Sinking stocks, battered bonds, rising rates and stubbornly high inflation roiled the markets during 2022, making it a challenging year for investors to find any kind of reliable income stream. But as the year draws to a close, a few opportunities are appearing on the horizon for 2023.
The financial turmoil of 2022, “Leaves investors with a wide range of opportunities, provided they have the flexibility to consider a broad spectrum of asset classes,” according to Karen Watkin and Edward Williams of AllianceBernstein. “Looking to 2023, we think income-oriented multi-asset investors should consider three key themes.”
Those themes: Diversified sources for equity returns, credit-worthy high-yield credit and diversification with government bonds.
Consider matching with a vetted financial advisor for free to see if these three investment themes fit into your overall financial picture.
AllianceBernstein Investment Themes for 2023
1. Diversified equity returns: Dividend-paying stocks are a traditional go-to in troubled markets for a number of reasons. First, and most obvious, is the fact that shareholders receive payments that can provide either income or be reinvested in new shares. Those payments are the result of companies that have grown and matured using successful business models.
That stability translates to a less-volatile share price that not only reflects the value of dividend payments but that can also respond to increased demand for high-dividend stocks during rocky markets, and 2022 has been no exception. Consider the Vanguard High Dividend Yield ETF (VYM), which was down slightly more than 1% at the end of November vs. more than 17% for the Standard and Poor’s 500 Index.
“With their defensive characteristics, dividend-payers proved steadier as markets grew choppy during the year,” Watkin and Williams write. “In fact, the sell-off for high-dividend stocks was half that of cap-weighted equities in 2022.”
High-dividend stocks tend to favor a few specific industries, they note, such as consumer staples, healthcare and utilities.
As for other equities, the authors point to shares of stable, high-quality companies with strong cash flows and good capital-spending strategies that could be trading at lower valuations because of inflationary pressures hitting both consumers and costs.
2. High-yield credit: Corporate debt issued by companies with strong fundamentals has become more attractive as inflation-fighting actions from the Federal Reserve’s Open Market Committee have pushed interest rates to their highest levels in years.
But because well-run firms with good cash flows took advantage of lower rates to restructure and retire debt, default risk isn’t a factor at this point, Watkin and Williams say. The ICE BofA US Corporate Index, which tracks investment-grade domestic corporate debt, posted yields of more than 5% at the end of October, more than double the April rate.
They also point out that, unlike stock indexes, high-yield bond indexes favor energy companies, which are benefiting from high commodity prices, over technology companies, which have been battered by market and profit pressures.
3. Government bonds: With yields at their highest levels in the last 10 years, government bonds have become a viable income source, including Treasuries and I Bonds. There was a huge run on I Bonds at the end of October before the 9.62% interest rate expired, only to be replaced by a rate of 6.89% which, for technical reasons, will actually pay investors more after four years.
But while higher rates were good for investors in new government debt, existing bonds were hammered on the secondary market, erasing the traditional diversification benefit that comes with a stock-bond mix, such as the classic 60% stocks/40% bonds portfolio.
With inflation beginning to ebb and some Fed members talking about easing back on interest rate hikes, Watkin and Williams expect the correlation between stocks and bonds to return to its traditional equilibrium, writing that, “The diversification benefits of government bonds could return now that inflation is showing signs of peaking, based on historical trends.”
Bottom Line
Karen Watkin and Edward Williams of AllianceBernstein are recommending three themes for income-oriented multi-asset investors in 2023: Diversified sources for equity returns, credit-worthy high-yield credit and diversification with government bonds.
Tips for Investors
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