January 2023 Monthly Review
"...And That Was Just Right"
By Loyd Johnson, Chief Investment Officer
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A Look Back
The quote above comes from the children’s book "Goldilocks and the Three Bears." It is one of my favorites that I’ve read to my four kids decades ago and now to my grandkids. I like it because it teaches a real-life lesson. It’s okay to try different things, and it’s even more okay to search for things that meet our tastes…and are right.
In the investment world the term “goldilocks” has come to mean just that for various subject matters. Something that is “just right.” It could be valuation levels, interest levels, asset allocation among many. In current economic conversations it has come to mean the idea of the Fed raising interest levels in its fight against rising inflation…and ultimately having an effect on our economy that is not too restrictive. It is indeed a high stakes balancing act where we want growth…but not too much right now. The Fed has made it no secret that the number one priority is to get inflation under control. Further, their goal is to bring it down to their preferred level of 2-2.5%. We peaked at year-over-year inflation last year at 9% levels. More recent reports show that same number at 6.5% at the end of 2022. That downward trend is encouraging, but many wonder how much pain might be involved in going from those levels to the 2-3% range. As you raise short-term rates, you make it more difficult for businesses and consumers to borrow. You give investors a real alternative to stocks.
There are some tangible causal links that flow through our economy as the Fed establishes monetary policy…some good and bad to be sure…but the ability to balance all of those and engineer a soft landing akin to the goldilocks scenario is more like high-wire balancing. In the meantime, January was a welcome breath of fresh air in the financial markets, and a departure from the negative returns seen in 2022. U.S Large-Cap stocks were up more than 6%, while Small and Mid-Cap stocks fared even better. Additionally, Core Bonds, as shown by the Bloomberg U.S. Aggregate, returned to some sense of normalcy with a +3.08% number in January, and has delivered + 6.39% over the last three months. Buoyed by lower mortgage rates, both domestic and foreign REITS performed extremely well in January after a woeful 2022. Finally, Cash is getting to be a fairly attractive place to be with a 1% quarterly return, that would imply over 4% annualized…much better than the nearly 0% investors could expect this time last year!
A Look Ahead
We look ahead, as we always do, with clear and critical eyes. It is our belief that the goldilocks scenario discussed above will be a difficult one to achieve. Historically, the Fed has either been too late, or too early and too restrictive or too loose. We do believe that, however late to the party they might be, they mean business. It is fair to take them at their own words as they say that reducing inflation is job one. The most recent Jobs report surprised markets as employers added over 517,000 jobs in January, as the unemployment rate fell to 3.4%. That represents the lowest level seen since 1969. Again, the Fed is looking for job gains and wage growth to slow to aid in inflation reduction. The Fed did as expected last week and raised the Fed Funds rate .25%. It now stands at 4.50-4.75% and offers savers a real return on their money. From a risk/reward standpoint, we favor cash and core bonds over stocks presently and believe that more volatility should be expected as we seek to maintain our balance of not-too-hot and not-too-cold. It worked for Goldilocks!