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Weekly Investment Commentary: Add structure to your portfolio
Bottom line up top:
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Markets peer beyond the fog, but the forecast remains cloudy. Both U.S. public equities and fixed income markets rallied in the opening weeks of 2023 as the disconnect between market expectations and the U.S. Federal Reserve rhetoric continued. The S&P 500 Index has reached price levels not seen since August 2022, while the Bloomberg U.S. Aggregate Bond Index added 3% in January. We remain more constructive toward fixed income thanks to sound fundamentals, higher yields and an improving rate environment. The recent equity market rally was bolstered by promising economic data that led the Fed to reduce the pace of its rate hikes and forced Chair Jerome Powell to acknowledge signs of disinflation. This is welcome news. Equity markets seem to insist on pricing in a best case scenario for a soft landing and policy pivot in 2023, despite the lingering and potentially risky downside.
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Lower and slower or higher and longer. The Fed is likely to hold rates higher for longer, until it is either satisfied that inflationary pressures among housing and wages have subsided, or the toll inflicted by 400-plus basis points of rate hikes becomes too painful. Consensus estimates still call for a recession, albeit a mild one, through the middle of 2023 (Figure 1). This view is supported by last week’s Institute for Supply Management’s Manufacturing PMI, which fell in January to 47.4. Since ISM’s inception in 1948, new orders have only been this low immediately before or just after entering a recession. For the S&P 500, earnings growth estimates in 2023 remain positive and continue to trade at the same valuation levels as when the fed funds rate was targeting 0.25% to 0.50%. Going forward, investors must balance the risks presented by current valuation levels and decelerating economic growth. We believe recession resilient asset classes including infrastructure, warrant consideration.
“We remain more constructive toward fixed income thanks to sound fundamentals.”
Portfolio considerations
In the near term, for clients and their portfolios, the best offense is a good defense and defensive positioning across equities, including in U.S. public infrastructure. This sector tends to be well insulated from the higher costs of rising rates and heightened inflation. Inflation continues to decline and has fallen by 2.6% since June of last year, although we expect the next 2.6% drop will be much tougher than the first. Inelastic demand for the essential services that infrastructure provides could also buffer the asset class from an economic slowdown. (Figure 2).
Within U.S. infrastructure, we prefer waste management, midstream pipelines and utilities. For utilities, U.S. oriented operations and a supportive regulatory environment provide a degree of protection from geopolitical threats and enable some of the increased cost of capital and inflation to be passed on to the consumer. The passage of the Inflation Reduction Act in 2022 makes green energy spending even more attractive. The legislation made deploying and financing renewables significantly cheaper, permitting acceleration of capital expenditures.
As the world relies more on U.S. energy resources, midstream pipelines are poised to benefit from the escalating challenges of scarce global energy. Most contracts have a fixed fee, with escalator, that allow revenues to increase in tandem with inflation. Waste management companies should deliver above-market growth thanks to unwavering demand for their operations that convert to pricing power. These high quality operations should generate predictable cash flows during an economic slowdown.
“Waste management companies should deliver above-market growth thanks to unwavering demand for their operations that convert to pricing power.”
Nuveen’s Global Investment Committee (GIC) brings together the most senior investors from across our platform of core and specialist capabilities, including all public and private markets.
Regular meetings of the GIC lead to published outlooks that offer:
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macro and asset class views that gain consensus among our investors
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insights from thematic “deep dive” discussions by the GIC and guest experts (markets, risk, geopolitics, demographics, etc.)
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guidance on how to turn our insights into action via regular commentary and communications
Endnotes
Sources
All market and economic data from Bloomberg, FactSet and Morningstar.
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