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GSAM's Investment Committee releases their 4th Quarter 2022 Quarterly Letter

Updated: Apr 1, 2023


January 13, 2023


With the fourth quarter and the entirety of 2022 in the rearview mirror, investors are looking

forward to 2023. Last year was undoubtedly a challenging year, both for markets and geopolitically. “Uncertainty” seemed to be the theme of the year. Russia invaded Ukraine, energy and food prices spiked, the U.S. faced a mid-term election, and the Federal Reserve took off on a historically rapid rate-hiking campaign with a fervor that was unexpected by investors. What historically would have taken the Fed two years in terms of hiking rates, it accomplished in less than one year, as it aggressively battled high inflation.


Volatility was heightened for most of the year, with choppy weeks and months of market

performance across equities and fixed income. While the months of July, October and November brought welcome recovery that pulled us up from the depths of the sell-off reached in June, markets ended the year in the red across nearly all asset classes, except 3-month U.S. Treasuries. For long-term investors, this challenging year fortunately comes on the back of solid equity market performance in 2020 and 2021, as reflected below.


Grant Street was proactive in adjusting portfolios throughout 2022. The fixed income section of clients’ portfolios looks quite different now than this time last year. After years of diligently positioning the fixed income section to achieve positive returns in a low-yielding world, and in anticipation of higher interest rates, we shifted to more traditional high-quality holdings with shorter maturities as the Fed hiked rates. Within equities, we reduced our weighting to developed international stocks early in the year. This was in response to the Russia-Ukraine war and a looming recession in Europe, but we maintained some exposure to the asset class due to very attractive valuations as well as a strong U.S. dollar. After a very difficult first three quarters of the year, international equities rallied strongly in the fourth quarter, primarily driven by a weakening U.S. dollar. This rally resulted in the MSCI EAFE Index outperforming U.S. large cap stocks for the first calendar year since 2017.


To recap fourth quarter events, inflation continues to run hot across the globe, although U.S. levels have fallen consistently since their peak in June (7.0% PCE/9.0% CPI), as energy and food prices have cooled. The most recent November PCE (Personal Consumption Expenditure Price Index) reading for inflation was 5.5%. On the geopolitical front, while not much has changed in the Russia-Ukraine war, China’s notable easing of COVID restrictions in December should positively impact global trade and travel in 2023. In U.S. politics, November’s mid-term election results reflect a split congress for the next two years. A split congress typically proves beneficial for markets since extreme legislation from either side is unlikely to pass. With that said, the last major piece of legislation passed in 2022 was SECURE Act 2.0. This is a $1.65 trillion omnibus spending bill that will fund the federal government through September 2023, but it also included several provisions that impact the finances and retirement savings of everyday Americans.


Looking forward to 2023, our Investment Committee is digesting plenty of economic data to identify trends and turning points in the economy as well as in the equity and fixed income markets. It is important to note that we do not expect the turning points across these segments to coincide. Economically, we anticipate that data in the U.S. will get worse before it gets better. The consumer remained incredibly resilient throughout 2022, but the consumer personal savings rate has recently fallen to the lowest level in over a decade. Revolving consumer debt levels (i.e., credit card debt) have also spiked from recent all-time lows. We believe this indicates the consumer has finally exhausted pandemic and stimulus savings and has turned to consumer credit to finance consumption. As a result, we expect consumer spending to slow, which will certainly create a drag on GDP growth. While a concerning trend if continued, we do not expect spending to nosedive. On the contrary, compared to previous recessionary periods, the consumer is still in reasonable shape. Current debt payments are 9.8% of disposable personal income, which is comfortably below the 11-13% levels we experienced between 1985 and 2007. With pre-pandemic years of 2011-2021 averaging about 10-11%, the takeaway is that the consumer is nowhere near overleveraged at this time, and we expect employment to remain resilient.


As for corporate earnings, which drive stock prices, corporations on average maintained stable earnings and revenue growth through the end of 2022. This occurred despite fighting higher labor and input costs. Year-over-year EPS (earnings per share) growth for S&P 500 companies was 9.2% in Q3 and revenue growth was 11.6%. On the surface, these numbers indicate stability, but recall that last year’s revenues were boosted by inflation, which is easing, and earnings are backward looking. Looking forward, we anticipate that, as inflation falls further and the consumer reduces spending, revenue growth will weaken. Although companies seem to have some pricing power left to offset declining volumes, margins and earnings are likely to weaken for the first part of 2023. Our belief in caution is rooted in the fact that the full impact of interest rate increases by the Federal Reserve has yet to be completely felt across the economy. The Fed has pushed rates up 4% to bring the target federal funds rate to 4.25% - 4.50%. The Fed remains committed to battling inflation, and we expect rate hikes to continue into the first half of 2023, albeit at a slower pace. These realities have recently been reflected in weaker corporate guidance commentary from executives.


In a recent interview, the head of the International Monetary Fund commented that 2023 is going to be tougher on the global economy than 2022, and they even expect one-third of the world economy to be in recession in 2023. We are positioning portfolios today for potentially choppy equity markets in the first half of 2023. We are expecting a mild and short-lived U.S. recession, given a moderate consumer debt picture and historically low unemployment. We remain prepared to tilt portfolios more defensively, if necessary, by reducing the overall equity allocation and increasing traditional fixed income. The biggest difference in investment opportunity this year compared to last year is that investors once again have a defensive section that can truly be defensive, with high-quality U.S. Treasuries yielding over 4% with little to no interest rate risk. This means balanced investors, or those using fixed income to hedge away some stock risk, should experience a less volatile portfolio in challenging periods. We believe those willing to take on the full risk of 100% equities will be the winners over time, but we do not believe the ups and downs of the equities markets are quite behind us in the near term. At this time, we anticipate that the second half of 2023 will be a period of recovery and growth for investors. Rest assured, there are attractive valuations to be found for long-term investors today. Equity and fixed income markets are forward looking. Equities will bottom and begin to recover well before we observe positive economic data. As such, we are closely monitoring valuations in markets to take advantage of buying opportunities in 2023 while staying focused on preservation of capital in challenging periods. As always, we value your trust and confidence in the Grant Street team, and we look forward to a successful and prosperous 2023.


GRANT STREET TEAM UPDATE

We wish to announce that Shannin Pettigrew joined the Grant Street team in December as a Client Service Administrator. Shannin comes to us with a professional background in technical writing as well as marketing and promotion experience. Shannin lives in Canonsburg with her husband, Matt, daughter, Veah (15), son, Drew (11) and three dogs. She enjoys theater and fitness in her free time. You will hear her friendly voice when you call into the office, and we are thrilled to have her join us.


Sincerely,

Grant Street Asset Management, Inc.

Investment Committee

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