Macroeconomic Highlights - Q1 2023
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Macroeconomic
Highlights
Q1 2023
20230104-2661919
Table of Contents
WestEnd Outlook Highlights ………………………………………………………………………………………………… 2
U.S. Equity Sector Allocations ………………………………………………………………………………………………… 3
U.S. Economic & Market Backdrop
Economic Cycle: Slowing growth, increased risks…….………………………………………………………………… 5
Economic Growth: Consumer savings provides less spending fuel…………………………………………………… 6
Labor Market: Leading labor market data starting to deteriorate……………………………………………………… 7
Economic Cycle: Leading indicators reaching recessionary levels…………………………………………………… 8
Inflation: Labor costs will be key focus…………………………………………………………………………………… 9
Monetary Policy: Impact of tightening yet to be recognized…………………………………………………………… 10
Economic Cycle: “Mild” recession would be unusual……………………………………………………………………11
Equity performance: S&P 500 return drivers limited………………………………………………………………… 12
U.S. Sector Outlook
Late-Phase Sectors: Steady earnings growth …………………………………………………………………………14
Health Care: Earnings resilient to downturns……………………………………………………………………………15
Mid-Phase Sectors: Economic sensitivity of revenues mixed …………………………………………………………16
Energy: Expect deteriorating fundamentals ……………………………………………………………………………17
Financials: Earnings vulnerable to cyclical forces .………………………………………………………………………18
International Economic & Market Backdrop
Developed Markets: Emphasizing more resilient areas……………………………………………………………… 20
Emerging Markets: Global demand a headwind……………………………………………………………………… 21
U.S. Dollar: Modestly overvalued but possible safe-haven…………………………………………………………… 22
Interest Rates & Inflation
Fixed Income: Compelling return potential…………….……………………………………………………………… 24
Fixed Income: Recessions create opportunity………….……………………………………………………………… 25
Interest Rates: Downside potential for long-term rates……………………………………………………………… 26
Disclosures …………………………………………………………………………………………………………………… 27
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 1
20230104-2661919WestEnd Outlook Highlights
• With the rapid evolution of this economic cycle, deterioration in some data along with the Fed’s aggressive monetary
policy stance point to later-cycle economic conditions in the U.S., where we see slower economic growth, increasing
risk of recession, and higher potential for disappointing earnings growth, particularly for companies in economically
sensitive parts of the market.
• A key variable, in our view, is the Federal Reserve’s accelerated path of monetary policy tightening, with the sharpest set of rate hikes in
at least a half century, which we believe has increased the risk of recession.
• Some areas of the global economy remain sound, such as the U.S. labor market and consumption, but we believe the full impact of the
Fed’s rate hiking cycle has yet to be felt.
• We believe long-term U.S. interest rates could decline in 2023, as growth and inflation slow.
• Internationally, as global economic growth slows, we see continued risks for Europe tied to the war in Ukraine, and we
expect headwinds for economically cyclical emerging markets, while developed Asia is a relative bright spot.
• We have continued to adjust portfolios for ongoing progression of the economic cycle and in view of new risks:
• In U.S. large-cap equity allocations:
– We are avoiding early-phase cyclical U.S. sectors in all our strategies. We instead are emphasizing sectors that we expect will
see less deceleration in earnings as economic growth slows.
– We have added to our late-phase, defensive sector exposure, with overweights of Health Care, Consumer Staples, and Utilities.
• In global portfolios, we remain underweight to international equities, as a whole, including underweights of Europe and emerging
markets, but we maintain an overweight of developed Asia, where we see the greatest potential for economic resilience abroad.
• In balanced portfolios:
– Seeing reduced risk to fixed income returns, and late economic cycle risks to equities, we maintain an overweight of fixed income
in balanced portfolios.
– Within fixed income allocations, we are emphasizing longer-term securities that should benefit from declining long-term interest
rates, and floating rate Treasury securities that carry high and potentially rising yields.
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20230104-2661919U.S. Equity Sector Allocations
WESTEND ETF STRATEGIES
Current large-cap U.S. equity sector allocation and avoidance*
Sector Sector
Allocations Avoidance
• Health Care • Energy
• Consumer Staples • Financials
• Utilities • Industrials
• Information Technology • Materials
• Communication Services • Real Estate
• Consumer Discretionary
* For illustrative purposes only. Allocation information as of December 31, 2022. Source: WestEnd Advisors.
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20230104-2661919U.S. Economic &
Market Backdrop
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 4
20230104-2661919Slowing Economic Growth Brings Increased
Challenges and Risks in 2023
CHICAGO FED NATIONAL ACTIVITY INDEX
3.0 Portfolio Impact: Increased risk of
2.5 recession in the U.S. warrants an
2.0 emphasis of defensive sectors like
1.5 Health Care, Utilities, and
6-Month Average
1.0 Consumer Staples, in our view, as
0.5 well as avoidance of highly cyclical
0.0 sectors like Energy, Industrials, and
-0.5 Financials.
-1.0
-1.5
-2.0
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Dec-15
Dec-16
Dec-17
Dec-18
Dec-19
Dec-20
Dec-21
Jun-07
Jun-08
Jun-09
Jun-10
Jun-11
Jun-12
Jun-13
Jun-14
Jun-15
Jun-16
Jun-17
Jun-18
Jun-19
Jun-20
Jun-21
Jun-22
Source: Chicago Federal Reserve Bank, WestEnd Advisors
Broad measures of U.S. economic activity like the Chicago National Activity Index weakened in 2022, even as quarterly GDP
readings swung from negative in the first half of 2022 to a strong gain in Q3 of last year. Despite the volatility in quarterly
GDP readings, we see late-cycle economic conditions carrying over to 2023.
We believe there will be additional negative economic fallout in 2023 from the Fed’s monetary policy tightening campaign
that began last year. Monetary policy challenges together with other fundamental headwinds, including consumers’ depleted
excess savings, points to slower economic growth, increased risk of recession, and higher potential for disappointing
earnings growth, particularly for companies in economically sensitive sectors of the economy.
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20230104-2661919Savings Unlikely to Support Spending Growth Again
U.S. PERSONAL SAVINGS RATE
35% Portfolio Impact: The U.S. consumer
is likely to have less spending fuel in
30%
2023 compared to last year. A more
25% challenged U.S. consumer should
20% contribute to more risks to the U.S.
economy in 2023.
15%
10%
5%
0%
Nov-72
Nov-74
Nov-76
Nov-78
Nov-80
Nov-82
Nov-84
Nov-86
Nov-88
Nov-90
Nov-92
Nov-94
Nov-96
Nov-98
Nov-00
Nov-02
Nov-04
Nov-06
Nov-08
Nov-10
Nov-12
Nov-14
Nov-16
Nov-18
Nov-20
Nov-22
Source: Bureau of Economic Analysis, WestEnd Advisors
Nominal personal income growth was well above the long-term trend in 2022, but the pace of inflation has been even higher.
A decline in the savings rate from 7.3% to 2.3% over the 12 months ended November 2022 accounted for 68% of
spending growth over that period.
With excess savings falling rapidly, we don’t see consumers reducing savings rates again in 2023. In fact, the savings rate
could rise to more normal levels in the period ahead. The savings rate has averaged 8.3% since 1970 and 6.4% between
1990 and 2019. These conditions point to a likely material deceleration in consumer spending growth this year.
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 6
20230104-2661919Leading Labor Market Data Starting to Deteriorate
JOB GROWTH RAPIDLY SLOWING IN LEADING INDUSTRIES
20% 10%
8% Portfolio Impact: Job growth remains the major pillar
15%
Year-Over-Year Growth
10%
6% supporting economic growth in the U.S., but the risks to
4%
5% the labor market have started to increase, in our view.
2%
0% 0% The trajectory of employment and layoffs is likely to be a
-5% Six-month growth -2% key determinant of the U.S. economy’s path and whether
(annualized) -4%
-10%
-6%
a recession is avoided in the intermediate term.
-15% -8%
-20% -10%
While total nonfarm payroll growth – a historically lagging
indicator – remains strong, signs of incremental softening
Nov-91
Nov-92
Nov-93
Nov-94
Nov-95
Nov-96
Nov-97
Nov-98
Nov-99
Nov-00
Nov-01
Nov-02
Nov-03
Nov-04
Nov-05
Nov-06
Nov-07
Nov-08
Nov-09
Nov-10
Nov-11
Nov-12
Nov-13
Nov-14
Nov-15
Nov-16
Nov-17
Nov-18
Nov-19
Nov-20
Nov-21
Nov-22
in the job market have started to show up in the more
Nonfarm Payrolls in Leading Industries* (LHS) Total Nonfarm Payrolls (RHS)
*Includes temporary help services, warehousing & storage,
leading labor market data.
nondepository credit intermediation, logging, and professional employer organizations Source: BLS, WestEnd Advisors
Payroll growth has decelerated sharply among sub-
JOB OPENINGS DECLINING FROM ELEVATED LEVELS
14,000
industries that have historically provided leading
signals for the overall job market, including temp
Job Openings (thousands)
12,000
workers, credit intermediation, and warehousing &
10,000
storage (top chart).
8,000
6,000 Furthermore, job openings peaked in Q1 2022 and have
4,000
since fallen at a -20% annualized pace, a sign that labor
2,000
demand is starting to cool (bottom chart).
0 If layoffs increase and consumers’ sense of job
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Dec-15
Dec-16
Dec-17
Dec-18
Dec-19
Dec-20
Dec-21
security declines materially, we would see that as a
Source: BLS, WestEnd Advisors
serious threat to spending and the economy overall.
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 7
20230104-2661919Leading Indicators Tracking to Recession Levels
LEADING ECONOMIC INDEX
20% Portfolio Impact: The deceleration
15% in U.S. growth we anticipated at the
10% start of 2022 is playing out. We have
5% transitioned portfolios to an avoidance
0% of highly economically sensitive U.S.
-5% early-phase sectors, like Materials,
-10% Energy, and Industrials. We have
-15% also added to late-phase sector
-20% exposure, and, in balanced portfolios,
Year-over-Year Change
-25%
have moved to an overweight of fixed
6-Month Annualized Change
-30%
income.
Sep-88
Sep-90
Sep-92
Sep-94
Sep-96
Sep-98
Sep-00
Sep-02
Sep-04
Sep-06
Sep-08
Sep-10
Sep-12
Sep-14
Sep-16
Sep-18
Sep-20
Sep-22
Source: Conference Board, WestEnd Advisors
After sharp economic recovery spurred by the containment of COVID in U.S., we expected the pace of economic growth
would shift lower, but the degree of monetary tightening and the prospect of more headwinds for consumers present
challenges to growth, particularly for cyclical sectors of the economy.
Year-over-year growth and 6-month annualized growth for the Leading Economic Index (LEI) have both entered negative
territory. The chart above illustrates that 6-month growth in LEI has fallen to a level that historically has coincided with
recessions.
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20230104-2661919Wages to Shape the Inflation Picture in 2023
WAGE AND CONSUMER INFLATION
16% Portfolio Impact: Allocations to Health Care,
14%
Utilities, and Information Technology should benefit,
12% Core CPI
Average Hourly Earnings in our view, as inflation and growth continue to
10%
decelerate, given their favorable business
Year-over-year
8%
fundamentals and less cyclical earnings streams.
6%
4%
Consumer goods inflation has likely peaked and could
2%
fall relatively quickly in 2023. Consumer services
0%
inflation should take longer to fall and could ultimately
Jan-70
Jan-72
Jan-74
Jan-76
Jan-78
Jan-80
Jan-82
Jan-84
Jan-86
Jan-88
Jan-90
Jan-92
Jan-94
Jan-96
Jan-98
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
Jan-14
Jan-16
Jan-18
Jan-20
Jan-22
keep core CPI above the Fed’s target well into 2023.
Source: Bureau of Labor Statistics, WestEnd Advisors
We anticipate that labor costs, which are sticky in nature,
WAGE GROWTH BY JOB TURNOVER will remain elevated absent a recession. The top chart
9% highlights the 1970s as a period when wage growth
Core CPI
8% Wage Gains: Job Stayers remained high despite swings in CPI. Even with a rising
7% Wage Gains: Job Switchers
6% likelihood of falling consumer inflation, wage inflation will
Year-over-year
5% become more of a focal point for the Fed.
4%
3% Today’s labor market, while beginning to cool,
2% remains very tight, as can be seen by the outsized
1%
compensation received for switching jobs (bottom chart).
0%
We expect monetary policy will remain tight as the Fed
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Jan-18
Jan-19
Jan-20
Jan-21
Jan-22
wants to prevent wage inflation from becoming
Source: Bureau of Labor Statistics, Atlanta Fed, WestEnd Advisors
entrenched.
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 9
20230104-2661919Impact of Policy Tightening Yet to be Recognized
UNPRECEDENTED PACE OF TIGHTENING
4.5
Portfolio Impact: We believe slowing economic
4
growth, combined with the Fed’s commitment to
Change in Fed Funds Rate
3.5
3 keeping rates elevated, warrants defensive positioning
2.5
across our portfolios, given that the economy has yet
2
1.5 to absorb the full impact of monetary tightening.
1
0.5
0
The Fed’s aggressive monetary tightening has
First T+2 T+3 T+4 T+5 T+6 T+7 T+8 T+9 T+10 heightened risks that the economy advances faster
Hike
Current 2016 Hiking 2004 Hiking 1999 Hiking
towards recession, in our view (see top chart).
1994 Hiking 1986 Hiking 1982 Hiking 1977 Hiking Historically, a rise in the Fed Funds rate has had a
Source: WestEnd Advisors, Bloomberg
negative impact on real GDP growth, albeit with a
QT CONTRIBUTING TO POLICY TIGHTENING lagged impact (research suggests that a +100 bps
9.5
Fed Funds rate shock has resulted in a ≈ -1.5% hit
Effective funds rate
7.5 to GDP over ≈18 months).
Proxy funds rate
5.5
In fact, the bottom chart illustrates that the overall
3.5 effect of monetary tightening on financial
1.5 conditions has been even greater than the
-0.5 Federal Funds rate suggests, given quantitative
-2.5 tightening and the speed and magnitude of this
hiking cycle.
Jun-96
Jun-97
Jun-98
Jun-99
Jun-00
Jun-01
Jun-02
Jun-03
Jun-04
Jun-05
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10
Jun-11
Jun-12
Jun-13
Jun-14
Jun-15
Jun-16
Jun-17
Jun-18
Jun-19
Jun-20
Jun-21
Jun-22
Source: San Francisco Fed, Bloomberg, WestEnd Advisors
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 10
20230104-2661919“Mild” Recession Would Be Unusual
UNEMPLOYMENT RATE DURING RECESSIONS
3.50
Cumulative Increase in U-3 Unemp Rate (PPT)*
3.00
2.50
Portfolio Impact: We see a growing risk that economic
2.00
growth could surprise to the downside, which we believe
1.50 warrants an avoidance of U.S. cyclical early-phase
1.00 sectors, emerging market regions, and high-yield
0.50 bonds.
0.00
The overwhelming consensus among U.S.
-0.50
M-3 M-2 M-1 M0 M1 M2 M3 M4 M5 M6 M7 M8 M9 M10 M11 M12 economists is that a mild recession will hit in 2023,
Months from Onset of Recession
75th Percentile Average 25th Percentile Consensus
but that excess savings and strong labor demand will
*Includes post-WWII recessions, excluding Covid-19 pandemic Source: BLS, WestEnd Advisors limit the pain. We agree that there is an elevated risk of a
Trai l i ng 12M EPS D ecl i nes D uri ng Recessi ons contraction, but we believe the economic fallout could
Date of Date of Earnings S&P 500 be average. We also don’t see the conditions for a
Recession Recession Decline (P eak- Return (P eak-
severe recession.
Start End to-T rough) to-T rough)
Feb-20 Apr-20 -20.1% -20.0% The top chart shows economists’ consensus forecast for
Dec-07 Jun-09 -49.2% -52.6% the unemployment rate in 2023, which remains below
Mar-01 Nov-01 -30.4% -46.3%
Jul-90 Mar-91 -38.8% -15.8%
even the low-end of the average recessionary trajectory.
Jul-81 Nov-82 -18.2% -23.8% In the event of a recession, we see potential for
Jan-80 Jul-80 -4.4% -10.6%
Nov-73 Mar-75 -17.5% -46.2% earnings declines relative to the mid-single-digit
Dec-69 Nov-70 -15.9% -32.9% growth analysts are currently expecting (bottom chart).
Apr-60 Feb-61 -14.6% -11.8%
Aug-57 Apr-58 -23.4% -19.0%
Waning savings, rising layoffs, slowing goods demand,
Av erage -23.3% -27.9%
tight financial conditions, and disinflationary revenue
2023 CY Consensus Estimate 5.3% TBD trends all have the potential to weigh on profit growth in
westendadvisors.com | info@westendadvisors.com | 888.500.9025
Sources: Bloomberg, WestEnd Advisors
2023. Macroeconomic Highlights Q1 2023 11
20230104-2661919S&P 500 Return Drivers Limited From Here
S&P 500 EARNINGS WELL ABOVE LONG-TERM TREND
Portfolio Impact: Earnings estimates appear
S&P T12M EPS vs Long-Term Trend
50%
40%
30%
increasingly optimistic, and rate-adjusted
20% valuations suggest equities are expensive. As
10%
0%
such, we are avoiding the most cyclical parts of the
-10% market, while favoring sectors with more resilient
-20%
earnings power, such as Utilities and Consumer
-30%
-40% Staples. We maintain an underweight to equities in
-50% balanced portfolios.
Sep-63
May-88
Sep-00
Dec-72
Dec-09
Nov-69
Nov-06
Jun-54
Jun-91
Oct-66
Feb-79
Mar-82
Oct-03
Feb-16
Mar-19
Jul-57
Jul-94
Apr-85
Apr-22
Aug-60
Aug-97
Jan-76
Jan-13
Against the backdrop of and a rapidly maturing economic
Recession S&P T12M EPS vs Trend Consensus Estimates
Source: WestEnd Advisors cycle, we see limited upside potential for the drivers
RATE-ADJUSTED VALUATIONS REMAIN UNCOMPELLING of equity returns – earnings growth and valuations.
0.0
S&P 500 profits have rebounded swiftly since the depths
More Expensive
1.0
of the pandemic. Consensus estimates are calling for
2.0
3.0
another year of solid earnings growth in 2023 (~5%
Yield (%)
4.0 year-over-year). If achieved, this would put S&P 500
5.0 EPS over 20% above its long-term trend, near the
Recessionary
6.0 Market Troughs high-end of the historical range.
Cheaper
7.0
Despite the equity market volatility, interest rate-
8.0
9.0
S&P 500 Fwd Earn. Yield less 10-Year Yield Avg 25th/75th Percentile
adjusted valuations became more expensive in
2022 (bottom chart), and were in the 86th percentile of
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Dec-15
Dec-16
Dec-17
Dec-18
Dec-19
Dec-20
Dec-21
Dec-22
Source: WestEnd Advisors
expensiveness relative to the past two decades.
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 12
20230104-2661919U.S. Sector Outlook
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 13
20230104-2661919Late-Phase Sectors Provide Steady Earnings
EARNINGS GROWTH BY SECTOR
100%
Portfolio Impact: We believe
80%
Average YoY EPS Growth
exposure to defensive areas of the
60%
market – such as Health Care,
40%
Consumer Staples, and Utilities – is
20%
warranted. Consistent and above-
0%
market profitability makes these
-20%
sectors more attractive than
-40%
economically-sensitive sectors at
-60%
this stage of the cycle, in our view.
-80%
Energy, Materials, Industrials & Financials Sectors
Health Care, Staples & Utilities Sectors
Source: Bloomberg, WestEnd Advisors
*Consensus estimates for 2023 sector EPS.
We see the financial stability of Health Care, Consumer Staples, and Utilities as desirable, particularly as the economic
cycle matures and the risk of a slowdown in economic growth increases.
Defensive, late-phase sectors have consistently generated consistent EPS growth over time. Alternatively,
economically-sensitive sectors like Energy, Materials, Industrials, and Financials have much more cyclical earnings, as
illustrated in the chart above.
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20230104-2661919Health Care Sector Delivers Steady Earnings Growth
STEADY HEALTH CARE EARNINGS, EVEN IN RECESSIONS
Portfolio Impact: We believe
3,200
Health Care sector exposure
T12M Earnings Indexed to 100 (Log)
1,600 provides attractive defensive
characteristics with insulation
800
from cyclical risks, but is also well
400 positioned if the cycle extends.
200
Health Care T12M EPS
S&P 500 T12M EPS
100
50
Dec-91
Dec-94
Dec-97
Dec-00
Dec-03
Dec-06
Dec-09
Dec-12
Dec-15
Dec-18
Dec-21
Jun-90
Jun-93
Jun-96
Jun-99
Jun-02
Jun-05
Jun-08
Jun-11
Jun-14
Jun-17
Jun-20
Shaded = recession. Source: WestEnd Advisors, Bloomberg
The Health Care sector’s strong earnings andlack of cyclicality offer an attractive combination, in our view, as the
pace of economic growth slows in the U.S. We see the sector as positioned well for 2023 as more elective procedures
and higher volumes overall benefit both health care providers and medical device makers. We also see a healthy
investment cycle as a further tailwind to the sector coming from pharmaceutical and biotechnology companies resuming
projects previously put on hold due to the Covid-19 pandemic.
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 15
20230104-2661919Mid-Phase Sectors Have a Mix of Economically
Sensitive and Non-economically Sensitive Revenue
SELECT INDUSTRY REVENUE VOLATILITY
25% Portfolio Impact: As economic growth
continues to slow, we believe Information
20% Early Phase Mid Phase Late Phase Technology and Communication Services
Standard Deviation of Revenue
will see less revenue and earnings
S&P Industry Median
15% growth deceleration than other
Growth
economically sensitive areas of the
10%
market due to strong secular growth trends
benefitting these sectors. As a result, we
5%
continue to maintain allocations to
0% Information Technology and
Communication Services, which we
currently see at attractive valuations.
Source: WestEnd Advisors
The chart above highlights that the revenue variability of companies in early-phase sectors is typically much greater than
those in late-phase sectors. For example, Oil & Gas industry revenue growth is nearly 5 times as volatile as Health Care
Providers industry revenue growth. Mid-phase sectors tend to have less cyclical revenue exposure than early-phase
sectors, but more sensitivity to economic growth than late-phase sectors. We see the lower revenue volatility and more
secular-oriented growth profiles for these mid-phase sectors as attractive versus early-phase sectors at this stage in the cycle.
Businesses and consumers have increasingly embraced digital platforms in recent years, and business investment
spending on information processing equipment and software rose to an all-time high last year, a trend which we
expect to continue as businesses look for ways to increase efficiency and margins in a slower growth environment.
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 16
20230104-2661919Expect a Deterioration in Energy Sector Fundamentals
ENERGY SECTOR INDEX VS. CRUDE OIL PRICE
800 $130
Energy Sector Sector Index (S&P 500)
$120 Portfolio Impact: We continue to avoid U.S. Energy
West Texas Inter. Crude, bbl
700
$110 sector exposure in portfolios as we believe the
600
$100 prospect of slower growth in the U.S. and abroad,
500 $90 coupled with the potential for significant margin
400
$80
compression, increases the likelihood of a
$70
300
deterioration in the earnings outlook for the sector.
Energy Sector Index WTI Price $60
200 $50 The global energy commodity complex has moved lower
since mid-2022 on the back of sluggish demand and a
Sep-21
May-22
Sep-22
Dec-21
Dec-22
Nov-21
Nov-22
Jun-22
Oct-21
Feb-22
Mar-22
Oct-22
Jul-22
Apr-22
Aug-22
Jan-22
stabilizing inventory backdrop. Still, the U.S. Energy sector
Source: WestEnd Advisors, Bloomberg
has continued to outperform.
ENERGY SECTOR MARGINS LIKELY PEAKED IN 2022
4.0
The top chart shows that the price of crude oil (WTI)
Stnd Devs. Above/Below 10-Year Average
WTI Crude has diverged from the S&P 500 Energy sector, which
3.0 HH Nat Gas
RBOB Gasoline presents a risk for the earnings power of Energy stocks.
Benchmark Crack Spread
2.0 Energy Sector 12M Fwd Net Income Margin Historically, Energy’s relative performance has peaked
1.0 alongside oil prices.
0.0 Margin expansion was a key driver of Energy companies’
post-pandemic earnings rebound, due in part to surging
-1.0
Reversion to average would
natural gas prices and above-average crack
-2.0 imply -50% EPS drop spreads. More recently, these trends have started to
-3.0 reverse (bottom chart). As global growth slows, we
May-18
May-19
May-20
May-21
May-22
Nov-18
Nov-19
Nov-20
Nov-21
Nov-22
Feb-18
Feb-19
Feb-20
Feb-21
Feb-22
Aug-18
Aug-19
Aug-20
Aug-21
Aug-22
expect these markets to continue to normalize, which
could put further downward pressure on Energy Sector
Source: WestEnd Advisors
margins.
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 17
20230104-2661919Financials Earnings Vulnerable to Cyclical Forces
LOAN LOSS RESERVES SET TO RISE
100% 6%
Portfolio Impact: We eliminated U.S.
80% 5% Financials sector exposure in portfolios as
60%
4%
we believe the prospect of slower loan growth
40% in the U.S. and the building of loan loss reserves
3%
20% increases the likelihood of a deterioration in the
0%
2% earnings outlook for the sector.
-20% 1%
-40% 0%
Sep-99
Sep-00
Sep-01
Sep-02
Sep-03
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Sep-13
Sep-14
Sep-15
Sep-16
Sep-17
Sep-18
Sep-19
Sep-20
Sep-21
Sep-22
% of Large & MM Firms Tightening C&I Lending Standards (LHS)
Loan Loss Reserves (% of Net Loans, RHS)
Source: Federal Reserve, Company 10-Qs, WestEnd Advisors
Loan loss reserves for JPM, BAC, WFC, C and PNC
Responses to the Senior Loan Officer Survey indicate that lending standards will begin to tighten. However, reserves for
loan losses are still only slightly above prior cyclical lows. As lending standards tighten, loan growth should slow which
removes a tailwind for bank earnings
Further, as the economy enters the latter stages of the economic cycle, we expect banks to build reserves for loan
losses as they have done in the past. This reserve build is a drag to bank earnings, which are a substantial driver of the
Financials sector’s overall expected earnings growth in 2023. While our base case does not imply that defaults to reach
levels seen in the GFC, we believe the market is underappreciating the impact of this cyclical dynamic on the sector.
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 18
20230104-2661919International Economic &
Market Backdrop
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 19
20230104-2661919Emphasizing Resilient Parts of Developed Markets
OECD COMPOSITE LEADING INDICATORS
104
103
102 Portfolio Impact: An overweight allocation to Japan
101 is warranted, in our view, given that its economy faces
Index Level
100
fewer economic headwinds from inflation and
99
98 monetary policy tightening. In the event of a global
97 recession, we would expect Japanese equities to
96
generate stronger sales and earnings growth than
95
Europe and EM.
Sep-06
Sep-09
Sep-12
Sep-15
Sep-18
Sep-21
Dec-05
Dec-08
Dec-11
Dec-14
Dec-17
Dec-20
Jun-07
Jun-10
Jun-13
Jun-16
Jun-19
Jun-22
Mar-08
Mar-11
Mar-14
Mar-17
Mar-20
Japan OECD Leading Indicators CLI Amplitude Adjusted SA In a maturing global cycle, it is important to emphasize
USA OECD Leading Indicators CLI Amplitude Adjusted SA
Euro Area OECD Leading Indicators CLI Amplitude Adjusted SA regions that can generate resilient earnings growth
in the face of rising global economic risks, in our view.
Source: Conference Board, WestEnd Advisors
U/W AREAS WITH SIGNIFICANT EARLY PHASE EXPOSURE
100%
Leading indicators suggest the risk of recession is
90% 25%
13% 18% 14%
24%
elevated in Europe (see top chart). The region faces
32%
80% 37% 14% several headwinds, including surging costs, monetary and
Phase Weights*
70%
50% 40%
fiscal tightening, and a smaller savings cushion relative to
60% 10%
50% 44% 25% 38% other developed countries. Downturn risks appear
40% more subdued in Japan, where economic output is
72%
30%
54% below potential and stimulative monetary and fiscal
42% 43%
20%
31% 37% 38% policies remain in place.
10%
0% Japan also has less early-phase exposure relative to
S&P 500 MSCI EM MSCI MSCI MSCI U.K. MSCI EM MSCI
Asia Japan Europe ex ex-Asia ACWI
Europe and EM (see bottom chart).
- Overweight UK
- Underweight Early Phase Mid Phase Late Phase
*As of 11/30/22 Source: WestEnd Advisors
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 20
20230104-2661919Global Demand Headwinds to Persist in EM
CHINA EXPORT GROWTH
60%
50% Portfolio Impact: As the global economic cycle enters
Year-Over-Year Growth
40%
the later stages, we remain underweight Emerging
30%
20%
Markets (EM) in global portfolios. We see subdued near-
10% term return potential for EM, given its dependence on
0% global goods demand and heightened uncertainty around
-10% China’s rapid exit from its zero-Covid policies.
-20%
-30% China Exports USD (3-Month Moving Average) The trajectory of the global cycle is likely to be determined
-40% by growth in the U.S. and E.U., which account for ~40% of
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Dec-15
Dec-16
Dec-17
Dec-18
Dec-19
Dec-20
Dec-21
Dec-22
global GDP. Slowing demand for goods in these regions
should continue to weigh on production and export growth
Source: NBSC
in EM countries, including China. During periods of
CHINA REAL ESTATE CLIMATE INDEX
slowing global demand in the last cycle, China’s export
103
102
growth remained sluggish for up to two years (see top
101 chart).
100
While real GDP growth in China is likely to accelerate
Index Level
99
98
following the removal of Covid-19 restrictions, we believe
97 any rebound could prove bumpy until the population
96 achieves herd immunity and the property market begins
95 to stabilize (see bottom chart).
94
93
Broad-based regulatory changes and the PBOC’s
China Real Estate Climate Composite Index
92 unwillingness to stimulate via another major credit cycle may
limit the upside potential for the Chinese economy, and by
extension, the potential for multiple expansion for Chinese
Source: NBSC
westendadvisors.com | info@westendadvisors.com | 888.500.9025
equities. Macroeconomic Highlights Q1 2023 21
20230104-2661919US Dollar Modestly Overvalued, But Could Rise in Recession
US DOLLAR TENDS TO RISE DURING RECESSIONS
50 140
% Over/Undervalued vs USD (%)
40
30
130 Portfolio Impact: We believe the
20
10 potential for further USD
0 120
-10 upside is limited, as markets
-20 have priced in widening interest
-30 110
-40 rate and inflation differentials.
-50
-60 100 That said, recessionary periods
-70 are typically associated with US
-80 90
-90 Dollar strength, and the Japanese
-100
-110 80 Yen could also see material
upside if global growth
Dec-82
Dec-84
Dec-86
Dec-88
Dec-90
Dec-92
Dec-94
Dec-96
Dec-98
Dec-00
Dec-02
Dec-04
Dec-06
Dec-08
Dec-10
Dec-12
Dec-14
Dec-16
Dec-18
Dec-20
Dec-22
deteriorates.
EUR PPP % Over/Undervalued JPY PPP % Over/Undervalued
Trade Weighted Real Broad Dollar Index (RHS)
Source: WestEnd Advisors
The U.S. Dollar Index surged ~8% in 2022, the most since 2015, due to the Fed’s rapid tightening cycle as well as concerns
about global economic growth. A rising USD is beneficial for domestic investors and net importers, but it can be a headwind to
the earnings of U.S. based-firms that do business abroad. Additionally, depreciating foreign currencies weigh on dollar-
denominated returns for those investing overseas.
Looking ahead, we do not expect the USD to repeat its strong performance from 2022. The purchasing power parity framework
implies the USD is modestly overvalued vs European currencies and significantly overvalued vs the Japanese Yen,
which depreciated sharply in 2022 due to interest rate differentials and capital outflows.
That said, recessionary periods have often resulted in USD appreciation as investors seek safe-haven assets, which could
repeat if the global economic backdrop deteriorates significantly.
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 22
20230104-2661919Interest Rates & Inflation
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 23
20230104-2661919Compelling Fixed Income Return Potential After Dismal Year
BOND PRICES HAVE FALLEN TO GENERATIONAL LOWS...
120
Par-Weighted Avg Bond Price
115
Portfolio Impact: Coming off the worst annual
110
105 performance for U.S. bonds in over four decades, we
100 believe the prospects for fixed income returns will
95
90 improve moving forward as disinflation takes hold and
85 economic growth decelerates. At the same time, earnings
80
headwinds could pose further risks to equity markets in
75
70 2023. As a result, in balanced portfolios, we have
Jan-73
Jan-75
Jan-77
Jan-79
Jan-81
Jan-83
Jan-85
Jan-87
Jan-89
Jan-91
Jan-93
Jan-95
Jan-97
Jan-99
Jan-01
Jan-03
Jan-05
Jan-07
Jan-09
Jan-11
Jan-13
Jan-15
Jan-17
Jan-19
Jan-21
maintained an underweight allocation to equities and
an overweight allocation to fixed income.
Bloomberg US Agg Gov/Credit Total Return Value Unhedged USD
Source: WestEnd Advisors
...MAKING POTENTIAL FORWARD RETURNS MORE ATTRACTIVE The surge in interest rates in 2022, coupled with rising
30%
Current Level credit spreads, led to the worst annual performance for
2-Year Forward Total Return (Annualized)
25%
bonds since at least the early 1970s.
20%
15% The top chart shows that the par-weighted average bond
10% price for the U.S. Government/Credit Bond Index has
5% plunged to the lowest level since the early 1980’s.
0%
Historically, average bond prices at-or-below these
-5%
levels have been consistent with above-average
-10%
fixed income returns over the subsequent two years
-15%
70 80 90 100 110 120 (see bottom chart).
Par-Weighted Average Bond Price (Gov't/Credit Bond Index)
Source: WestEnd Advisors
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 24
20230104-2661919Recessions Create Opportunities Within Fixed Income
RE-STEEPENINGS SIGNAL ONSET OF RECESSIONS, NOT INVERSIONS
4.0
3.5 Portfolio Impact: As the Federal Reserve
3.0
remains firmly committed to reducing
Interest Rate Spread
2.5
2.0 inflation, we see a growing risk of an
1.5 economic recession. As such, in balanced
1.0
portfolios, we have reduced our overweight
0.5
0.0 of corporate credit and initiated a position in
-0.5 floating-rate Treasury notes. We have also
-1.0
added to our defensive long-duration
-1.5
-2.0 Treasury exposure, which we believe will
outperform if growth and inflation surprise
Jul-78
Jul-03
May-99
Sep-82
Dec-88
Aug-80
Apr-97
Sep-07
Dec-13
Aug-05
Apr-22
Nov-86
Nov-11
Jun-76
Jun-01
Oct-84
Jan-91
Feb-93
Mar-95
Oct-09
Jan-16
Feb-18
Mar-20
to the downside.
Recession 2Y-3M Spread 10Y-2Y Spread
Source: WestEnd Advisors
Many leading economic indicators suggest that the risk of a recession is elevated in the next 12 months, though the exact
timing of its onset is uncertain. As shown in the chart above, yield curve re-steepenings, not inversions, typically indicate a
recession is imminent. We see several opportunities to position accordingly within fixed income:
• Long-duration Treasury bonds have historically outperformed significantly during recessionary periods, and the risk of a sustained
inflationary spiral has diminished, in our view.
• Treasury floating rate notes are an attractive defensive allocation, in our view, as the Federal Reserve continues to raise policy rates
in order to control inflation. Floating rate securities are insulated from duration risk.
• Intermediate-and-long duration corporate bonds are yielding over 150 bps more than the equivalent-maturity Treasury securities,
and are also likely higher quality than short-duration and high-yield credit.
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 25
20230104-2661919Peak in Interest Rates May Be Approaching
SOFTENING NOMINAL ACTIVITY REDUCES UPWARD PRESSURE ON RATES
90.0 4.5%
Portfolio Impact: Given the largest
4.0%
annual interest rate increases in six
ISM Manufacturing New Orders
80.0
decades and a growing likelihood that
3.5%
70.0 the peak in long-term interest rates
3.0%
10-Year Yield
60.0
could be approaching, we believe the
2.5%
duration risk to the fixed income
50.0 2.0%
market has diminished. As such, we
1.5%
40.0 maintain an overweight of long duration
1.0%
bonds in balanced portfolios.
30.0 0.5%
20.0 0.0%
Sep-10
May-11
Sep-12
May-13
Sep-14
May-15
Sep-16
May-17
Sep-18
May-19
Sep-20
May-21
Sep-22
Jan-10
Jan-12
Jan-14
Jan-16
Jan-18
Jan-20
Jan-22
ISM New Orders (3 Month Average) ISM Prices (3 Month Average) 10-Year Yield
Source: Institute for Supply Management, WestEnd Advisors
Acute inflationary pressures and a rapid pull-forward in the Federal Reserve’s tightening timeline caused interest rates
across the curve to surge higher in 2022 by the most in at least 60 years. Looking ahead, we believe the upward
pressure on longer-term interest rates is likely to diminish as economic growth slows and inflation pressures begin to
moderate.
As shown in the chart above, longer-term interest rates tend to move lower during periods when leading economic
indicators, such as the ISM Manufacturing New Orders Index, signal declines in real economic activity. More
recently, the ISM Prices sub-component, a leading indicator of headline inflation, has moved sharply lower as well.
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 26
20230104-2661919Footnotes & Disclosures
On December 31, 2021, Victory Capital Holdings, Inc. (“Victory Capital”) acquired WestEnd Advisors, LLC (“WestEnd”). WestEnd, an SEC-registered
investment adviser, operates as an autonomous Victory Capital Investment Franchise. WestEnd’s active principals continue to be responsible for managing
the firm and its day-to-day operations. Registration of an investment adviser does not imply any level of skill or training. WestEnd manages equity securities
for individuals and institutional clients.
This report should not be relied upon as investment advice or recommendations, and is not intended to predict the performance of any investment. Past
performance is not indicative of future results. It should not be assumed that recommendations made in the future will be profitable. The information
contained herein is not intended to be an offer to provide investment advisory services. Such an offer may only be made if accompanied by WestEnd
Advisors’ SEC Form ADV Part 2. These opinions may change at anytime without prior notice. All investments carry a certain degree of risk including the
possible loss of principal, and an investment should be made with an understanding of the risks involved with owning a particular security or asset class. The
information has been gathered from sources believed to be reliable, however data is not guaranteed.
The Standard and Poor’s 500 Stock Index includes 500 stocks and is a common measure of the performance of the overall U.S. stock market. The MSCI
ACWI consists of 47 country indexes comprising 23 developed and 24 emerging market country indexes. The total return of the MSCI ACWI (Net) Index is
calculated using net dividends. Net total return reflects the reinvestment of dividends after the deduction of withholding taxes, using (for international
indices) a tax rate applicable to non-resident institutional investors who do not benefit from double taxation treaties. The Bloomberg Barclays US Aggregate
Treasury Index measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury. The Bloomberg Barclays US Aggregate Corporate
Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. An index is unmanaged and is not available for direct investment.
Any portfolio characteristics, including position sizes and sector allocations, among others, are generally averages and are for illustrative purposes only and do
not reflect the investments of an actual portfolio unless otherwise noted. The investment guidelines of an actual portfolio may permit or restrict investments
that are materially different in size, nature, and risk from those shown. The investment processes, research processes, or risk processes shown herein are for
informational purposes to demonstrate an overview of the process. Such processes may differ by product, client mandate, or market conditions. Portfolios
that are concentrated in a specific sector or industry may be subject to a higher degree of market risk than a portfolio whose investments are more
diversified.
Holdings, Sector Weightings, and Portfolio Characteristics were current as of the date specified in this presentation. The listing of particular securities should
not be considered a recommendation to purchase or sell these securities. While these securities were among WestEnd Advisors’ strategies’ holdings at the
time this material was assembled, holdings will change over time. There can be no assurance that the securities remain in the portfolio or that other securities
have not been purchased. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities
presently in the portfolio. Individual clients’ portfolios may vary. Upon request, WestEnd Advisors will provide a list of all recommendations for the prior year.
westendadvisors.com | info@westendadvisors.com | 888.500.9025 Macroeconomic Highlights Q1 2023 27
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