Our 2023 economic and market outlook and you

What lies ahead

We all know it’s been a tough year for investors. We’ve been through monetary tightening and persistent inflation across global economies. We’ve seen an unprecedented period of volatility in the bond market, where such fluctuations are highly unusual. So what does the future look like and how do we move forward?

The good news is that Vanguard’s 2023 outlook actually puts us in a better place than where we were 12 months ago from a return expectation standpoint. There are some differences when you start to break down stock markets versus fixed income markets. We’ll get into all that, and what it means for you, in more detail below.

Beating back inflation

For the last few years, we’ve seen an increase in inflation driven by an imbalance in supply and demand. While global supply chains are still recovering from the effects of the COVID-19 pandemic, households and businesses are driving demand, thanks to the economic stimuli they received. In other words, people are willing to pay more for products and services, which results in increased prices and elevated inflation.

Additionally, the war in Ukraine that started in February of 2022 has carried on, potentially leading to another surge in energy and food prices. Inflation has continued to trend higher across most economies, in many cases setting multidecade highs.

We expect consumer behavior to begin the process of normalizing and supply pressures to start stabilizing in the months ahead. We’ve seen central banks take action to combat the persistent and broad-based inflation through monetary tightening, and we expect that to continue in the months ahead. In our view, this will help bring down the rate of inflation. Consequently, we can also expect to see some volatility in asset prices. 

Recession expectations

We believe that rapid monetary tightening aimed at bringing down inflation will ultimately succeed but at a cost: We predict a high likelihood of a global recession in 2023. However, the pain of a recession in the short term is better than the inflationary pressures that will plague households and businesses if aggressive action isn't taken.

When it comes to recession, I advise my clients not to focus too much on the technical term. That's because it's something of a backward-looking concept. When you’re categorizing a recession, you’re using previous data to make a determination.

For individual investors, that means you’ve already experienced at least part of the contributing factors to a recession by the time it gets officially “declared.” There may still be a few bumps ahead, but you’re that much closer to the end of the tunnel and the turning point when we move into recovery.  

The forecast for fixed income

We’ve been through a unique time for fixed income investments. It’s been many years since the Federal Reserve has raised rates in such significant amounts and in such a compressed time frame. That combination has had a 2-part impact on fixed income.

The painful part has been the inverse relationship with interest rates and bond prices. That’s our experience today. But on the back end of that, we’re moving from a decade-plus period of very low interest rates into a higher interest rate environment. Rate hikes can create short-term pricing volatility but can also result in much better bond yields moving forward.

Although the volatility is unexpected, staying patient and sticking with your plan is critical. This is especially true for preretirees and retirees, who will benefit from greater income generation as part of their more conservative allocations.

What’s the outlook for equities?

When it comes to stock markets, I would point to modest improved expectations. We expect slightly better average returns as compared to last year’s economic outlook, but not by huge percentages. So it’s important to temper your expectations for the future, even with the drop we’ve already experienced.

Although the stock market recovered swiftly in 2021 after the early part of 2020, U.S. equities were more overvalued last year than at any other time since the dot-com bubble. The fact that we’ve had a pullback brings stock valuations into more realistic territory.

Our value framework suggests that stock valuations still don’t reflect current economic realities, so it’s important to proceed with caution. We could continue to see volatility for some time.  But we foresee a better outlook for equities, global equities in particular, where our economists believe valuations look a little more reasonable.

These variations are one reason why I emphasize the importance of keeping your portfolio diversified. This could mean addressing underweighted and overweighted assets in your sub-allocations.  

What about the 60/40 portfolio?

I’ve been asked many times this past year whether the unique market conditions we’ve just seen suggest the death of the 60/40 portfolio. My perspective—and Vanguard’s—is that one year of atypical markets should not cancel out decades’ worth of smart planning. We stick to strategies that have consistently worked over the long term.  While the 60/40 portfolio continues to be a sound strategy, every situation is different. I work with clients to develop personalized financial plans that take their individual goals and circumstances into account and that risk-adjust their portfolios throughout the course of their lives.

What does all this mean for you? 

Naturally, I tailor my conversations to the needs of each individual client in terms of what’s important to them and what applies to their situation. We can’t control what happens in the economy, but we can look at their portfolio and see if any adjustments would make sense. For every investor, time horizon is a major consideration. So it’s important to think about what stage of life you’re in and whether your financial goals have changed.

For the younger investor or anyone in the accumulation phase of life, expected returns for the equity markets on average are still better than the fixed income markets. From a long-term growth perspective, in terms of outpacing average inflation over an extended time frame, it makes sense for you to have exposure to the stock markets. If you’re an accumulator, you have time to take on more risk since you likely won’t be accessing most of your money for several years.

For those who are preretirees or retirees, this past year has been a great reminder to have a comprehensive plan for retirement. That means not only maintaining your investment portfolio, but also making sure you have an appropriate emergency fund as well as a spending fund to cover expenses. And always keep the big picture in mind—because we know that from time to time there are going to be one-off years like the one we’ve just experienced.

For those already in retirement, who are withdrawing from their portfolios, this change in interest rates should mean much better yields on their fixed income investments. If you can weather this period of rising interest rates, that will mean greater income generation in retirement, which will be a big help in covering your expenses.