit of a story of 6 to 9 months ago.  So, uh, you know, gas prices in Europe are down 75 percent from the peak so they had a huge spike, they’re not back to roughly where they were before the invasion.  So Europe has done a lot.  Uh, Europe tends to move very slowly in these things.  Uh, they’ve, they’ve moved aggressively to diversify their energy, to increase their storage.  Uh, so that isn’t to say that we couldn’t have another round of it but I think that Europe is dramatically more insulated from, uh, from the gas price, uh, than they were 1 year ago.

Mike O:           Thinking outside of the gas price, Jeff, you know, there seems to be no end in sight to this conflict.  Is, is the Russia-Ukraine, uh, saga, is that, is that still kind of, uh, fairly insulated or, or are there, are there other things that we need to think about, uh, this year?

Jeff K: I mean, one of the hardest to predict but I think always needs to be investors’ radar is, is geopolitical risk has been relatively contained through 2022, right?  And so we talk about of course the, the atrocities between Russia and Ukraine and the, the broader feed through of that.  But I would really be focusing on U.S.-China relations.  And, and two world superpowers, right, are, are finding a way to peacefully coexist today but I continue to expect the rhetoric to, to, to increase there.  I don’t think that’s on investors’ radar.  I think it’s incredibly difficult environment to navigate, but to directly answer you question, I think we’re in for the long haul between Russia, uh, and, and Ukraine, right.  But it’s not about Russia-Ukraine, it’s really about East versus West where Russia as a, as potentially a fading global super power has to address what their, what their future is in, in the world, uh, relative to, to, to Europe which is potentially realigning with, with, uh, the classic U.S. side of things.

Mike O:           Well, let’s, let’s stick with the East.  Ben, you know, it seems like Xi Jinping after China party congress really was focused on, on, on scrapping zero COVID really, uh, to, to hopefully inject some growth into their economy.  Um, many believe that it’s, that it’s the reason for, well, the supply chain, uh, disruptions, uh, industrial production disruptions.  Do you think that it’s gonna take more than just months to, uh, start an economic recovery in China?

Ben K: So, Michael, youth unemployment in China hit 20 percent and there was, there was social unrest, and so I think that, that they realized they needed to relax the zero COVID policies sort of, no matter what the cost, they needed to get the economy going again.  The downside of course is that we have a lot of cases of COVID and that, that shuts the economy down in a different way from a quarantine standpoint, now, it’s, it’s now shut down due to, uh, disease risk.  So you know, that, that will eventually work its way through the economy and we think that, that, uh, that China will provide a growth impulse for the global economy this year.  How much, uh, we’re not exactly sure.  We do see they’re stimulating, we do see they’re opening, we do see they’re turning a bit more pro-market with some of the, uh, technology companies, um, and as they stimulate, that’s also good for commodity demand.  So, you know, China is an important growth impulse, uh, kind of always, and, you know, this is the year that we, we hope especially in the second half, that they can go a different direction, uh, from the rest of the developed world.

Mike O:           One question that we got in here was, and Ben, I’ll go to you as a, as a manager on, on one of our multi-asset income portfolios, uh, it’s really a demographic question.  How does the significance of millions of baby boomers retiring annually impact the labor market picture going forward, and, and, and maybe some, some self-promotion on, on why income, uh, particularly multi-asset income is important in, in their portfolio?

Ben K: Sure.  So I think, I think the labor force in the U.S. has a couple challenges.  One is the baby boomers retiring, two is lower workforce participation among younger people as well.  Um, and that, that’s inflationary and, uh, it tends to, uh, increase the need for investment income, right.  So as, as you retire, you, you, uh, need more money to come from your investments.  So we think that the ongoing structural demand for investments that can generate, uh, attractive current income and as we saw in 2022, very importantly, the ability to grow that income over time because inflation is a real thing, right?  Whenever inflation was 1-1/2 or 2 percent, people didn’t worry about it so much.  When it’s 7, we worry about it a lot.  So to have some investments in the portfolio, uh, that have the ability to pay today and grow over time, protect from inflation, that’s a really powerful formula especially for those, um, aging investors to be considering.  So dividend paying stocks are the investment that has that characteristic.  And what’s interesting, dividend paying stocks are attractively valued today especially on a global basis.

Jeff K: Now I want to add on just real quick.  I mean, it’s, look, I think, I think that question highlights the, the predicament that the Federal Reserve finds itself in, right.  It all comes down to labor.  And again I’ll go back to what I saw at the very beginning.  This isn’t been one of the biggest economic experiments in, in history, it’s been one of the biggest social experiments in, in history, right, because what we find ourselves in today is perfectly incapsulated with that question.  You do have a significant cohort of baby boomers that are potentially and likely never coming back to the labor market.  Now, in a more traditional state of the world, what you would find is they’re being replaced by the, the 18- to 24-year-old who’s just entering the labor market, and that isn’t happening.  And it’s not happening because of that incredibly strong starting place of the consumer because of the ability of governments to fund themselves at zero percent.  The ability of corporations to fund themselves at 1, 2, 3 percent, in some cases zero percent for even some companies in Europe.  And, and for the consumer to fund themselves also at an incredibly low interest rate, right.  It’s amazing to look back and think that we were able to borrow for 30 years, to take out a, a loan to buy a home at 2-1/2 to 3 percent with complete optionality in our favor.  That to me actually is a much more social backdrop that, that this question I think really gets into.  It’s, it’s such a difficult starting place for politics and, and what we, we see today as a significant diversion between the left and the right and trying to answer some of these questions of the power of labor versus the power of capital.

Mike O:           Let me ask one last question before we wrap up, and I’m curious to hear, uh, your, your, your thoughts on, on a particular asset class that you think is interesting given all the market dynamics that we’ve, we’ve, we’ve discussed today.  Um, yeah, what, what, what are you interested in and, and, and what looks appealing to you in, in this, in this market context?  Jeff, why don’t you start?

Jeff K: Sure.  Look I would agree with, uh, Ben in, in, in some ways that, that the barbell portfolio actually does look very interesting.  And what I mean by that, I think short duration, asset-backed securities in particular, are incredibly interesting.  Yes, they’re focused on the consumer, you have to have a hawk’s eye on watching the, the, the, the trajectory of that consumer.  But spreads remain relatively wide.  Um, and, and you’re getting cash back on a regular basis which means no matter what state of the world we, we move into potentially you have the ability to put that cash to work in a more interesting environment but despite the fact the starting place is incredibly, incredibly interesting.  For buy and hold investor, actually high yield looks pretty interesting.  But what we worry about is the volatility of the ride.  So we don’t own a ton of it in our portfolios, but on a true very long-term spectrum, yields today are just tremendously more interesting than they have been in the past.  Um, that’d be my, my, my two places.

Mike O:           Ben?

Ben K: Yeah, left, left barbell from, uh, the ABS, I think that, uh, international equities look interesting today.  So we’ve had a 15-year period of the S&P 500 outperforming inter-, international equities.  Uh, maybe that doesn’t continue.  A few arguments I would have, international including emerging markets, uh, we can debate China’s long-term, uh, growth potential sort of how sustainable that, uh, economic model is.  But in the near term, China has a cyclical bounce ahead of it and so I think that the growth impulse coming from China is going to bleed into emerging markets.  They have high trade linkages with China so growth coming from China I think is gonna be good for EM and it’s also gonna be good for Europe.  So European valuations are extraordinarily low and we talked about how they’ve navigated this, this natural gas crisis and we think that, that they’re gonna come out okay.  So I would focus on international equities from a valuation standpoint, from a growth impulse standpoint, and then lastly from a currency standpoint.  So the U.S. dollar is about 13 to 15 percent above its long-term average which means it looks kind of expensive versus international currencies.  And as the U.S. rate hike cycle ends, we think some of the impulse for money to be coming to the U.S. abates and that should be over time dollar bearish.

Mike O:           Ben, Jeff, thank you very much for your time, really appreciate it.  Uh, I’d like to say thank you to all of the listeners, um, on the webcast today.  We really appreciate, we know that there is a lot going on in markets and we certainly appreciate you spending the time with us.  Hopefully you found that informative.  Um, two, uh, favors to ask.  One is we have a survey that will be, uh, that, that you’ll see at the conclusion of this webcast that we’d love for you to, to, to give your honest feedback.  We’re always trying to improve, uh, the quality of our content and, and what you, you all are looking for.  I appreciate, uh, that everything, uh, uh, you guys have done today in making this as interactive as, as it has been.  The second is please take a look at our 2022, uh, outlook written piece which, uh, which is online and available on Thornburg.com.  From everybody at Thornburg here in Santa Fe, New Mexico, I’d like to say thank you.  Uh, again, speak to you soon and looking forward to a prosperous 2023.  Take care.