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Truist Wealth economic and market insights Q2- 2023 webcast
OSCARLYN: Hello, and welcome to Truist Wealth's Economic and Market Insights client call. Thank you for being here. We appreciate you taking time out of your day to join us. Today our goal is to provide perspective on markets year to date, our outlook for both markets and fed policy from here, and offer guidance on the most pressing issues and questions you've asked us about.
I'm Oscarlyn Elder, co-chief investment officer for Truist Wealth. My team is responsible for selecting and analyzing the investment solutions and strategies that your Truist advisor may use in creating your portfolio. These include mutual funds and ETFs, private equity and hedge funds, as well as diverse asset manager solutions. Joining me is Keith Lerner, co-chief investment officer and chief market strategist.
Keith and his team guide Truist advisors and clients through all market environments. They provide timely advice with the objective of helping clients achieve their long term goals. Keith leads our portfolio and market strategy, equity, and fixed income groups. Keith's work is frequently highlighted in financial press, and you'll often see him on CNBC or Bloomberg TV.
For today's discussion we're joined by Mike Skordeles head of US economics, and Chip Hughy, managing director of fixed income. Both are seasoned investment strategists. They publish and are cited frequently in the media, and most importantly, they help drive our investment guidance. First let me start by setting the stage for our conversation. Global markets are in positive territory year to date. This is after an extremely challenging 2022, where both stocks and bonds traded down.
And despite significant challenges in the banking system, further increases in the fed funds rates and continued elevated inflation levels, the S&P 500 is still up around 7% for the year. And after the worst year in decades for bonds, bonds are up more than 3%. With that backdrop, Keith, why do you think the market has been so resilient this year?
KEITH: Yeah. Well, first, great to be with you and the rest of the team today. You're right, the market has been relatively resilient, and I think there's a couple of reasons for that. The first thing is we actually had a pretty good sell off at the end of December so we started this year at a lower starting point. Markets, if you look at the S&P 500 as an example, were really back to where we were before that sell off in December, so we had good starting points.
I think the other thing is if we were talking a month ago and we said there's going to be some stress in the banking system, a lot of us would probably have a discussion about how far the market was down, not whether it was up or down. The market's actually been up since then, which is somewhat surprising. But I think the main reason behind that is when we had the banking stress, the market is looking at that as far as bringing the end of the fed rate hike cycle closer to an end.
And if we think about the last year, you just mentioned how tough the market was last year. A lot of that was because of these really aggressive rate hikes and inflation, so the market's starting to think that brings that closer to an end. And then the other thing I think is important is a lot of the market's resilience is because of these big mega-cap growth stocks.
Some of these stocks are up 20%, 30%, even 50% this year. If you look at the S&P, you just mentioned we're up about 7% for the year. The average stock is up about 1% or 2%, so in some ways it's good those mega-cap growth stocks are doing well because a lot of our clients own those. But underneath the surface we've actually seen a little bit less resiliency than meets the eye.
OSCARLYN: Yeah. Thank you for touching on those points. Will you talk to us for a second, explain to our viewers today, just walk us through what our current positioning is from a tactical perspective, a high level tactical perspective?
KEITH: Sure. And the graph that you're looking at right now looks at our asset allocation. So from a big level perspective-- and this is relative to a long term investment objective-- we're seeing bonds are more favorable than stocks, and we have a tilt towards fixed income and cash and an underweight in equities.
That doesn't mean that we are recommending 30% cash, it just means relative to those long term targets we would have a little bit less equities, a little bit more fixed income than typical, because we still think the economic backdrop-- which I'm sure Mike will talk about today-- is still going to be somewhat challenging. And we also think that the market right now is pricing in a lot of good news and not leaving a lot of room for error, so that's the big asset allocation.
Within equities we still like the US. We think about the US as that big blue chip country. Typically during economic slowdowns the US tends to outperform. We're more neutral on smaller and mid-cap companies. Longer term we find the valuations as compelling, but right now the business cycle is working against these companies at this point.
We are underweight international markets, though we did upgrade developed international markets earlier this year. We just think they're more in a fragile state if we're heading into this global slowdown that we think. And then on the fixed income, which my friend Chip here will talk about, we are overweight fixed income, but we're also trying to keep things really simple and focus on high quality fixed income.
And things we're underweight or have less favorable view of things that are more leveraged to the economic cycle. If the economy is going to slow down, things like high yield and leveraged loans are things that we would like-- we would be less positive on, at least at this point of the cycle.
OSCARLYN: So the main message is, if I were to capture it maybe in one statement, we remain defensive.
KEITH: We remain defensive. But also sometimes I get the question of, what does that mean?
KEITH: And I always want to bring this back to a long term investment objective.
OSCARLYN: Yeah. KEITH: It's within the confines of that investment objective we're being more defensive than we normally would be at other parts of the cycle where we would be--
--or on offense.
OSCARLYN: Right. Thank you.
OSCARLYN: All right. Mike, I'm going to turn to you now. So with the US economy, one of our key themes coming into 2023 was fading growth and easing inflation. It seems like that's working. It seems like that theme is still appropriate. Is that correct?
MIKE: Absolutely. In fact, almost to a T, that fading growth has definitely materialized and we've seen, particularly at the end of 2022, inflation has been easing. So that's exactly what we expected. On the first slide there, you'll see that we had this big growth spurt in 2021. That was because we had a lot of fiscal stimulus, so things like the stimulus checks, the PPP program, and those sort of things, as well as monetary stimulus.
So bringing rates down to zero during the pandemic helped things certainly work their way through 2020 into 2021. They helped in '22. We've seen this step down and growth that you're seeing on this chart. Now we get to 2023, and definitely growth has faded-- partly because some of that stimulus is no longer in the system. But then the other piece that Keith mentioned is how aggressively the Federal Reserve has increased interest rates, and for normal people these are things like credit card rates, auto loans.
And then certainly for businesses the cost of capital is increased, so that slows things down. We've definitely seen that materialize in most of the data. It was particularly acute in 2022 with the housing market and also commercial real estate. So those parts of the puzzle are already in place. The other pieces were, I think, to Keith's point of markets being resilient is that we're not seeing or expecting a falling off the table, a great financial crisis, sort of, unfolding of, or unraveling in a recession.
It's going to be a lot more gradual, certainly, than the great financial crisis or the pandemic recession. But also how quickly that comes or when it comes is a little bit more of a guess. In our case, particularly with the banking system and the tightening of credit conditions, we've pulled forward our recession expectations from being much more in the back half of the year to probably be more mid-year. So maybe second quarter, the current quarter, and the third quarter we're going to see a little bit more wobbling.
OSCARLYN: Yeah. Is there anything special that you would call out after Silicon Valley Bank? I was about to say SVB. So, no acronyms here. Silicon Valley Bank. After the collapse of Silicon Valley Bank, is there anything that's changed in your outlook that you would want to highlight especially?
MIKE: Yes, so the biggest piece is the one I just touched on, which is the pulling forward of our recession expectations. That's because a lot of people-- rightfully so, and my friend Chip is going to talk about how much rates have jostled about. That that jostling of rates and really having rates bumping up and down makes people sit back and say, I don't want to try to either price credit or try to get more credit or buy a piece of equipment if I don't know what my financing costs are going to be.
So that's definitely impacting the economy. The important but very nuanced point here is that it isn't a slowdown of the economy right this second. You're slowing things down for later in the year because it takes a while. Even if you did buy that piece of equipment, it takes months for it to be made and fulfilled and all that sort of thing. So we've taken things out of the pipeline, if you will, out of the economic pipeline for later this year, and that's why essentially we've pulled forward our recession expectations.
OSCARLYN: So our base case is still recession.
OSCARLYN: It's simply it's being pulled forward, likely into--
MIKE: Yeah, the middle of the year--
OSCARLYN: --if you will.
MIKE:Yeah. And then the other point that's on this other slide that's up is how much we've slowed things by increasing rates. So essentially here it's showing the fed funds rate, how much the fed has increased interest rates over the last year, and how, when it gets married up with actual growth and that time lag that I was talking about, that it takes, call it six, nine months for things to really slow down.
Well, they started last March. We're already seeing that slowdown in the cost of capital was more expensive as we move through 2022. Now that we're staying above 5%, as far as the fed funds the overnight rate, that's slowing things down even further.
OSCARLYN: And then lending standards, also. We're seeing those impacted by the Silicon Valley Bank.
MIKE: Yeah, absolutely.
OSCARLYN: And the banking.
MIKE: Yeah. Sorry I wasn't more specific on that point, but yet... In the aftermath, particularly those couple weeks with rates moving up and down, a lot of banks-- so both borrowers and lenders said, I don't know what the cost of capital is going to be either day to day or from the next week or next couple of weeks. So there's a natural tightening of credit conditions which, again, slows things down. But not immediately. OSCARLYN: Right.
MIKE: That's down the line.
OSCARLYN: Delay. MIKE: There's a bit of a delay because, again, whatever you're building-- if you're building a building or building a home, it doesn't happen overnight. It happens over a longer period of time.
OSCARLYN: Great. Thank you, Mike. Chip, I'm going to turn to you. What's the bond market telling us about the potential for a recession?
CHIP: Yeah. A lot. I think it has a lot to say, and typically when you look at US Treasury yields you should have this nice upward sloping left to right yield curve, right? And so we know that last year around the July 4th holiday we saw that yield curve invert between the 2 year and 10 year, and that simply just means that 2 year yields moved higher than 10 year yields.
So the inversion started at that point. And if you go back through history, typically that foreruns a potential recession by 15 to 16 months. More lately what we've seen has actually been a resteepening of the yield curve, which by itself sounds like that's a good thing, right. But what typically is happening is as you see that resteepening, it's because the market is growing more convicted that the fed will eventually have to start cutting rates.
And you see short rates start to fall, and that's a resteeping of the curve. When you see that happen by about 50 basis points, or half a percent-- which is in the neighborhood of where we are right now-- that typically foreruns recession by five to six months. So we're kind of moving through that, that sort of, that trajectory. So I do think that if we continue to see that resteepening continue, you get towards the hundred basis point range, that really is more saying that a recession looks fairly imminent.
I will say too lastly that our credit spreads, which is simply the amount of incremental yield that are paid on average by corporate bonds over treasuries, that has stayed really, really stable. That typically does widen or grow larger as recession becomes more and more kind of on the doorstep. So we're not there yet, but hopefully that puts in context what fixed income markets are saying.
OSCARLYN: So we're not seeing distress in the investment grade bond market at this point? The spreads aren't indicating--
CHIP: Correct. On the corporate side, exactly.
OSCARLYN: So what does all this mean for the Fed and their rate hike path?
CHIP: Yeah. At the, right now the market is sort of split on will the Fed raise rates on May 3 by 25 basis points? Will they hold steady? They very well may be done. They may execute one more, and that will depend a lot on the data between now and May 3. I think what's really the most important aspect is that effectively we think that the Fed's rate hike cycle is over. Right? The 25 basis points is simply very little in comparison to the 500 basis points that have already been executed. So we think that that's really what's important.
And we also think that the Fed is going to-- one thing that's underappreciated right now if you look at what markets are looking at, the Fed is likely to hold rates at these restrictive levels for longer than we think the market is currently anticipating. The market is expecting this kind of swift pivot into rate cuts, and we actually think that it's going to be a fairly high bar before the Fed starts to entertain those rate cuts. And at the same time, we also think that they're going to continue along this path of quantitative tightening, reducing the balance sheet. And that's important too because that has big ramifications for volatility and liquidity in the market as well.
KEITH: Do you mind if I jump in?
OSCARLYN: Jump in.
KEITH: Just as you were talking, we talked about resiliency, why the market's been resilient. I think the market, as we mentioned, is thinking the Fed's coming to an end. So what we often get is once the Fed pivots, this market is going to take off. When we look back at history, the market does do well when the market, when the Fed pivots. However, the sustainability of that rally depends on whether the economy holds up or not.
Mike just mentioned earlier that we still think recession risk is elevated. So our point of view would be even if the Fed pivots and maybe that does support markets and maybe the markets go a little bit higher than expectations, that if the economy slows down that's going to hurt corporate profits eventually and still be a cap for the overall markets as well.
OSCARLYN: Right, right. So overall, one of the key messages for our listeners today, our viewers today would be we're not expecting a quick pivot.
OSCARLYN: Our, kind of our base case is recession, not a quick pivot, and it could take some time before we see a more accommodative Fed, at the end of the day. And to your point, Keith, all of that equates into a more difficult economic environment, and likely more challenging environment for equities.
KEITH: The other point is if the Fed keeps rates at 4% or 5%, you have more competition sustained at that level from just things like cash. OSCARLYN: Yeah.
CHIP: And the cooling inflation, it's a process. It's going to be a process for inflation to come back down. So that we think the Fed is just going to be very patient and be sure that inflation is cooperating before making some major pivot kind of move.
OSCARLYN: It's that scar tissue. So Keith, you talked a lot about scar tissue in the past, and you and the team, you all really believe that the scar tissue is going to delay the Fed pivot at the end of the day.
KEITH: Yeah, because normally if the economy is going to weaken, they would typically come in pretty aggressively. In fact, I think you have the stats, Chip. When the Fed stops, within six or seven months they typically cut. But this time they've had to deal with inflation over the last year so they're probably not going to react as quickly to an economic slowdown because they're still worried about the inflation side. So it puts them in a challenging position.
OSCARLYN:Yeah. Definitely. So with that, we've also had a number of questions from folks who are listening in today, viewing the webcast, asking lots of questions around commercial real estate and what's the state of commercial real estate. How are we feeling about commercial real estate? And so Mike, I'm going to turn to you. Is commercial real estate the next domino to fall, if you will?
MIKE: I like to go back to the great financial crisis playbook of we used to talk about the next shoe to drop. Unfortunately, during the great financial crisis, it was a centipede. There were lots of shoes dropping all over the place. So joke aside, there's a lot of different pieces there. But it's also important to understand some of the concerns about commercial real estate generally are absolutely understood and very rational.
On the other hand, there's a lot of comparisons and very quick knee jerk reactions to, geez, these are smaller banks. And smaller banks, they originate more than half of the commercial real estate loans that are done in the US. Those are all true statements. But the key word in that statement was originate. And there's also a bunch of people saying, oh, well, this is just like the early '90s when we had the S&L crisis, the savings and loan crisis.
Well, it's quite different than then for a number of reasons, not the least of which is we didn't have commercial mortgage backed securities back in the early '90s. And that's why they originate the loans and then they package them up and they sell them to investors. These are things like investors, pension funds, et cetera, insurance companies, that hold these things till maturity that are packaged with all these commercial real estate mortgages.
That's a very big difference, so they're not necessarily holding them on their balance sheet Additionally, those that are being held on their balance sheet, these aren't big buildings. Big buildings are the places where you're seeing office space being given back and subleased and all these issues within the office part of commercial real estate. Quite different. Again, the typical small bank, they're loaning on the two or three floor or two or three story building that has a couple of dentists and maybe a beauty shop and some of these other things. Those are small offices.
They're not giving back a bunch of space. Additionally, they're more resilient than these bigger office sort of situations. Those big office situations are on the big bank balance sheets and insurance companies, and even some of the shadow banks. So now we have private equity in different other pieces, but I come back to that commercial mortgage backed securities being a very big differen... A big, big distinct difference between some of these prior cycles and what's going on today.
OSCARLYN: Yeah. And so with that, you open the door to commercial mortgage backed securities. Chip, what are you seeing within those securities from a pricing perspective?
CHIP: Yeah. I think if you look at that space at the sector right now, it's flashing concern and questions but not panic. And we're at the highest measures of risk in that space that we've seen since the pandemic, but they are far away from where those measures got to during the pandemic. And the stresses there are really centered on two spots, and that is in the office space and the retail space.
Right? Work habits have changed dramatically in the last three years, shopping trends you have as well, so you're seeing pressure there. But I think it's worth noting, though, on the better side, you're seeing properties like multifamily housing and mixed use properties are actually faring pretty well-- very well. So there is an offset there, but that office and retail space is where you're seeing that pressure centered.
OSCARLYN: Right. Keith, is there anything that you would add from the equity market perspective into this conversation?
KEITH: Yeah, sure. We are underweight to REIT sector as a whole, but to your point, it's very diverse. When you think about REITs in general, the reason why we're underweight is that's an area that benefited from low rates and easy credit conditions. So if you're going to have a slowing economy and tighter credit conditions, that's a negative for REITs in general.
But if you look at the composition of the REITs themselves, to your point, hotels are doing fine. Some of the warehousing is doing fine. But where you're really seeing the pain is the office and the malls and things of that nature. So on a net basis we're still underweight, but there are some areas where there's more pain than others.
OSCARLYN: Yeah. Yeah. Any parting thoughts before we leave commercial real estate and move on?
MIKE: So I would say the biggest one, Oscarlyn, is this tightening of credit conditions, which is really impacting it. But again, much like I mentioned much earlier is that this isn't a today slowdown. Those tightening of credit conditions mean down the line, you're not adding new commercial real estate, which ultimately may prop up price because there's just not enough space for some of these offices, but also for retail.
That said, we are going to have a business cycle. We think that there's going to be a recession, and that's an important facet. We very much think that there's going to be a recession and a reset and valuations and everything else across all asset classes.
OSCARLYN: What I think I heard you say-- you can correct me if I didn't hear it correctly. But what I think I heard you say in essence, right, there will be some pain in the commercial real estate. We know it's happening in office. We've seen it in retail. Kind of your perspective is that the impact to smaller banks, though, is different than it has been in prior cycles because the risk has been distributed in a different way this time.
MIKE: Absolutely. And then the availability of some of these liquidity programs. So not to get too far down that path, but the discount window and other things. Those are giving some relief to the liquidity pinch
that's happened and why credit conditions have tightened for some of these smaller banks, but also the larger banks as well.
OSCARLYN: Yeah. All right. Anything else on commercial real estate before we move on? All right, if not, let's move forward. Keith, coming into 2023 one of our key themes was choppy waters to continue, and that seems to be playing out. Even though the market the market is up year-to-date, we certainly have seen some choppiness. Can you talk to-- discuss why you think the market has been choppy and why it's set to continue?
KEITH: Sure. And the graph that you all are seeing on the screen hopefully really illustrates this. If you look back over the last year, we've been going from these bouts of optimism to pessimism or risk on and risk off. And I think a lot of this is because each headline is overextrapolated and there's this ongoing debate you start with Mike with the economy. Is it a hard landing or a soft landing?
And depending on where the economic data point comes out, you move in one direction or the other, is inflation sticky or is it easing? Right? So you have these factors, and then even with the Fed, is the Fed going to be higher for longer like we expect or are they going to pivot? So as the market gets new data points, they're shifting really dramatically between risk on and risk off. And I think that's likely to continue. But I would say as we move forward, if we do see start seeing that economic weakness start to manifest later in the year, and we just think the upside for the market is somewhat capped.
And if there's some other alternatives today that are paying-- such as in fixed income that are paying a reasonable return, we just think there's more attractive opportunities. But we expect this to continue, and we also will be looking for tactical opportunities. When the market had a big move in January, our point of view was that was a good time to reduce equities or take some of profits from the more speculative areas of the market. And then you had a move down in February and then a bounce back more recently again.
OSCARLYN: Let's talk about valuation, because I know you've done a lot of work on valuations and valuations have rebounded, really, just with the market, right? That we've seen recently. What do you think the market's telling us from a valuation perspective? What's priced in at this point?
KEITH: Sure. You know when we look at the overall market valuation, we're trading at pretty rich valuations. If you look at the S&P and the chart we have for you, it's just a chart of the S&P 500. And this is the-- sorry, S&P 500 PE, just a measure of valuation. And what I like to do on the chart is to put my thumb over the pandemic because you had this overshoot of valuation because you had rates at zero and you had a huge amount of stimulus.
But if you look prior to that pandemic overshoot, the highest valuation we got over the last decade was about 18.5 or 18 to about 18.5 on a forward price to earnings ratio. So where are we today? We're around 18.1. So what does that tell us? That just tells us the market is baking in a lot of good news, but not baking a lot of recession concerns. And by the way, there's no magic number. It doesn't mean that valuations can't go to 19 or 20, and a lot on the short term is based on sentiment, positioning.
So we can certainly overshoot this, but from our point of view you're not being adequately compensated for taking on excess risk today. And then if we look-- I believe we have another slide on this that looks at earnings, and a lot of times we'll talk about earnings and the economy. So what's notable is today we're seeing a disconnect in that the industry analysts that are following companies like Microsoft and Apple and Caterpillar, they're looking for earnings for the overall market to make a new high in the second half.
A new high, a new all time high. We heard from Mike and also the consensus of economists, they're expecting the economy to slow down in a material way. So there's a disconnect. New high in earning
s versus a significant slowdown in the economy. Something has to give. Our view would be that more likely those earnings will have to come down.
So what does that mean? That means that PE ratio we just discussed, which is at the high end, is actually probably a bit higher because those earnings are somewhat inflated. But that's also what we're looking at. Earnings have been very resilient over this cycle, so we'll be paying attention to it. But that's part of the reason why at this point we're still more on the defensive side of the market.
OSCARLYN: Okay. Where do we see opportunity?
KEITH: Well, I think there's always going to be opportunities. It's not a this-'n'-that, is not like all in or all out, so we always think that you should have exposure to some equities if that's within the context of your long term portfolio goals. I think big picture we still like the US relative to the overall globe, and I think even within the US we did have some of these-- the average stock is only up 2%, so beyond just the big cap part of the market we still think there's opportunity there.
But I think it's also time to be somewhat patient. I mean, we are overweight-- we're overweight technology, not because we think there's so much upside. We just think it's going to hold up somewhat. But I really think this is a time where we're being patient and looking for a more, you know a better risk, reward situation to get more aggressive on adding to stocks.
OSCARLYN: So that's the word I'm going to take away. Patience. Patience. Keep the long term view from a tactical perspective. We think folks really need to be patient right now.
OSCARLYN: Right. All right. So, Chip, let's move to fixed income. Another key theme that we had coming into 2023-- and we talked about this back in January when we had our January webcast-- was that bonds are back. That was our theme. And year to date, it's been-- I've called it a head spinning journey. I mean, just lots of movement with bond yields. It's been a bumpy road. Since mid-March, high quality bonds have rallied substantially. So my question to you-- are bonds still back? And how do you see the current environment?
CHIP: Yeah, we do still see a great deal of value, especially in high quality fixed income. I do think in our view we have already seen the peak in yields. We think that shorter dated yields likely did peak back in March, the 10 year peak back in late October. So, that's to say that we do think that the broader overall trend from here is towards lower yields.
That's higher bond prices, right? But the trend from here is to lower yields. So one thing that I think that we are preparing ourselves for and staying very aware of is that as the fed continues its quantitative tightening, the reductions of its balance sheet, we also think that these large intraday, day to day bumps in yields, the swings in yields are going to continue. We expect volatility to stay elevated.
OSCARLYN: Will you take a second and just explain what quantitative tightening is for folks?
CHIP: Sure. Sure.
OSCARLYN: Because you said it quickly, and I think we all know what it is, but I just want to make sure everybody listening knows what it is.
CHIP: Yeah. So whereas the Fed was purchasing a tremendous amount of assets in support of the econo
my, they are now allowing those purchases that they made on their balance sheet to mature and roll off so that their balance sheet is going down. So it's the opposite of the support. They're actually trying to contain inflation, to cool demand a bit in order to create the opposite effect. That's what the Fed is currently undertaking. And we think that's going to continue, but we also know that is contributing to the volatility in rates that we are seeing.
OSCARLYN: Yeah. How about the 10 year from a valuation perspective?
CHIP: Yeah. As it stands right now, the 10 year is trading right in the middle of the trading range that we've identified between really 4% on the top end-- we lowered that top in a bit over the course of the past month. We think that it's going to be a harder bar for the 10 year to get back above that kind of 4% range or that 4 and 1/4% range we saw in October on the 10 year. And kind of the bottom end of the range in that around 3% to 2.75%, that would be kind of less compelling.
At that point, it seems like yields have probably moved pretty aggressively lower. But as it stands today, we are right in the middle of that range of the 10 year. So we wouldn't be extremely aggressive either way as far as intermediate yields are currently position to Keith's point, right? Where the 10 year is today feels somewhat fairly valued and suggest patience is probably a prudent way to approach.
OSCARLYN: Now that yields have fallen and you've talked about that and bonds have rallied, do we still see value in bonds?
CHIP: We do. We do. I think in particular, in the front end of the curve, I think it's important to note, yes, yields have fallen, right? We have seen Fed rate hike and now rate cut expectations affect the yields in the front end of the curve. They still remain very high. Relative to where we have come from over the course of the past 10 to 15 years, yields in the front end of the curve for passive income seekers, high quality passive income seekers, right, they still are at very productive levels.
I think that's important to note even where we are today to where we were just over a year ago is still very, very notable. So we do think that for those seeking individual security purchases, again, we would recommend keeping that bias towards high quality there. But although we have seen yields come down, they have not come down so much lately.
OSCARLYN: Chip, we talk a lot about treasuries, and I know you and I have talked about this. We talk a lot about treasuries, and treasuries are very important because they're kind of the baseline fixed income instrument that everything else measures itself by at the end of the day. But what are you thinking about investment grade fixed income and high yield fixed income?
CHIP: Right. So if we look at credit spreads, I think that this speaks to why right now, when it comes to investor grade but especially high yield, why we are patient in those spaces. And high yield being one of the places where we are most unfavorable right now in fixed income. If you look at where credit spreads are-- and as I mentioned, credit spreads, again, are just the extra yield that investors are demanding above US treasuries. The highest quality of US Securities.
What is the extra yield that they are demanding to enter those spaces? And right now, if you look at investment grade and high yield spreads that are up on your-
- up on the screen there, they're effectively at their 10 year averages. They're saying that there's not a lot of risk being reflected in those current levels. And you can see that relative to where those levels typically go around recessions-- and here we're showing '02, '08, and 2020. That's a long way to go.
That means that yield is moving much higher, therefore the valuation-- the value of those bonds is dropping potentially, especially when you get into these really dramatic spread widening events. So that is why we think that actually we may have some opportunities there, right? If we see the risks, more accurately reflect what we expect or if it aligns with the risk we're seeing in the economy, that would create an opportunity. But for right now we would be a little bit more patient in this area until we see that happen.
OSCARLYN: All right. Thank you. All right, Keith. Before we move on to questions that our viewers have given us to talk about at the end of this session, let's take a second and zoom out and put into perspective really our long term view. What's the long term picture? We talked a lot about tactical. And from a zoom out perspective, how are we seeing things in the long term?
KEITH: Sure. And we probably sound a bit more, I don't know, pessimistic than we have historically. Remember, we were extremely positive coming out of this. And I think longer term, we are optimists. Believe it or not, we are optimists on the economy. We think we'll get through this. But we also believe that there's a business cycle as well.
And by the way, when we say patience, that doesn't mean not doing anything. We still think investors should have a plan. They should stick with it. It just means within that plan, how aggressive you want to be. But as we look at, say, 5 and 10 years out, I mean, we think equities will do fine. We think earnings will eventually come to all time highs and stocks will come to all time highs, but we're just going through that part of the business cycle where things tend to be a little bit more challenging.
But also I think it's really important context. If we do have a recession-- and the average recession is about 10 months. The average expansion is over five years. So I just think that's important in context as well. And maybe I'll flip the script on you a little bit as well because I know you-- I think you just recorded your fifth podcast?
OSCARLYN: We did. We just recorded the fifth episode.
KEITH: "I've been meaning to do that." And I know as I was looking through some of the questions that came in, there was a lot of questions about retirement readiness. So I think, if I'm not mistaken, you just recorded an episode,
OSCARLYN: That's right.
KEITH: You want to share some of your thoughts on that?
OSCARLYN: That's correct. So we just finished our episode number five, and we had two Truist teammates, Tony, Brian, and Paul Shorter join me for a conversation about retirement readiness. And I won't give away the whole discussion, but we focused on non-financial and financial, and how both elements are really important as someone prepares for retirement.
We also focused on the journey three to five years out, and maybe what should that look like as we're fine tuning our retirement thinking. And lastly, I think one of the key takeaways for me was the thought of building a retirement liquidity cushion so that if you're retiring into a difficult market you actually have a liquidity cushion so that you don't have to draw dramatically off of your investments in the be
ginning. And what we find often with folks who are transitioning to retirement is that their spending the first few years often is elevated because they're wanting to remodel their home.
They may be buying a second or third home. They may be traveling the world. There are just all these great possibilities that appear as folks make that transition. And so that liquidity cushion helps in that transition. But would really just ask if folks have the time, please go out to either Spotify or Apple, also truist.com/dothat, do and you'll see the episodes. The fifth episode on retirement should be dropping next month.
KEITH: That's a great point. Having a liquidity budget really helps you get through it because it's not a loss until you have to sell it. So if you can get through that more difficult period--
OSCARLYN: It'll help if you have that extra cushion to kind of get you through so that you're not pulling dramatically off of the portfolio in a down market. Should the down market happen as the same time that you retire. All right, so enough of flipping the script there on me. I like to ask the question, but I don't mind answering too. But with that, Keith, you talked about it just a minute ago. We have been defensive in positioning.
OSCARLYN: What would it take for us to move more offensive with our-- more risk on within our portfolios? And several of our clients asked this, and I know our advisors are too.
OSCARLYN: So what would it take?
KEITH: Well, the first thing I wanted to say is when we look at markets, the future is unknowable. Right? We have a process and we look at the weight of the evidence, and the weight of the evidence has to shift. You have to have a heavy dose of humility, but we are really tracking the data. And as we meet in our strategy meetings, ask these gentlemen, and you are in the meetings as well, what I'm pushing a lot of is, what are our blind spots? Where could we be wrong?
And then adjusting it. One thing-- in our position, the most important thing is to be able to adjust and to be nimble. So one of the things we're looking at, one, going back to corporate profits would be important. Mike discussed the probability of recession being relatively high. Let's say that becomes less likelihood.
The other thing is I think one thing right now, why it's more attractive-- I mean, there's other attractive opportunities. If the Fed became much more aggressive than we thought and rates had come down substantially, then stocks start looking more attractive again. You get more in that there is no alternative again, which hopefully we don't get back to that. So I think those are things that we're looking for.
The other thing is markets can correct in price, meaning they come down, or they correct in time, which is normally what we seen where they just shop around sideways. You kind of let earnings catch up and you move through the business cycle, and that could be a healthy environment too. At some point later this year, the market will start to focus on 2024 earnings. I think it's a bit too early to do that. If that outlook starts to brighten up as well, that could have us change our view as well.
OSCARLYN: And certainly we'll keep folks updated. I know you're constantly communicating with clients and advisors as to our viewpoint there. Mike, let's turn to you. What's the probability that the banking stress that we've been experiencing becomes much worse?
MIKE: So there's a couple of different facets to it. One I already mentioned, which is some of the liquidity facilities that the Fed has offered these banks and lending institutions to try to provide a backstop. So that's one piece is they have the knowledge, or the-- we've mentioned scar tissue, but they have the knowledge and that playbook of what happened during the great financial crisis and during the pandemic that they can easily pivot and say, hey, we've got stress in the banking system.
We can either use these facilities, we can re-establish some of the facilities that were used during the great financial crisis, or make some new ones. So again, I think there's a number of different levels that the Fed can do. The other thing to understand, particularly with Silicon Valley Bank and Signature Bank among others, is that the system worked as designed.
MIKE: The regulatory system is not-- and I'm not here to be a shill for the regulatory system, but the regulatory system isn't to prevent bank failures. It's to prevent contagion, or problems with one bank filtering into other banks and then cascading the system. It's not set up to stop bank failures. In the average year, the typical year, we see three to five bank failures. Certainly Silicon Valley Bank and Signature Bank were larger, and they were two of the largest that we've ever seen. There's probably issues within regulatory that are going to get plugged.
We're hearing Congress, among other regulatory bodies, talking about increasing regulations and closing some of these holes. Certainly warranted. That said, I don't see the situation where that causes some sort of cascade. That said, we still think there's a business cycle, and as I mentioned earlier, the tightening, the natural tightening or even just leaning back of banks and borrowers does squeeze the economy some. You didn't ask about what would make me more positive.
OSCARLYN: What would make you more positive, Mike? (group chuckles.)
MIKE: But if you did ask that question, it would be jobs. And so that resilience within the labor market, well, it's easing some of the pressures, the extreme pressures where you couldn't find employees is that if demand hangs in there and you maintain the job situation, employment really is the linchpin. When people have a job, they maintain their spending, they keep paying their mortgage, they keep buying groceries, and doing those sort of things, paying their credit card.
All those sort of things. That really supports the overall economy and that maintains further jobs, so you get this positive spiral and you have a negative spiral. If you maintain job growth, that's a path through that we were maybe able to have some sort of slowdown here in 2023 as we expect. But it's certainly not as bad as some people expect in that you could see a kind of quicker recovery as we work through into 2024, back to Keith's point of we're going to shift here as we move through the year.
It's not just about 2023, it's about 2024. In my world talking about the economy, and Keith's world talking about profits and how businesses are going to deal with that. But that's certainly one of the things that would make me more positive on the US economy. My friend Eylem Senyuz he's my global counterpart, we're also seeing more resilience particularly in old time Europe, that the global economy is doing better than a lot of people expected. So that would be helpful as well.
OSCARLYN:Thank you Mike. So Chip and Keith, I'm going to turn to you both now and ask this question. Someone with a large cash position, so maybe a business owner who's just monetised and has a lot of cash. How does that client approach this time from an investment perspective?
KEITH: You want to start?
CHIP: You go.
KEITH: OK. The research actually says to plunge, to go in right away. But behavioral and also taking into the business cycle probably says you don't want to be that aggressive. We mentioned pause before. I think it's still important to activate a plan. What our advisors do, first and foremost, is set up a plan and figure out, what should that money do over the next 5 and 10 years? So it doesn't mean just sit on it and wait for that perfect opportunity.
I think even if you had let's just say a 50/50 portfolio, we think you need to put a decent amount of that to work right now. What that percentage number is, that's going to be with the advisor working with you to figure it out. That also you as-- how are you going to feel if you put money in tomorrow and the markets down 10% to 15%? Right now we're seeing stocks and bonds act like they should, meaning when the market has gone down, bonds have gone up.
So I would say activate the plan. And when we talk about the aggression side, let's say we put 2/3 of that money into the market right now. The other third you can wait and have a dollar cost average program being more aggressive on pullbacks, should we get those as well. And then I think, Chip, you and I have talked about some interesting strategies on the fixed income, even laddered portfolios I think would be--
CHIP: Yeah. Yeah. I think that with a cash position, if appropriate for that plan, as you say, I think that most investors could feel confident about the types of yields that are still available in the front end of the curve for productive assets there. In the context of that, we would recommend keeping it focused on higher quality at this point and look for opportunities. And then we were talking about, do we add duration? Do we go buy longer dated bonds that are more sensitive to moves and interest rates, for instance?
It's likely more fairly valued in taking a little bit more of a patient approach to that. But yeah, to your point, the strategy of the barbell, mixing the high productive yields in the front end with a little bit of intermediate exposure, for instance, to lengthen that duration, to get that investment rate sensitivity, but where yields are still productive. There can be a nice combination there as well.
KEITH: Yeah. If I can just add, also if some of those bonds mature-- I mean, if short term bond finance, if the market pulls back you can take some of that money and move it over to equities. We're going to try to provide more guidance as well within the context, again, going back to that long term.
OSCARLYN: All right. Thank you all very much. In closing, if you want to view the charts that we've shared with you today again and explore other visuals that we hope will help you understand the markets, Truist Wealth's monthly publication called the Market Navigator is available through your advisor or through truist.com. Our latest edition was published on April 5. In an environment where recession risk remain elevated, our message is to remain defensive and be patient.
That said, we want to emphasize the importance of adopting a long term view of markets and creating a diversified investment portfolio with an asset allocation and investment selection that is based upon a thorough understanding of your unique financial situation and goals. A Truist advisor can support you on your personal investment journey.
They will listen to you and will seek to understand your goals. They will help you put stressful market environments as well as potential opportunities into long term context, and together you can make prudent adjustments to your investment strategy while keeping your long term wealth objectives in mind. Thank you for trusting the Truist team to be part of your financial journey.
And lastly, I have one more request. Our aim with this webcast is to create an exceptional virtual experience for our clients. In a few seconds a survey will appear in your Webex screen. Please take 30 seconds to complete it and to give us your feedback. Your opinions will help us shape our future events. With that, thank you again, and we look forward to talking with you in July.
April 11, 2023
We wanted to share our recent webcast. Truist Wealth’s Investment Advisory Group’s experts deliver their latest analysis and perspectives on the economy and capital markets. The discussion will include:
Please access our most recent Market Navigator for more details.