Investors guide to the first half of 2023 — and beyond

As the markets and economy continue their reset, these insights can help you tailor your portfolio to your risk tolerance, goals and personal investing style

Photo of stock market analysis chart showing trends superimposed over image of George Washington on a dollar bill

“Stock valuations, while not cheap, have become more attractive, and rising rates have created new income opportunities.”
— Chris Hyzy, Chief Investment Officer, Merrill and Bank of America Private Bank

“HAVE PATIENCE,” SAYS CHRIS HYZY, Chief Investment Officer for Merrill and Bank of America Private Bank. It may take another six to nine months for the markets and economy to “reset” after a period of historic challenges, including the highest inflation and the quickest interest rate increases by the Federal Reserve (the Fed) in 40 years.

“It’s possible that the economy will enter a recession later this year or in early 2024,” Hyzy says. It could be brief and mild if we see a sharp drop in inflation, he adds. “That might prompt the Fed to pause its rate increases and start focusing on both inflation and growth, instead of just inflation.” Other positive signals to watch for are a bottoming in the leading economic indicators, stabilization in corporate earnings and a weakening U.S. dollar, all of which could lead to a new bull market phase by mid to late 2023, Hyzy says.

What are the economy and markets doing right?

Please read important information at the end of this program. Recorded on 02/07/2023.

With all the talk about high inflation and interest rates, global turmoil and recession, you could easily overlook that so far, 2023 has been a pretty good year for many investors. Surprisingly good, in fact.

Hello, I’m Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank.

CHRIS HYZY

Chief Investment Officer

Merrill and Bank of America Private Bank

Let’s look at a few of those surprises.

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Early 2023 surprises

· January was a strong month for stocks

· Small-cap stocks have outperformed expectations

As-of Feb. 7, 2023

U.S. stocks posted strong gains in January, major global indexes started the year up 5% or more, and even beleaguered tech stocks have rallied. Small-cap stocks have done significantly better than expected at a time when inflation and slower economic growth seemed likely to pressure them.

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Early 2023 surprises

· January was a strong month for stocks

· Small-cap stocks have outperformed expectations

· Fed raised rates by only 0.25% at its Feb. 1 meeting

As-of Feb. 7, 2023

The Federal Reserve recently raised interest rates by only 25 basis points. That’s about half the increase we saw in December and a sign of Fed confidence that inflation is finally moderating.

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Early 2023 surprises

· January was a strong month for stocks

· Small-cap stocks have outperformed expectations

· Fed raised rates by just 0.25% at its Feb. 1 meeting

· Europe’s economy has been looking up

As-of Feb. 7, 2023

And there was a big surprise overseas: Europe. A mild winter has kept energy prices under control despite the war in Ukraine, and the reopening of China, Europe’s largest trading partner, has boosted the economy. Add it all up and European stocks have thus far outperformed expectations.

You may be asking, “Why are market watchers downplaying the good news?” We’re wondering the same. Some worry about lack of liquidity in the bond markets or that money supply growth turned negative. Others say the recent tech rally is misleading and stock valuations must drop further before they finally bottom out.

These are all valid concerns. Now, we’re not out of the woods yet, and we still think a mild recession is likely later this year or in early 2024.

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We believe markets may have already

factored in some of the biggest risks

But we also believe markets may have already factored in some of the biggest risks that we have all been discussing for quite some time … and what we are seeing is a glimpse of a new and improved economic and market cycle ahead.

How can you prepare?

We suggest a two-part approach:

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2 approaches you could take to prepare

· Consider more “defensive” investments for now:

o U.S. Treasuries and municipals bonds

o Healthcare and energy stocks

First, consider an active approach on defense for the next several months of uncertainty. More attractive yields likely mean bonds such as U.S. Treasuries and municipals are competitive again and can provide a good ballast to portfolios. Among stocks, we are currently favoring healthcare and energy sector stocks for potential total return, including dividends and solid earnings growth.

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2 approaches you could take to prepare

· Consider more “defensive” investments for now:

o U.S. Treasuries and municipals bonds

o Healthcare and energy stocks

· Consider more “offensive” investments later this year:

o Value and small-cap stocks

o European and emerging markets

But we also believe you should consider shifting to offense for a time of greater stability 12 to 18 months out. You might already start looking for opportunities to strategically add exposure to value stocks, small-caps, and European and emerging markets stocks, among others.

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Remember to stay diversified across

and within different asset classes.

As you look ahead for opportunities, though, remember it’s important to stay diversified across different types of assets and within each asset class. Market direction can change quickly and many times without clear signals.

If you’re working with an advisor, be sure to speak with them about steps to consider based upon your goals and what’s in your best interest. And we’ll continue to keep you posted as events unfold.

Thank you.

Important Disclosures

The opinions expressed are as of the date of this video and are subject to change.

Investing involves risk, including the possible loss of principal. Past performance is no guarantee of future results. It is not possible to invest in an index.

All recommendations must be considered in the context of an individual investor’s goals, time horizon, liquidity needs and risk tolerance. Not all recommendations will be in the best interest of all investors.

Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets.

This material does not take into account a client’s particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security or investment strategy. Merrill offers a broad range of brokerage, investment advisory (including financial planning) and other services. There are important differences between brokerage and investment advisory services, including the type of advice and assistance provided, the fees charged, and the rights and obligations of the parties. It is important to understand the differences, particularly when determining which service or services to select. For more information about these services and their differences, speak with your advisor.

Bank of America, Merrill, their affiliates, and advisors do not provide legal, tax, or accounting advice. Clients should consult their legal and/or tax advisors before making any financial decisions.

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The Chief Investment Office (CIO) provides thought leadership on wealth management, investment strategy and global markets; portfolio management solutions; due diligence; and solutions oversight and data analytics. CIO viewpoints are developed for Bank of America Private Bank, a division of Bank of America, N.A., (“Bank of America”) and Merrill Lynch, Pierce, Fenner & Smith Incorporated (“MLPF&S” or “Merrill”), a registered broker-dealer, registered investment adviser and a wholly owned subsidiary of Bank of America Corporation (“BofA Corp.”).

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May Lose Value

Despite expected continuing volatility through the first six to nine months of the year, there are some steps you can consider now, Hyzy adds. “Stock valuations, while not cheap, have become more attractive, and rising rates have created new income opportunities.” A recent Portfolio Positioning report from the Chief Investment Office, “Considerations Through the Reset to the Next New Cycle,” details approaches tailored to different investing styles and priorities. It all starts with your personal investing preferences and goals, Hyzy says. Explore the areas below that match your main investing focus.

Fast track: Select your investing priority

Balance and diversification
Putting excess cash to work
Retirement cash flow
Long-term growth
Conserving my assets
Exploring alternative investments

I’m concentrated on balance and diversification

“Your portfolio should include investments across and within asset classes. When volatility is high, that’s essential,” Hyzy says. Consider large and small companies, growth (stocks that may outperform the market) and value (those that may be currently underpriced) and U.S. and international stocks. Bond investors should consider high-quality government, corporate and international bonds. Amid volatility, high-quality investments and defensive areas such as healthcare and utilities should be considered.

I want to put excess cash to work

“For the first time in more than a decade, U.S. Treasurys are providing income that’s higher than the expected rate of inflation.”
— Chris Hyzy, Chief Investment Officer, Merrill and Bank of America Private Bank

People sometimes wait until markets surge before investing. Yet that can mean paying elevated prices, Hyzy notes. “The recent market weakness creates opportunities,” he adds. Downgraded corporate earnings estimates, inflation-related volatility, and negative sentiment over European stocks could offer various ways to enter markets at attractive prices in the next few months. This is not the same as market-timing — a high-risk activity that usually fails, Hyzy stresses. “It’s essential to invest in a disciplined manner.” Dollar-cost averaging (methodically purchasing assets at regular intervals) could help you enter markets in a disciplined way, he suggests.

Generating cash flow for retirement is my top concern

There’s good news for those in or nearing retirement and looking for ways to boost investment income: “For the first time in more than a decade, U.S. Treasurys are providing income that’s higher than the expected rate of inflation,” Hyzy notes. And while falling bond prices (a result of rising rates) worry traders, income-focused investors who hold bonds to maturity receive the same interest and principal regardless of price fluctuations.

Consider Treasurys, Agency Mortgage-Backed Securities and investment-grade corporate bonds, Hyzy suggests. Keep in mind that bond income is taxed as ordinary income rather than at lower capital gains rates. If rising bond income creates tax concerns, options might include shifting some bonds to tax-advantaged accounts or investing in municipal bonds. Consult with your tax professional as well as your financial advisor, says Hyzy.

“Patient investors may find relative bargains in fundamentally solid companies poised to rebound when the reset period is over.”
— Chris Hyzy, Chief Investment Officer, Merrill and Bank of America Private Bank

I’m focused on long-term growth

Volatility, which prompts short-term investors to divest from out-of-favor sectors, creates opportunities for those with a longer horizon. “Patient investors may find relative bargains in fundamentally solid companies poised to rebound when the reset period is over,” Hyzy says. Areas such as digitization and automation, climate change mitigation, clean energy and others may hold promise. Yet such investments could decline further amid short-term volatility, so it’s important to consider the risks and maintain a long-term perspective, Hyzy says.

My priority is conserving capital

Short-term bonds could lower your portfolio risks while generating some current income, says Hyzy. “Shorter-term yields are more attractive than they’ve been in a decade, providing solid cash flows while the Fed is bumping rates.” The trade-off: Short-term bonds typically offer lower yield than long-term bonds. A purely defensive portfolio may not provide capital appreciation or even keep pace with inflation and reinvesting for growth when the reset is over may be costly as asset prices rise.

I’m interested in exploring alternative investments

For qualified investors alternative investments (AI) such as hedge funds, private equity or real estate offer potential diversification, volatility control or enhanced returns. “These may perform relatively well because of their low correlations to traditional asset classes or because they tend to do well during times of high inflation,” Hyzy notes. For example, some real estate strategies benefit from the ability to charge higher rent. As with traditional asset classes, diversification is essential, Hyzy notes. And investors should keep in mind that AI investments tend to be less liquid than assets such as stocks or bonds.

Whether you fit neatly into one of the groups described above or your needs encompass several of them, it’s important to consider any portfolio changes in the context of your overall financial goals, Hyzy says. Ask your advisor what steps might best prepare you for the next several months and beyond.

Important Disclosures

Investments have varying degrees of risk. Some of the risks involved with equity securities include the possibility that the value of the stocks may fluctuate in response to events specific to the companies or markets, as well as economic, political or social events in the U.S. or abroad. Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration. Bonds are subject to interest rate, inflation and credit risks. Treasury bills are less volatile than longer-term fixed income securities and are guaranteed as to timely payment of principal and interest by the U.S. government. Mortgage-backed securities are subject to credit risk and the risk that the mortgages will be prepaid, so that portfolio management may be faced with replenishing the portfolio in a possibly disadvantageous interest rate environment. Investments in foreign securities (including ADRs) involve special risks, including foreign currency risk and the possibility of substantial volatility due to adverse political, economic or other developments. Keep in mind that dollar cost averaging cannot guarantee a profit or prevent a loss. Since such an investment plan involves continual investment in securities regardless of fluctuating price levels, you should consider your willingness to continue purchasing during periods of high or low price levels.

Alternative investments are intended for qualified investors only. Alternative Investments such as derivatives, hedge funds, private equity funds, and funds of funds can result in higher return potential but also higher loss potential. Changes in economic conditions or other circumstances may adversely affect your investments. Before you invest in alternative investments, you should consider your overall financial situation, how much money you have to invest, your need for liquidity, and your tolerance for risk. Alternative investments are speculative and involve a high degree of risk.