Greetings from all of us at BSW! Through early 2023 we have enjoyed catching up with many of you during Q1 check-ins, strategy reviews and tax planning sessions.
Like baseball teams regrouping for spring training, we believe this is the time of the year to take inventory of assets, lay out plans for the long season ahead and maybe even make some trades. In our second update of the year, we’ll hit on some of our favorite players (investments) this year and who we feel still needs to work out some kinks.
Happy International Women’s Day!
This is also the time of year when we collectively celebrate International Women’s Day, March 8th. #EmbraceEquity is this year’s theme and something that BSW takes to heart and, we believe, is part of our DNA. As a GEN Certified firm, we have committed to gender equity and believe we are held to the gold standard of excellence across five principles of workplace culture.
In our opinion, a company can have the best product or service in the world, but when you boil it down, a firm is only as good as the people who contribute to its success. Studies have shown that workplace diversity improves multiple performance metrics; especially having diversity among executives and board members. As part of our Values Aligned, ESG, and Impact investment offerings, we attempt to allocate to managers that favor companies that embrace workplace equity.
The Story of the Market
The story of the market in 2022 has been inked and is now on the shelf – you might find it under the themes Drama/Thriller/Coming of Age. While the story of 2023 is still being written, we sense that a few of the chapters will be familiar. Our main antagonist from 2022, Mr. Inflation, is still playing a lead role, as is our protagonist, Fed Chair Powell.
Reports show inflation is still running well above the Fed’s target of 2%, which has meant that the Fed has remained hawkish in its comments and actions. The market is now pricing in a Fed funds rate well above 5.25% and interestingly, most market participants now do not expect the Fed to start lowering rates until well into 2024.
Just like major league baseball managers who will have to adapt to rule changes to the game this year (bigger bases, pitch clock, shift limits), investors will likely have to shift to the new reality of higher rates for longer. While the BSW playbook is always subject to change with the changing investment landscape, for now this is how it’s sketching out:
Cash gets our vote for Most Improved this year. But not any cash. Cash in the bank is still, in our opinion, unimpressive. Traded money market funds are our real MVP. Cash is no longer boring, with yields topping 4.5% and likely to go higher. Timing is, in many ways, the key here. Funds needed in the short term can find a home here, but funds intended for investment longer than 1 year should probably look to an old favorite that has found its swing again – bonds.
It’s been a while since yields in investment grade bonds have been this high. Our fixed income managers have been able to buy tax-free municipal bonds at ~5% taxable equivalent yields lately. In our opinion, this is attractive – both from a portfolio buffer standpoint and an after-inflation (or real yield) standpoint. While we can’t be sure what inflation will be over the next 10 years, if the Fed has any say, it should be closer to 2-3%, making today’s 5% a valuable player in any portfolio.
It might be a while before stocks find their groove again. Last year saw equities fall from what we viewed as very high valuations to now more normal valuations. Notice I didn’t say cheap. Given the interest rate environment, high labor costs and the potential for margin compression, we think stocks might not pick a decisive direction to head this year. We have already seen this play out as the S&P 500 jumped out of the gate this year up 9%, only to fall back to its current March 7th level of up ~4%.
As the saying goes, in periods of inflation you want to own things that hurt when you drop them on your foot. This held true last year, and we’d generally expect more of the same going forward. However, we do expect most real estate sectors to go through a transition period of prices adjusting lower in response to higher mortgage costs. BSW real estate managers, historically, have been able to take advantage of these types of environments. As forced sellers (maybe those that need to refinance at today’s higher rates) seek operators in a position of financial strength to get them out of dire straits, deals are done at favorable terms to those who are reliable and can close quickly.
Other real assets like timber, farmland and infrastructure investments look to take a prominent role in portfolios looking forward. As inflation creates an environment where prices can be hiked, many of these types of investments find themselves in the catbird seat. This is simply because many are backed by fixed cost equipment, land and machinery. As prices for food, timber and resources go up, the added profit goes right through to the bottom line.
While we believe the longer-term prospects of private equity are still solid, we expect that last year’s stock market turmoil will negatively impact private equity with a lag this year. Due to private equity typically being valued on a delayed basis, markdowns in private fund values should be expected. The other near-term obstacles for private equity, as we see it, are higher interest rates (fewer leveraged buyouts) and a stock market that is still not conducive to initial public offerings (IPOs). IPOs have been a primary way to monetize private holdings. Until there is some stability within the market, private firms generally hesitate to tap this source for fear of not getting reasonable valuations.
One thing is for sure – this year will not be boring. We’ve got lots to discuss, plan for, and reflect upon. As an important reminder, all the crazy stuff that seems to come at us investors non-stop is not new. We have dealt with most of it before – war, debt ceiling drama, interest rate hikes, and recession fears. We have attempted to inform our investment allocations and plans with these events in mind.
If there is an investment question or concern on your mind, please feel free to reach out. Sometimes just hearing our side of the stories you hear on CNBC or read in the papers can help to reassure you.
Until next time –
Director of Public Investments