Patient investors will be rewarded in 2023, as markets should be less volatile and there is no need to return to the “era of free money” to have a more constructive investment environment, according to Columbia Threadneedle investment managers.

Three investment managers with the firm representing macro, equities and fixed-income perspectives today presented the firm's 2023 market outlook in a webinar they titled “Are We There Yet?”

“If ‘Are we there yet?’ is are we getting back to an era of free money, of peak valuations, then no, we’re not there yet, and we do not expect to get there either,” said William Davies, global chief investment officer at the Boston-based firm. 

More realistic, the firm's managers said, is imminently getting to a period where there is more stabilization in terms of interest rates peaking.

“And boy, that would be so much better than the environment that we’ve seen in 2022, when it’s been a race to predict how high rates could go and how quickly they’d get there,” Davies said.

Coming off the “tumultuous year” of 2022 and presenting a macro view of the investment landscape, Davies said he expected inflation to remain high but falling, interest rates to stabilize, Covid-19 to normalize in the West (but not necessarily in China), an economic slowdown that flirts with recession, and supply chains and labor supply to start recovery.

Within that framework are opportunities for investors that weren’t present this year, they said.

Gene Tannuzzo, global head of fixed income, said that 2022 was a transitional year in the movement from low- or zero-interest rate borrowing to much higher interest rate borrowing. The market volatility in response to that transition, however, is now over.

“We’re already adapted to a higher interest rate regime, we’ve already adapted to a higher inflation regime, and what we heard from [Fed Chairman Jerome] Powell yesterday is while the evidence might be early there is building evidence that inflation pressures are coming down,” he said. “And there’s also evidence that the lag effects of monetary policy will begin to impact economies in a way that we haven’t fully recognized in 2022.”

It’s rare, Tannuzzo said, for returns from both duration (pegged to the Bloomberg 7-10 Year U.S. Treasury Index) and credit (pegged to the Bloomberg U.S. Corporate High Yield Index) to be negative at the same time, but in the first and second quarters of this year, that’s exactly what happened. The third quarter saw credit returns become positive, he said.

Deceleration of inflation, the resolution of supply chain bottlenecks, a drop in goods pricing and the slowing of manufacturing and housing construction are all things that should help duration returns, he said.

“On the credit-sensitive side, we’ve now built in a risk premium for volatility and for volatile events. So even if we have a mild recession, you now have a risk premium that is now double what it was a year ago, and you can withstand the volatility and produce better returns,” Tannuzzo said.

The investment grade bond market is particularly attractive, in both Europe and the U.S., he said.

“If I start with a 5.5% yield and I build on maybe a little bit of price appreciation, it’s not a difficult forecast to get to a modest double-digit return in an investment grade asset class,” he said. “And starts to look very, very attractive. But investors are going to have to focus on those higher quality balance sheets with sustainable cash flows that can weather economic volatility ahead.”

Melda Mergen, global head of equities, said companies felt two major impacts of the inflation and interest rate increases in 2022. The first impact was the suppression of valuations, as current cash flows are more valuable than future cash flows in this environment.

The second impact was on a company’s business model, where questions arise as to whether a company can sell as much as it did before, customers can continue to buy, and margins can be maintained in the face of an increased cost of doing business, she said.

“Even if the interest rates stop rising, they will be much higher than what we’ve experienced recently,” Mergen said. “That gets translated into really looking at each company and individual sectors’ ability to navigate through this time period.”

Columbia Threadneedle’s earnings estimates for 2023 are that the U.S. will be more resilient than the rest of the world, coming in at around its historical average despite slowing GDP and a possible recession, she said. But with P/E ratios remaining high, value stocks remain preferred over growth stocks.

“This doesn’t mean we shouldn’t invest in growth companies, there are still a lot of sector trends that carrying over and will create a lot of opportunity for the growth companies to continue to deliver earnings and returns for our clients,” Mergen said. “But it’s not as easy as it used to be.”