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Like many of you, we enter 2023, relieved that 2022 is over and looking forward to better, warmer, and longer days ahead. Curiously, market prospects appear to be improving as the economic numbers appeared to weaken during late 2022 due to rising Fed Funds rates and borrowing costs. That’s due to the perspective of the markets, by nature looking 6-9 months ahead, as more investors believe slowing inflation and temporary economic cooling can result in a “soft landing” in 2023. According to the Labor Department’s consumer price index, the good news is that inflation has come all the way down from its June high of 9.1% to 6.5% in December. Although we agree this is progress, employment remains stubbornly strong, perhaps lengthening the time it will take inflation to approach the Fed’s 2% goal.

Interest Rates

Fed Funds rates have risen from historic lows to normalcy in seven quick steps, leaving bond investors in unusual pain and leading to an inverted yield curve (where short-term rates are higher than long rates). This indicates that markets believe rising rates will eventually fall again due to coming economic weakness. We view now as an opportune time to increase the duration of our bond holdings, as some bonds look reasonably attractive for the first time in years. We are also increasing fixed-income allocations in our models. We continue to weigh equity positions more heavily towards Value vs. Growth. Still, we are decreasing our Value overweight slightly as Growth, international and smaller stocks have gained attractiveness as their prices have become more reasonable.

Globally the war in Ukraine is still an issue, and news reports indicate it may go on for quite some time. As winter began, some European countries braced for higher energy prices due to the conflict. Strong measures to limit energy consumption and unseasonably warm temperatures in parts of Europe have caused the energy hit to be lighter than expected. This has led to the gradual strengthening of their equity markets over the last several months.

Many eyes are on China as the government abruptly reversed its Zero-Covid policy to stimulate the economy. Most market strategists expect Chinese assets to stage a comeback in 2023, and there are proposals within the Chinese government to offer further stimulus. That said, many foreign companies have reconsidered their business in China. Sweeping policy moves and lax intellectual property protections have created a feeling of distrust and unease with re-engaging Chinese suppliers.

The oil and gas industry continues to reap record profits. Ironically, the Biden administration’s policies limiting pipelines and drilling on federal lands have led oil and gas companies to private shale reserves and record margins. For example, Exxon Mobil Corp.’s shares rose 80% in 2022. A resumption in the global growth of demand for energy in 2023 bodes well for energy producers and ill for lower energy costs.

Conference Board Leading Economic Index

Economic statistics have yet to declare we’re in a recession, but most market analysts believe we’re heading into a short and shallow recession if not already there. Our expectations are similar, and we expect volatility in the first half of 2023 as corporate managements adjust to higher costs. So far, results are mixed, with some companies lowering expectations and others navigating reasonably well. We believe the second half of 2023 holds better opportunities for gains as Fed rate increases cease and economic damage decelerates. There are plenty of “X-Factors” to create havoc, but with a strong job market and ample liquidity, we expect modest but positive returns in 2023.

We appreciate your business and confidence during these times when asset allocation decisions have been more challenging and flexibility has become very important. As long-term investors, we have weathered storms before and remain committed to continually assessing the markets and changing with them.

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