Outlook 2023: Why this could be a pivotal year for investors

Text size: aA aA aA
As the global economy and markets reset, our Chief Investment Office sees many new opportunities emerging. Here's what to watch for.
"2023 could be a foundational year for investors," says Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank. After a period that most investors would like to forget — with surging inflation, rising interest rates, geopolitical conflict and the worst performance for financial markets in decades — Hyzy characterizes the year ahead as "back to the new future."
By that, he means a likely return to pre-pandemic economic conditions — and the opportunities that were emerging before the pandemic turned everything upside down. "The next business cycle could be characterized by new investing themes and new drivers of growth," Hyzy says. Innovation will address many needs, from bringing supply chains closer to home to expanding and refining how big data is used to preparing for a more sustainable future.
And although the recession that may arrive in early 2023 could feel like more bad news, it is likely to be mild and relatively brief, helping reset an economy that ran too hot for too long. This might provide an opportunity for investors to reexamine their strategies and portfolios and put themselves on firmer ground as they prepare for better days ahead.
Below, Hyzy and other top strategists from the Chief Investment Office (CIO), Merrill and Bank of America Private Bank, discuss what they believe will be the key drivers of — and risks to — growth in 2023 and share ideas for how you can prepare for both.
For more on the CIO's outlook, read 2023 Year Ahead: Back To The New Future (PDF) and watch our webcast Outlook 2023.

Headwinds vs. tailwinds

The transition to the new future may not be smooth, with conflicting economic forces likely to compete through much of the year, Hyzy says. That could create continuing uncertainty and disrupt investment markets. "The headwinds are the geopolitical landscape, including the war in Ukraine; concerns about how large a recession we'll see in the United States, the UK and Europe; lockdowns in China that have limited its contribution to global growth; and the inversion of the yield curve, with interest rates on short-term bonds higher than those on long-term bonds," he says.
The tailwinds are an expected decline in inflation, stabilizing energy prices and corporate earnings, better equity valuations and, as a contrarian indicator, poor investor sentiment that could provide opportunities to purchase equities at low valuations as earnings recover. "This foundational year should be the base year of a renewed bull market cycle," Hyzy adds.
What this could mean for your portfolio: "At a time when there's so much uncertainty — including elevated inflation and the lingering global impacts of the pandemic — it makes sense for your portfolio to be as diversified as possible," notes Marci McGregor, senior investment strategist with the CIO.
"On a scale of one to 10 for diversification, you want to be at a 10 right now, and that means using all of the tools in your toolkit, which could include investments in commodities and real assets." This would include exposure to global equities as well, McGregor says.

Tempering demand to control inflation

Particularly crucial to the outlook for 2023 is what happens to consumer spending, which accounts for more than two-thirds of U.S. gross domestic product (GDP). "Consumers' savings accounts swelled during the pandemic, and they still have more than $1 trillion of excess savings,"Footnote 1 says Niladri Mukherjee, head of CIO portfolio strategy. "In addition, the labor market has been very strong, and wages have been rising." Those factors help explain why spending, especially on services, has remained buoyant.
Unfortunately, for the Federal Reserve (the Fed) to succeed in tamping down inflation, it will take a rise in unemployment, which should lead to a moderation in consumer spending, Mukherjee adds. This is why we've seen the Fed raise interest rates by more than 400 basis points in 2022, and the impact on the economy is likely to be a mild recession. But inflation, as a result, should continue to come down to under 4% in 2023, Mukherjee suggests, and should begin to approach the Fed's target rate of 2% by the end of 2024. "The Fed is showing a lot of resolve and is very likely to win this battle."
What this could mean for your portfolio: Those conditions could benefit defensive stocks such as utilities and healthcare, as well as cyclical stocks that may recover as the economy begins to rebound. "We have a slight preference for value stocks over growth stocks, and we suggest broad exposure to the market," says Hyzy. Looking further ahead, Hyzy sees another possible market shift, with small-cap stocks and select emerging markets, both of which have underperformed recently, gaining momentum.

A tale of two halves

If a recession comes, the Fed will need to shift its attention from fighting inflation to encouraging growth. That could mean a pause in interest rate hikes around the end of the first quarter, Hyzy says, and by the end of the year, rate cuts might begin. Against that backdrop, investing conditions are likely to shift mid-year. During the first half, high-quality bonds may outperform other parts of the market, while in the second half, conditions for stocks are likely to improve. Hyzy notes that stocks are a leading indicator. "With the potential for a mild recession, equity markets should start to anticipate a much better environment, with corporate earnings stability and ultimately a new profit cycle beginning in 2024," he says.
What this could mean for your portfolio: Investors shouldn't try to time that expected bond-to-equity shift, Hyzy emphasizes. Rather, you might take McGregor's suggestion about greater diversification to heart. "Making sure you have a very broadly diversified portfolio at the start of the year can help you take advantage of potentially better risk-adjusted returns throughout the year regardless of when sentiment moves from bonds to stocks," Hyzy says.

Finally: Real income from bonds

The historically low bond yields of recent years have frustrated investors looking for income, says Matthew Diczok, head of fixed income strategy for the CIO. And because bond yields were already at such low levels, they had little room to fall further. That meant that bond prices, which rise when yields move down, had scarce potential for appreciation. "Now we're in a much better place," he says. "Because yields are currently much higher, you not only get the income you need, but you also get more portfolio diversification — because if yields move lower, bond values will rise."
At the same time, Diczok notes, investors who hold bonds to maturity don't have to worry about volatility in yields and prices. "You get the income you need now, and as long as you match the maturity to your investing time frame, you get the return of your principal when it's needed — to pay for a child's or grandchild's education, for example, or for other large, planned expenses," he says.
What this could mean for your portfolio: Diczok suggests a mix of fixed-income holdings that includes four kinds of high-quality securities: U.S. Treasurys, agency mortgage-backed securities and investment-grade corporate and municipal bonds. "Historically, all of these have shown very little in the way of credit losses, regardless of what's happening in the economy," he says.

With volatility comes opportunity

After the stock and bond market declines of 2022, investors are understandably hoping for a calmer 2023. Still, Mukherjee expects ups and downs to continue, especially during the first half of the year. "Volatility is an integral part of investing," he says, "and in a dynamic economy, slowdowns in growth are essential for removing excesses from the markets. Then capital can flow to the most productive areas of the economy, creating new drivers for the next business cycle." Mukherjee notes that potential returns for many asset classes are better than they have been in years, especially for bonds.
What this could mean for your portfolio: Ongoing volatility will present chances for rebalancing your portfolio, McGregor says, giving you opportunities to increase allocations to global equities, for example. Stocks in energy and healthcare, among other sectors, are now paying attractive dividends. And long-term, growth-oriented investors could look for opportunities based on themes such as digitization, clean energy and healthcare infrastructure.

Know what you can control

Looking ahead, Mukherjee sees a time of accelerating innovation. "Money is going to flow into all kinds of areas — artificial intelligence, big data, cybersecurity, cloud computing," he says. "There will likely be a lot of investment in energy and commodities and a build-out of high-tech manufacturing coming back to the U.S."
Yet the path ahead will inevitably be bumpy, with many factors remaining outside of an investor's control. "You can't control volatility any more than you can control what the Fed is doing, or what Congress does, or what the next geopolitical crisis may be," he says. "But armed with knowledge and perspective you can control your emotions and your investment approach, and you can stay the course on a plan you've built around your financial goals."
Now, after such a difficult year and amid considerable uncertainty about how 2023 will unfold, that outlook could be more useful than ever.

Suggested for you

Footnote 1 Aditya Aladangady, David Cho, Laura Feiveson, and Eugenio Pinto, "Excess Savings During the COVID-19 Pandemic," FEDS Notes, October 21, 2022.

Important Disclosures

Opinions are as of the date of this article 12/15/2022 and are subject to change.

Investing involves risk including possible loss of principal. Past performance is no guarantee of future results.

This information should not be construed as investment advice and is subject to change. It is provided for informational purposes only and is not intended to be either a specific offer by Bank of America, Merrill or any affiliate to sell or provide, or a specific invitation for a consumer to apply for, any particular retail financial product or service that may be available.

The Chief Investment Office (CIO) provides thought leadership on wealth management, investment strategy and global markets; portfolio management solutions; due diligence; and solutions oversight and data analytics. CIO viewpoints are developed for Bank of America Private Bank, a division of Bank of America, N.A., ("Bank of America") and Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S" or "Merrill"), a registered broker-dealer, registered investment adviser and a wholly owned subsidiary of Bank of America Corporation ("BofA Corp.").
Asset allocation, diversification, and rebalancing do not ensure a profit or protect against loss in declining markets.
Investments have varying degrees of risk. Some of the risks involved with equity securities include the possibility that the value of the stocks may fluctuate in response to events specific to the companies or markets, as well as economic, political or social events in the U.S. or abroad. Dividend payments are not guaranteed and are paid only when declared by an issuer's board of directors. The amount of a dividend payment, if any, can vary over time. Bonds are subject to interest rate, inflation and credit risks. Income from investing in municipal bonds is generally exempt from Federal and state taxes for residents of the issuing state. While the interest income is tax-exempt, any capital gains distributed are taxable to the investor. Treasury bills are less volatile than longer-term fixed income securities and are guaranteed as to timely payment of principal and interest by the U.S. government. Investments in foreign securities involve special risks, including foreign currency risk and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are magnified for investments made in emerging markets. Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates, and risk related to renting properties, such as rental defaults. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes, and the impact of adverse political or financial factors. Mortgage-backed securities are subject to credit risk and the risk that the mortgages will be prepaid, so that portfolio management may be faced with replenishing the portfolio in a possibly disadvantageous interest rate environment.

Merrill Lynch, Pierce, Fenner & Smith Incorporated (also referred to as "MLPF&S" or "Merrill") makes available certain investment products sponsored, managed, distributed or provided by companies that are affiliates of Bank of America Corporation ("BofA Corp."). MLPF&S is a registered broker-dealer, registered investment adviser, Member Securities Investor Protection (SIPC) popup and a wholly owned subsidiary of Bank of America Corporation ("BofA Corp").
MAP5352422-12152023