The Good, the Bad and the Ugly
Different asset classes appear to be discounting different outcomes for the economy in 2023. Equities are discounting a slowdown but with continued earnings growth (the Good), credit markets seem to be pricing in a soft-landing for the US economy with only a mild economic slowdown (the Bad), and the US Government bond market is firmly indicating that the US economy is heading for a recession, the Ugly.
Equities appear richly valued in the US. With a price-to-earnings ratio of around 18x, the equity market isn’t cheap. This valuation is predicated on earnings growth of around 4% next year, albeit earnings expectations have been cut in recent months. In our view, the equity market is discounting a resilient outcome for earnings in 2023, despite the fading expectations for a solid earnings base as the economy weakens.
In times of economic distress, higher risk investments tend to underperform. High yield bonds are those bonds issued by companies with a low credit rating. In recessions, credit spreads tend to widen. In a recession the credit spread generally widens to around 10%. So, whilst high yield bond spreads have increased from cyclical lows of 2.3% in 2021 to 6%, currently, we deduce that the credit market is only discounting a mild economic slowdown (the Bad).
Credit spreads are discounting a poor outcome, but in a recession typically see wider spreads. Shown against Gross Domestic Product (GDP) year on year (yoy).
Source: Bloomberg, Artorius
A tried and tested economic signal is the yield curve (which shows the difference between the level of yields at different points of the bond market). Usually the yield curve slopes up (that is yields are higher for longer-dated bonds than shorter-dated) but this is now showing the reverse, that yields are higher for short-dated bonds than longer-dated bonds. This inverted yield curve, implies that bond market investors are expecting a recession.
An inverted yield curve (short-dated bonds yielding more than long-dated bonds) have predated recessions. Shown against Gross Domestic Product (GDP) year on year (yoy).
Source: Bloomberg, Artorius
All expressions of opinion reflect the judgment of Artorius at 12th December 2022 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. Past performance is not a reliable indicator of future results. Nothing in this document is intended to be, or should be construed as, regulated advice. Artorius provides this document in good faith and for information purposes only. Reliance should not be placed on the information contained within this document when taking individual investments or strategic decisions. Artorius Wealth Management Limited is authorised and regulated by the Financial Conduct Authority. Artorius is a trading name of Artorius Wealth Management Limited.