On-Demand: Wealth Management Economic Impact Webinar Series | Q1/2023- Economic Update
January 26, 2023
Join EisnerAmper Wealth Management and J.P. Morgan for an in-depth analysis of today's economy and the factors shaping economic outcomes as we dive into 2023.
Wealth Management Economic Impact Webinar Series
Before we get going into our prepared material, I just wanted to spend a moment to talk about who we are for those of you unfamiliar with the wealth management practice and corporate benefit practice within EisnerAmper. So, from a 30,000-foot view, we are a practice within the firm that works with both individuals and business clients to help them achieve what we call their one best financial life. Taking the time to understand what's important to them, why it's important to them and their families, and if they're a business owner, helping them attract, retain, and reward talent.
We will also for the business owner need to discuss for today to look at preparing for an eventual business succession, or exit, and construct the plan from a truly comprehensive standpoint. As we like to say, we plan for where life intersects with wealth. As our mission statement shows, we are committed to helping our clients navigate through all the risks and opportunities they may face in looking to achieve their life and or corporate goals. We look to foster an environment to inspire trust and confidence through all the facets of the services we provide through our planning process. So, how do we do that? Well, we've developed a trademarked planning process for both individuals and businesses, starting with helping our clients understand how they think about money, their approach to spending, and how that impacts their decisions and potential outcomes based on the resources they have available to themselves.
Next, we help them to identify and prioritize their values and their goals, what's important to them, what are they looking to achieve? This ensures that we leave no stones unturned when we build the financial game plan for them, whether they're at accumulation phase, still working, or distribution phase and retired, making sure that we have a plan in place not only to help protect them, but to also help them achieve their goals in the broadest range of circumstances. At the end of the day, our clients simply want to make sure they're going to be okay and that they've lived the life that they've envisioned. So, that ties into what we're going to be covering today related to the market economic outlook for 2023. So, today, we'll be discussing the economy and the various factors out there today that can have an impact on it.
So, we're all aware of Jerome Powell and the Federal Reserve working diligently to lower inflation by, I would say, interesting techniques and approaches. Unemployment plays a role, wages play a role. We will touch on obviously the recession talk that's out there. Has the market already built it in? Are we headed for a soft landing? We'll talk about areas of market growth, and also how current sociopolitical and geopolitical events are shaping the markets and the economy. Obviously, referring to the Russia, Ukraine conflict, our own domestic midterm elections, China's no COVID policy lift, and most recently we've all been reading about the debt ceiling. So, it is my privilege to yes, introduce once again our guest speaker today, Jordan Jackson. He is a global market strategist from J.P. Morgan, one of EisnerAmper Wealth Management's strategic partners, and just a little bit about Jordan before I pass it over to him.
Jordan's been in the industry for close to a decade now. He has spent most of his career, entire career actually at J.P. Morgan and asset management. He began on the institutional side, then moved over to global market strategy with a focus on fixed income and global monetary policy. He is a frequent guest and speaker on Bloomberg, CNBC, discussing markets and the broader economic impacts, which will really be the subject matter of today's call. Just on the personal side, Jordan's recently a new dad with a 13-week-old, and is experiencing the not surprising sleep deprivation period. So, welcome Jordan. Thank you so much for joining me today, and hoping you got at least a couple of hours of sleep last night.
Jordan Jackson: Well, thank you so much for the introduction, Larry. Our baby girl journey actually gave us four and a half hours of sleep last night, and that's great progress. So, you guys are going to get the bright-eyed and bushy-tailed Jordan today.
Larry Seigelstein: Sure.
Jordan Jackson: But, thank you for that introduction, and I think that was a great setup to the conversation and dialogue today. And the timing of this webinar is actually almost spot on. We just received fourth quarter GDP numbers this morning. And so, we have a better sense on how the economy rounded out 2022. As Larry mentioned, when the Federal Reserve meets for their first policy meeting of 2023 next week, and so we're going to hear from Jerome Powell and hopefully get a sense of the trajectory of where monetary policy is headed. And, of course, of the next few weeks we are going to be in the thick of the earning season.
So, days like yesterday where markets were certainly a bit choppy on earnings reports, we're seeing maybe a bit of a bounce back on various earnings as are being reported today. So, again, I think great timing for the webinar. We're going to cover a lot. So, let's jump right into the content. Just to level set, we're going to be referencing slides from our guide to the markets. This is our flagship publication that has about 80 pages covering the economy, equity markets, fixed income, international markets, a bit of alternatives, as well as broader investing principles. So, we're going to be leveraging a truncated version of that broader guide to really bring home the key messages we think that helped round out 2022, but also provide a better perspective in investing for 2023.
So, to kick things off, just to start with U.S. growth. So, 2022 was certainly a year of two halves. On the left-hand side of this page, we just saw real GDP growth going back over the last 20 years, and then we highlight that trend growth rate of around 2% in the U.S. economy. We show in that table to the top left, your last four quarters of economic growth on a quarter over quarter as well as the year-over-year basis. And then, on the right-hand side of this page, we show the big components in GDP growth. If you can think back to your economic textbooks, growth equals N plus X plus C plus I minus net exports, so we'll talk a little bit about what's driving growth? But again, as I mentioned, it's really been a tale of two halves. And so, the first half of the year you saw a bit of a contraction in overall GDP growth.
You can see the first two quarters down 1.6, down 0.6% quarter over quarter. The second half of the year was very much of a different story. We saw growth bounce back in the third quarter, rising 3.2% quarter over quarter, and just this morning we see the first estimate of fourth quarter GDP coming in at a pretty robust 2.9% quarter-over-quarter seasonally adjusted basis. So, what that means is, even though we had a contraction in the first half of the year, the year-over-year numbers, so 2022 growth over 2021 growth allowed a roughly positive 1% growth rate. So, again, what we're seeing now is some pretty strong momentum coming out of the year, but we're seeing some signs that growth is actually slowing. And the reality is, there is a number of breaking pressures that are being applied to the economy today.
Now, if we look at the right-hand side and walk through some of these components of broader economic growth, you first, if you think about the housing market. Actually, when we look at fourth quarter growth, the housing market actually contracted by about 26% quarter over quarter. Again, this is a large part of reflection of the move higher in mortgage rates and really most of that contraction being confined into the construction part of the housing market. And so, if you consider the idea that mortgage rates are now more than double where they were at the start of 2022, this is really decreased overall housing affordability, and as a result we've seen overall construction activity really slow. We think this dynamic continues as mortgage rates continue to float around the six and a half, 7% range over the course of 2023.
Now, if you think about investment X housing, so this is business spending. In an environment in which our earnings are very volatile, companies are dealing with higher cost pressures, they're dealing with higher wage pressures. We're actually anticipating earnings to contract over the course of this year, and we're going to talk a little bit about that. It stands to reason that investment spending, so companies investing in new projects and initiatives is likely not going to be as robust. And I also highlight that this seems to be the majority of CEOs are projecting a recession. And so, of course, in an environment in which business leaders anticipate a bit of slowing in the economy, they're going to be slow to put capital to work. Now, we talked about government spending. The reality is, we're dealing with the debt ceiling, so we're not necessarily issuing any new debt from the government and I'd certainly argue that we're likely not to see any additional fiscal spending coming from a divided government. And so, we could see government spending remain fairly weak.
And then, lastly, when we think about net exports, the value of the dollar though it has fallen over the last couple of months is still quite high, and that has a X as a bit of a headwind to our export business from a trade standpoint. So, you put all this together, it's really the consumer that's likely going to continue to drive economic activity and clearly it's the largest share of overall economic activity. And when we think about the health of the consumer, that really hinges right on the labor market, and the labor market more or less is tied by a number of different metrics.
Also, when you think about roughly 66 million Americans are going to be receiving one of the largest adjustments in their social security payments that have just started this month, roughly 8.5% increase in their social security payments given the elevated inflation that we saw over the course of last year. So, you've got a bit of support, hidden consumer balance sheets. Also, the extension of not payments of federal loan, student loan payments. That's also going to be extended to the middle of the year. I think you put all this together, this is just that the consumer is sort of bending but not yet breaking. And so, our anticipation is slower growth. It's still a tough call on whether an outright recession materializes, but we're starting to see more evidence that maybe a soft lending is actually possible over the course of 2023. I know we're going to start off with the polling question, so I'll turn it over to Larry.
Larry Seigelstein: You got it Jordan. So, polling question number two is, how do you feel about the state of the economy heading into this year 2023? Are you optimistic? Do you have no feeling, you're neutral, or are you pessimistic?
Jordan Jackson: Very interesting results. So, we've got about close to 50% are fairly neutral on the economy. About 36% are outright pessimistic on the economy, and then you've got about 15% that are optimistic. And so, I think we'll talk a little about more in depth about the recession probability, but I would follow in the camp of more neutral. As I talked about, it's still a tough call on whether the economy dips into a recession. There are obviously risks in terms of the Federal Reserve and raising interest rates to try to curtail demand in the economy, but it does seem like the consumer, particularly the excess demand for labor can keep the dynamic, or at least the overall economic activity a positive over the balance of the year. Now, how do we know that we're in a recession? What's going to be that definitive, this is the sign that the economy is contracting?
Now, I think in the middle of last year everyone was clamoring and saying that we were in a recession because we had that two quarters of negative GDP growth back to back. But, for us, we subscribe to the National Bureau of Economic Researchers' definition of a recession. Now, the NBR are historically the official scorekeepers of the U.S. economy. They've been around for about a century now, and so we think they know how to do their jobs. But, they look at, they don't just subscribe to two negative GDP quarters, but they look at these six key variables that we show on this page in determining whether the economy is contracting or whether the economy is expanding. Now, on our group, we like to use heat maps, because we think visually it's much easier to tell the story.
If you were to rewind the clock back to March and April of 2022, looking at those six variables, and those six variables are real personal income, less transfers, less government transfers. So, removing out the fiscal stimulus that the federal government provided to consumers. Looking at employment data by way of the non-farm survey and the household survey, looking at spending data, real consumer spending as well as real institutional spending and then industrial production. Those are the six key metrics that they tend to look at.
Now, again, if we rewind the clock back to March and April of 2020, the pandemic recession, you can see the deep red and all those six variables, that deep contraction, the quickest and steepest contraction in the economy that we've seen on record. But then, you can see that V-shaped recovery coming out of the pandemic, that bright green that all these indicators were flashing as we saw significant, both monetary as well as fiscal stimulus hit the economy. Now, as we move to the far right-hand side of this page, you're starting to see colors that look a bit like my front lawn, tinges of yellow, some beige. Unfortunately, we've got some outright contraction in industrial production, but we don't think that we are outright in a recession just yet.
As I talked about, there's still some pressures that are being applied to the economy. When we look at the bottom half of this page, we actually show the trailing six-month change in these variables, and you can see as of the end of last year, four out of the six variables are still flashing in positive territory. So, we don't think we're in a recession just yet, but we certainly acknowledge that those risks still are out there. And this will be a great chart to keep your eye on as the year goes on to determining if the economy is indeed in a recession or if we are still expanding. I want to take some time to talk about the labor market, because that has really an earnest span, a bright spot for the U.S. economy.
In this chart here we're looking at the unemployment rate. We'd like to show as much history as possible. We're showing the unemployment rate going back over the last 50 years or so in gray, and then the blue line, we show wage growth. And we like to use this series private production and non-supervisory workers. In simple terms, this represents about 80% of the U.S. workforce and they are your typical clock in and clock out workers. So, it's much easier and I think a cleaner measure on how to calculate actual average wage growth. Now, you can see the unemployment rate at 3.5% as of December, that matches a 53-year low in the unemployment rate. But, interestingly, while we would've assumed that this very tight labor market was going to see wage growth continue to accelerate, we're actually seeing signs that wage growth is in fact cooling off. And I think there's a couple of reasons why that's the case.
I think the first is somewhat psychological. As I talked about, a growing chorus of CEOs and business leaders are calling for a recession. Now, if an employee steps into their office and says, hey, I'd like a wage increase, and I think the response would be, well, the economy is coming under a lot of pressure. We're not really heavily investing in various projects, and so unfortunately we're not going to be able to meet that wage increase. So, I think that's some of what's happening. I also think the bargaining power of the American working age population is somewhat less given the decline in overall union membership. You think 30, 40 years ago it was the union going up against J.P. Morgan, not necessarily Jordan Jackson going up against J.P. Morgan. So, I think that's hurt some of the bargaining power amongst the American consumers.
And then, I think lastly, there's been a massive or big divergence between the demand for labor amongst smaller medium sized businesses as well as relative to their large counterparts. We've seen headlines around large tech companies, even some large financial companies, and even more so in real estate announcing layoffs. Job freezes or outright layoffs. But, when I travel across the country speaking to small business owners they're claiming for labor. They can't hire workers fast enough, and they're struggling to find that qualified labor. So, I think what this means is that, we could continue to see wage inflation numbers come down, but I actually think wage inflation's going to be still run at above that roughly 4% long-term 50-year average wage growth rate or at least over the first half of this year. And so, I think this is something that the Federal Reserve is certainly watching for.
They're worried about what we would call a wage price spiral and in that environment, super low unemployment, excess demand for labor, that keep wages elevated. If individuals are lobbying for higher wages, companies will feel like they need to charge more for their businesses and for their products and services that they're producing, and that might potentially keep inflation elevated over the course of this year. Again, we're not seeing signs of that wage price spiral happening, we're actually seeing wages decrease, but I do think it is a concern from the overall Federal Reserve. So, labor markets are tight, a positive sign for the economy. Now, let's talk a bit about corporate profit margins. The left-hand side is just looking at the S&P 500. So, these are the largest 500 companies in the U.S., and this is again looking at quarterly operating earnings or profit margins going back over the last 30 years or so.
You can see as of the far right-hand side of that chart, profit margins have come under pressure, and in large part what's been driving that has been higher wage costs. Companies having to pay up to attract that additional worker and higher input costs. If you think back a couple of quarters, supply chains was the buzzword, and companies were struggling to get goods across their borders. That was causing, again, higher costs across businesses. And we do think these dynamics are likely going to continue to persist to a certain degree over the course of 2023, which continues to threaten margins. And I think the right-hand side of the chart certainly highlights the challenges from a margin perspective. Now, the blue line on that right-hand side chart shows the net percentage of companies that plan to increase their prices over the next three months. The green line shows the net percentage of companies planning to increase compensation, so having to increase their labor costs. But, the challenge is, if you look at the gray line, that's the net percentage of companies expecting higher sales or higher revenues.
And so, you're in this dynamic in which companies are more or less expecting that top line revenue growth is going to struggle, could very well struggle, but they recognize that they're going to have to continue to pay more in wages and in order to try to protect those margins, they're probably going to have to charge more, a bit for prices. And so, this is something that the Fed, again, as we've talked about, is worried about. They're worried about the companies committing to try to protect those margins. They need to report to shareholders, and so on a quarter over quarter basis. And so, they may feel incentivized to try to protect those margins and lay off workers to try to keep their costs low. But again, this is certainly a challenge that we think certainly threatens the overall earning story as we look ahead towards 2023.
Now, to firm up some of that earnings story. If we look at the left-hand side of the chart, we still think that earnings are a bit optimistic when we think about the dynamics at play in the broader economy. If you look at the left-hand side chart, this is just to look at annual operating earnings, the top line earnings for the S&P 500. The blue bars show the consensus analyst estimates for where they expect earnings to go over the next three months. And so, that first blue bar is 2022 numbers. If the fourth quarter numbers are realized, we're actually expecting a roughly 4% contraction in earnings growth over the course of 2022. But, look at that big step up into 2023. Analysts are still expecting a roughly 11% earnings growth for calendar year 2023. Now, I've talked about some of the challenges in terms of margins, margins impacting earnings, and also slower growth in the economy. That's likely going to weigh on earnings as well.
And, if you look at the right-hand side, if you are an equity analyst, you probably really don't like this chart. Because, what this essentially says is, how effectively wrong you've been over the course of, in terms of forecasting earnings growth. That right-hand side chart just looks at the average that analysts tend to either over or underestimate earnings in a given calendar year. And this is looking at data going back over the last 25 years. So, I want you all to focus your attention to the fifth bar from the right-hand side, that 5.5% bar. What that effectively is saying is that, on average analysts tend to overestimate calendar year earnings by about 5.5% at the start of that given calendar year. And so, let's paint this picture. Analysts are now expecting 11% earnings growth for 2023 at the beginning of this year.
Historically, they tend to overestimate by about 5.5%. So, now you go from 11% down to let's call it a 5% number. If we take in the regulatory and legislation, there's the inflation reduction act. And, the way that's going to generate revenue is a 15% tax on profits above a billion dollars, and a 1% tax on share buybacks. Now, we think this is going to impact directly roughly about 17% of S&P 500 market cap, and that should shave off about three percentage points to earnings growth over the course of 2023, or could shave off 3% over the course of 2023. So, now you go from 5% down to roughly 2%. Now, if we're talking about, again, earnings in a year in which growth is expected to slow, consumers are expected to come under a bit of pressure, margins are still going to be a challenge, the dollar continues to be high, and so they've got a lot of multinational companies that have businesses all over the world, and so a higher dollar actually acts as a headwind to those reported earnings back into the U.S.
I know a lot of accountants on here probably are familiar with some of those adjustments. All of those pose a bit of a headwind to these optimistic earnings per share estimates. And in our view, we think earnings have to come down to the tune of closer to around down 10 to down 15% earnings growth for 2023. Again, not saying that is what will materialize, but that is what we are currently anticipating for earnings growth over the course of this year. And we do think this is going to add a bit of volatility in markets over the near term. And, it seems certainly markets are trading more in the micro, which is not surprising over the next couple of weeks as you get earnings report, but we certainly acknowledge that we'll start to see those revisions happening as companies continue to deliver a bit on that forward guidance for this year.
Now, really quickly, I want to talk a bit about inflation, and we do think that the inflation heat wave that we've experienced over 2021 and 2022 could cool off over the course of 2023. Now, again, this is another heat map, pretty busy, so we'll take this one fairly slow. But, what we've done is, we've bucketed inflation in four broad categories. You've got energy inflation towards the top of the page. You've got food and core goods inflation towards the middle, and then you've got core services inflation at the bottom of the page. Now, what was really the buzzword in the first half of 2021, it was supply chains. And supply chains really impacting core goods inflation. And so, if you look at the first half of 2021, you can see that red coloring in the core goods parts of the market, things like new vehicles, used vehicles for an example, really contributing to some of the higher inflation over the first half of 2021.
Then as you move ahead towards 2022, of course, you have the early in the year, you had Russia's invasion of Ukraine and that really impacting energy inflation, food inflation as well, and those prices continue to run fairly elevated over the course of 2022. Now, as we round out the year, what's really been driving these high inflation prints has been core services, and in particular shelter inflation. And I really like that we actually include the weights of all these different components in the headline CPI basket. You look at shelter effectively accounts for about a third of overall headline CPI. So, you can see that sea of red down to the bottom right-hand side of this page, again, showing that core services inflation is running pretty hot. The big challenge is the way that the BLS calculates the CPI numbers.
There's a really long lag between realized home price movement in the economy and how that filters into the broader CPI calculation. And so, we don't think shelter's inflation really begins to peak out until the end of the first quarter, call it March, April of this year, before we expect shelter inflation to begin to roll over. On balance, we've got inflation that ended the year at about a 6.5% year-over-year rate. We're now calling for a year end 2023 inflation number of between two and a half to 3%. Still above that of what the fed is targeting, but we're still seeing signs that energy inflation is coming down, core goods inflation is coming down, housing inflation should turn the corner again sometime in the end of the first, beginning of the second quarter, and all that should allow for disinflation to come through the inflation prints that we're seeing, and that's our expectation as we move over the course of this year.
Jordan Jackson: Now, we've got another polling question.
Larry Seigelstein: Jordan, before we get to that, there are questions that are coming. I wanted to address that and we'll get to the polling question in a moment. Somebody's just asking again, clarification on a point you made, J.P. Morgan's expectations. Obviously we don't know exactly what's going to happen. As you'd said, there's not a crystal ball for 2023 corporate earnings. He wanted to clarify, as you said, down 10% from analyst expectations of 11% growth, or if you could just clarify that one more time if you don't mind.
Jordan Jackson: Sure. So, we anticipate that earnings for 2023 will contract for the S&P 500 by about 10%. That's our expectations. That's actually a little bit better than what earnings tend to contract in a broader economic recession. We historically we'll see earnings contract by about down 25 to down 30%, where we anticipate given the pricing power that companies still have, that earnings will contract by about 10%. The challenges of markets or analyst estimates are still calling for modestly positive earning growth, and so we think there needs to be a bit more revisions that need to happen in order to accurately reflect some of the downside risks to earnings.
Larry Seigelstein: Thanks, Jordan. Now, we get to the question that people seem to be clamoring for. Polling question number three, what are you most interested in when thinking about economic impact? One, the impact on my investment portfolio. Two, the impact on my business. Three, the impact on prices and inflation. And, D, something else. Now, while they're doing that, Jordan, I had a question for you that came through that people were asking about based on your previous slide, what is expectation on consumer products like gasoline and eggs and things such like that?
Jordan Jackson: Well, I think gasoline prices, they've actually started to rise modestly over the last couple of weeks, but now I think the national average will stay below $4 a gallon, and so I don't think you'll see a lot of movement in overall gasoline prices. I think from a food perspective, to a certain degree, I do think obviously weather and climate challenges have continued to persist and that impacting the food dynamic. But, reality of food prices were, broadly speaking, were very elevated over the course of 2022, and I think the natural progression of prices on a year-over-year basis, we could see food prices actually beginning to decline over the course of this year, which surely would be welcome. As we think about eggs, I was chatting with a financial advisor and they said that, for Easter this year, they're going to be painting potatoes instead of painting eggs, because the price of eggs have gotten so expensive.
Larry Seigelstein: Fair enough.
Jordan Jackson: Thought that was funny.
Jordan Jackson: Interesting. So, we've got about 53% that are interested about the impact on their investment portfolio. About a third are concerned about the impact on prices and inflation, 11% the impact on my business, and about 4% something else. And so, I think the broader group is concerned about my investments, retirement accounts, personal accounts. And so, we're certainly going to talk more in depth about certainly what a challenge 2022 has been from the investment perspective, but also some of the opportunities that we're seeing going forward.
Now, I want to start off to talk a little bit about the Fed. And again, the timing of this meeting is pretty appropriate given that the fed meets next week, but what we're showing here on this slide is the federal funds rate. So, the Fed's primary interest rate tool showed that rate in the gray line, so the historical rate, but I think what's really important and interesting is, if you look at the dotted line to the right-hand side of the chart, the blue diamonds show what the fed is currently calling for, what the fed expects, that fed funds rate to be over the next three years.
This is as of their December meeting, so as at the close of last year. And then, the green diamonds are showing what the markets are currently pricing in. And what's most fascinating to me is that, even as you've had various feds governors speak over the beginning of the year, and they more or less continue to talk tough on inflation and seem committed to at least lift rates to 5% or slightly above 5% and keep rates there for the duration of 2023, markets just aren't buying what the fed is selling. Markets are saying that, the fed will be able to get maybe two more rate increases, 25 basis point rate increases over the first half of the year, but then the fed is going to have to make a complete roundabout and actually start cutting rates or reducing the federal funds rate over the second half of the year.
And again, this is even amidst as fed governors have continued to push back against that notion. And so, what I expect to see is, or I guess, the question is, who's right? Well, what the markets are currently anticipating is, or maybe not a soft landing, but maybe a bit of a hard landing. And as a result, the fed is going to have to start cutting rates. The fed is trying to communicate that the economy is headed for a soft landing, and this will allow the fed to keep rates relatively elevated before they need to cut rates over the course of 2024. The challenge that I really have with that backdrop is, if you look historically, the fed tends to take the escalator up, but the elevator down. The challenge is, the fed took the elevator up with rates over the course of last year, but if the economy comes under pressure and the fed needs to cut rates, they're likely going to take the elevator right back down.
And so, I think even the rate cuts that are pricing to the market, if the economy dips into recession, are probably aren't accurately capturing just the speed at which the fed is going to have to cut rates. But, with all that being said, I do think that the fed's probably got the ability to hike rates once, maybe twice. And so, I think they'll go 25 basis points next week. There's a bit of a question mark on whether they'll be able to go again in March if we're seeing signs that inflation is really coming back down to Earth. And so, the reality is, the fed might, they'll be able to do a bit more, but they're in the ninth inning of this ballgame. They're in the ninth inning of this rate hiking cycle. And the reality is, the next move from the fed is likely going to be rate cuts, but we should acknowledge that they've done a significant amount of tightening.
This is the fastest the fed has tightened policy rates since the Volcker era tightening, since 1980. So, they've been very aggressive here over the course of 2022, and now as a result, that brought a significant amount of volatility to the stock market as well as the bond market over the course of last year. Now, I think this is a great slide, because it really shows just how difficult a year like 2022 was from an investment standpoint relative to really the last 70 years. We actually have taken this back all the way back to 1950. And, what this chart is showing is the annual calendar year return on a 60, 40 portfolio. So, 60% stocks, 40% bonds. We've decomposed that return. The green bars show the equity return on that 60, 40, then the gray bars show the fixed income return on that 60, 40. Take a look at 2022. 60, 40 portfolio down by about 16% on the year.
You've got to go back to 2008 in order to get a return year that bad on a 60, 40. And you've got to go all the way back to 1974 to get a year in which both stocks and equities or bonds, and bonds were down similar to what we saw last year in 2022. So, again, a very challenging year. Encouragingly though, you have started to see both bonds and stocks begin to rebound at the beginning of this year, and I think a lot of that has hinged on the idea that, again, the fed is closer to the end of the hiking cycle than they are at the beginning. Remember, bonds don't like higher rates. The inverse relationship between bond yields and bond prices, higher bond yields, lower bond prices, and stocks don't like higher rates. And the fed was very much increasing rates over the course of 2022 and that really spooked overall bond and stock markets. We're going to hit this next question, so I'll pass it back over to Larry.
Larry Seigelstein: Thanks, Jordan. So, we're polling question number four, final one, which do you think will perform better in 2023? Stocks, bonds will perform equally, or you just have absolutely no clue? Jordan, while we await the results, there is a question that came that I wanted to ask you. And I think it's pertinent going back to polling question number three where we talked about 53% are currently concerned about their investment portfolio. So, on the previous slide that you had, we look at a traditional 60% equity, 40% fixed income portfolio. Is that something that's a dead strategy or you feel it's something that could be coming back?
Jordan Jackson: Well, we'll certainly talk about this. But, because you've been in an environment in which both equity sold off and bonds sold off, valuations look pretty attractive or look a lot more attractive in both parts of the market, and really even more so on the bond side of things. I would go as far as to say, well, I won't give away my thoughts around this polling question, so I won't say, but we're just seeing evaluations look a lot more attractive on both sides. So, I don't think a 60, 40 is dead. Maybe it died over the course of last year, but it's been revived as from an investment perspective, on a look forward basis, given that big reset in valuations.
Larry Seigelstein: Got it. Thank you. Bella.
Jordan Jackson: So, we've got 35% that think stocks will perform better. 28% that think bonds, 10%, 11% think will be equal, and about a quarter that says, I don't know. Well, I'll go as far as to say that I'm going to be more in line with that 28% that think bonds will perform better than stocks this year. And I'll try to make the case on this slide here. And again, as I talked about, valuations have really improved across the board. If you actually look at what we're showing here is a Z score. And what that means is, the standard deviation of valuations away from the long-term average. So, where average levels of evaluations have been over the last 20 years, how far away you've been. So, if you're above that line of zero, you're expensive. If you're below that line of zero, you're outright cheap.
Now, the first point I want to make is, the green diamond show where these valuations are as of the beginning of 2022, the brown circles show where these valuations are currently trading. The first thing I would look at is, look at the change, look at the spread between those green diamonds and those brown circles. You're talking about roughly two standard deviation moves in places like U.S. growth stocks to the far right-hand side, U.S. large cap stocks as well. But, even more so in areas like treasuries, which are to the far left-hand side and core bonds. And when you think about what's outright looks cheap, it's bonds, it's treasuries, it's U.S. core bonds, it's municipals. These parts of the market look outright cheap where equities, although they have cheapened a lot, are still somewhat expensive relative to their long run average.
So, let's talk about both sides of the equation. Well, as you think about the stocks, certainly I think markets will be a little bit choppy over the medium term, but if you think of keep a longer term perspective, it's really a question of if, not when, sorry, it's really, it's not a question of if, but a question of when markets reach their previous peak. Because, we know markets spend more time rising than they do falling. Now, that last peak on the equity market was on January 3rd, 2022. That was a level of 4,797 on the index. So, a little bit over a year ago today. As of the end of last week, the market was trading at about a 3,900 handle on the index. Now, again, I've talked about some of the risks to equity markets over the course of this year that could very well materialize, but let's just take a longer term perspective.
Let's just look out towards January 26th, 2026. So, three years out, that middle bar to the page on the chart on the left-hand side. If it takes three years for the markets to get back to 4,797 on the index, you're looking at an annualized return of about 9% over the next three years. That's a pretty solid story. And we know that markets are forward looking. And so, I think that if markets start to look ahead towards 2024 and 2025, they're going to start to see a little bit more optimism given that's likely going to be the environment which growth starts to come back online. The Federal Reserve reduces interest rates, and I think markets may be able to rally pretty strongly out the gate before the economy actually begins to roll over. So, again, I think having a longer term perspective and in an environment which valuations look a lot more attractive today, certainly could play out well to have an allocation towards equities.
And also, when you think about valuations in the bond market, bonds are back. The way to read this, look at this chart here, we show a variety of different fixed income sectors. We have your more investment grade sectors on the left-hand axis, so things like treasuries, investment grade corporate bonds, and then we have your more extended sectors on the right-hand axis. So, things like high yield and leverage loans. The gray bars show the range, so the spread between the max and min of where yields have been on these different fixed income sectors over the last decade. Now, that purple bar shows the 10-year median, and then the blue diamond shows where yields are currently trading. Generally speaking, when that blue diamond is above that purple bar, bonds look attractive relative to over the last 10 years. But, interestingly, that blue diamond is actually closer to the top of the range that they've been over the last 10 years.
And so, when you think about what you're buying into today by investing in bonds, you're able to get five, 5.5% on investment grade corporate bonds. These are high quality companies with strong balance sheets that are likely to weather a recession particularly well. Within municipals, depending on where you shop, you're able to get similar yields, five and a half, 6% on a tax equivalent yield basis. So, that looks like a really attractive area to us. And then, when you think about bonds that are backed by the health of the consumer, and we talked about consumers potentially being supported in the near term, able to get five, 5.5% on these bonds. Again, these are numbers that we have been able to talk about in over a decade, and the fed was at zero following the financial crisis.
And so, looking at valuations or yields, bonds look pretty attractive in this environment, and this is a great chart, because it shows really just bond math. The tight relationship between when you buy a bond at the current yield level and the projected subsequent returns, total returns that those bonds are going to generate over the next five to seven years. And so, that X axis is showing that starting yield for the Bloomberg Barclays aggregate. And then, that Y axis shows the annualized five-year return subsequently after you're buying at that prevailing yield level.
So, plainly speaking, right now you're able to buy the Bloomberg Barclays agg as of the end of last year between a four and a half to 5% yield. We feel pretty confident that buying up the agg at that level of yield will generate a roughly 5% annualized return over the next five to seven years. Now, again, I would take the overall on that, because we know the relationship between bond yields and bond prices. And, when bond yields come down, bond prices move higher. And if we're in an environment in which the fed over the next five years is going to have to cut rates after lifting rates and restrictive, if inflation is coming down, if growth is coming down, these all suggest that bond yields can come down and that provides a big boost to bond prices.
And so, we do expect, again, we can't call definitively, but we do expect buying yields at, again, some of the highest levels that we've seen in over the last decade are really going to be a really small window of opportunity for investors to take advantage of the reset that we've seen in the overall bond market. Now, really quickly, I'm going to touch a little bit on international, and then we're going to open things back to questions from the audience. And so, thank you all for putting questions there in the chat box. This is another heat map, and it shows overall global economic activity. We list a variety, a number of different developed market economies towards the middle of the page and emerging market economies towards the bottom of the page. And we're looking at global PMI, so purchasing managers' indexes, composite PMIs, and these are a month-to-month indicator of overall economic activity in these different economies.
Now, again, we use this heat map based off of that key level of 50, and I'm looking at PMI's. Above 50 means expansion, below 50 meaning contraction, and you can see clearly periods of stress in the global economy. So, the far left-hand side, the global PMI's across the world coming out of the financial crisis. We're in deep contraction. You can see that deep red. As you move to the Eurozone debt crisis in 2011 and 2012, you can see economies like Spain, Italy, and France, those economies really coming under pressure from a broader economic activity perspective. Moving ahead to the commodity collapse in 2016, commodity exporters like Brazil, we used to have Russia on this page, but we took Russia off. Those economies coming under pressure. And then, of course, that sea of red during the pandemic in which the global world, the world effectively shut down.
Now, moving to the right-hand side of the page, remember as we round out the year, that key level of 50, a number of economies are sitting below that key level of 50 signaling contraction. The reality is, you have China that is dealing with an overly leveraged property sector or the hangover from trying to cure it, an overly leveraged property sector. As of while they have seen some of their COVID numbers come down, they were dealing with a very big spike over the tail end of last year. Europe is, of course, dealing with the energy crisis given the fallout in Russia and Ukraine. And so, the global economy is certainly, could very well come under pressure over the first half of this year. That being said, as we look towards the second half of the year, we could start to see global economies begin to rebound and begin, and growth turn positive in those regions.
And so, from an investment perspective, we think stepping into international in a big way could feel a bit early, but markets are, we're seeing some opportunities really present themselves in global markets. On the left-hand side, we're just showing the valuation discount that you're able to get by going international versus owning domestic stocks. So, a way to read this chart on the left. On average, international stocks trade at about a 14% discount relative to the U.S. They're now trading at about a 30%, well, roughly 25% discount relative to the U.S. And if we're having more conversations about investors using equities as a source of income, on the right-hand side shows that you're able to get roughly 1.5% more in dividend income, than you're able to get by owning U.S. stocks. And then, lastly, 2022 was certainly a very difficult year, but above all, investors really need to stay diversified and not try to time the market.
On this chart, on our team, we call this our jellybean chart, more of a skittles guy, so we'll call this a skittles page. But, each of these skittles represent a calendar year return for a specific asset class. So, we've got small caps in orange, large caps in green, but then if you look at that lightly gray shaded box that's tracking that black line, that is a globally diversified portfolio that has a little bit of all these different asset classes baked into that portfolio. This is a massive skittle, if you will. But, that portfolio is never at the top of the page. It's never at the bottom of the page. It's always hovering right around the middle, and that's the benefits of diversification. We don't diversify our portfolios, we don't diversify our retirement accounts, because myself or Larry think we can cobble together the best performing assets in a given year.
We diversify so that when one part of the portfolio zigs, the other part of the portfolio zags. Now, the challenge of 2022 was a lot of stuff was zigging and not enough was actually zagging. But, the reality is, over time, diversification has continued to provide the best risk adjusted set of returns than any individual asset class. And that is really why we diversify across assets on a global lens. So, with that, I want to pause. I've probably have taken up a little bit too much time and I want to see if we can tackle some of these questions in the chat box.
Larry Seigelstein: Jordan, absolutely. And there's some great questions coming in. Obviously, if we don't get to all of them, we could address them post the event. But, one of the things we touched on earlier was the debt ceiling, and what's going on with the negotiation of that right now. Just some input on what you see, potential risk, to what the economy, the markets could impact from these negotiations, where this might go down the road in the short term?
Jordan Jackson: Sure. The biggest risk is, what is that X date? Right now, given we are in what is called a debt issuance suspension period, the U.S. Treasury is no longer allowed to issue new debt in order to fuel to spending. And so, what they've been doing is that, they have been pretty much exhausting these extraordinary measures. And so, what that effectively means is, in order to pay the obligations of the government, they can use their checking account at the Federal Reserve. That's the treasurer general account. They can choose not to make payments to various government retirement accounts. And they've also got a little bit of extra money in the exchange stabilization fund. Now, so analysts' estimates suggest, or Janet Yellen, the Treasury Secretary suggests that they can exhaust these extraordinary measures to meet their obligations up until June, but that is a big question mark on that date.
The reality is Federal Reserve or treasury revenues tend to be very volatile around tax season. And if you think about revenues, a lot of it comes from income tax. And so, yes, a very tight labor market can certainly boost income taxes, but then also a big chunk of that, are capital gains. And so, given the selloff that we've seen in both stocks and bonds, it's likely that the treasury is not going to see any significant amount of capital gains taxes over the course of this year as investors lock in capital losses to offset that. So, that's a big question mark. Our best case though is that something gets resolved probably closer to that X date than markets would like. And if we use 2011 as an example, basically the fed came, the treasury came right down to the wire in terms of approving a lift of the debt ceiling. And we do think that things could potentially play out similarly in this year.
Now, again, the big risk to markets is, 2011 you saw S&P 500 or S&P ratings downgrade U.S. debt from a AAA rating to a AA plus. If you start to see another rating agencies say Moody's or Fitch considered downgrading, that could have pretty significant ramifications for the broader treasury market. But, we don't think that is the best case. We do think the debt ceiling will be lifted. The big question mark again is really, what that X drop date is?
Larry Seigelstein: Thank you, Jordan. Now, we're running out of time. I'm going to do one quick question before we close out and it's related to, we talked about the geopolitical impact, obviously, Ukraine, Russia conflict. We talked about impact on global supply related to food and or energy. Do you see what they call, some people are writing down the Putin effect. What's the ripples on that? Just in 15 seconds before we close out, Jordan.
Jordan Jackson: Unfortunately we don't see scope for any diplomatic solving of the issue over in Russia, Ukraine. Clearly we used to the Western allies are sending support over to Ukraine, where now there's been more rumblings about backdoor deals amongst China and Russia. Unfortunately, I think this conflict will continue to persist. From an investment perspective, it does seem though that Europe has done a decent job, a good job of rediverting their natural gas flows and their oil imports away from Russia and gearing them towards places like the U.S. And so, it does seem Europe could potentially outright avoid a recession, although growth is still expected to slow.
Larry Seigelstein: Terrific. Thank you so much. So, thank you, Jordan, for your insights, your input and your time. And, obviously, on behalf of Jordan and myself, we want to thank everybody for taking the time to be with us today. Just a quick reminder for folks out there that, part two of this webinar series titled Market Volatility and its Impact on Your Retirement will be held on February 16th at noon, followed by the third and final part of this particular series on March 16th at the same time titled Business Succession and the Markets, When Is It The Right Time to Exit? Thank you so much for your time.
Jordan Jackson: Thanks everyone.
Transcribed by Rev.com