Fourth Quarter 2022

Wildfires can play an essential role in reshaping ecosystems by clearing out dead matter and returning nutrients to the soil which supports future plant and animal life.  Recognizing these benefits does not ignore the pain fires cause including death, smoke pollution, and destruction of homes and habitats. Recessions also have this duality.  Companies may fail and households could see income decline undermining financial security.  Yet there are positive aspects to the economic cycle turning over. Lower demand can alleviate high inflation. Companies that close free up capital for more productive uses. Price declines across assets creates better entry points for investors. As we enter 2023, we keep in mind the positives that evolve during a period where we expect to have some challenges.

While a recession is not a given, the risk is high as real personal income increases are stagnating with growth in real personal spending and industrial production decelerating.  The fuel for a recession has been tighter financial conditions reflecting the Fed’s increase in the policy rate with the goal of pushing inflation down. For fixed income investors, the broad back up in interest rates in 2022 has resulted in Treasury yields not seen for over a decade.  This higher income profile across risk-free rates has also translated to attractive yields across spread sectors.  At these levels of interest rates, there is substantial protection against rates moving higher.  While we expect higher rate and spread volatility early in the year, the fixed income sectors should generate attractive total returns in 2023.

As we get closer to the end of the U.S. monetary tightening cycle, which is expected in the first half, market participants have begun to price in Fed rate cuts later in the year.  While we do believe that Treasury rates can decline this year, we think the Fed will likely pause and reflect, rather than pivot and reduce policy rates.  The Fed Funds rate could remain elevated for an extended amount of time to provide the Fed sufficient visibility that the current high inflationary period will end.

We enter 2023 with investment grade corporate spreads towards the lower end of the range in place since last spring with aggregate corporate fundamentals only now beginning to reflect the headwinds of the expected slowdown. Technicals are mixed with a lower level of issuance and retail flow stabilization being supportive while foreign demand is anticipated to decline.  While there are cross currents and we expect spreads to widen over the near term, decade high yields provide a good buffer to support total returns.

Valuations for structured securities are favorable.  The ABS sector’s short duration, high quality and structural protection make it an attractive investment that we will look to increase.  Non-agency CMBS is trading cheap to corporates but anticipated secular challenges in commercial real estate have us being very selective. The persistence of rate volatility and potential supply challenges posed by the continued reduction of Fed holdings have kept us neutral MBS. We will look to build exposure into spread widening.


Past performance is not a guarantee or a reliable indicator of future results. Investing involves risk; principal loss is possible. Fixed income market data provided is drawn from the Bloomberg Indices for informational use only and is not representative of account performance. It is not possible to invest directly in an index. Investors should carefully consider risk when investing in bonds or other securities, which include, but are not limited to, default, credit rating, interest rate, duration, prepayment, liquidity, and structural risks. Securities are also subject to general market risks due to factors that affect the overall market, which may include, but are not limited to, government actions, investor behavior, and economic conditions. Economic conditions may be influenced by liquidity risk, geopolitical risks, monetary and fiscal policy, interest rate risk, and inflation, among others. There is no guarantee that investment strategies presented will work under all market conditions. Risk management processes including diversification cannot eliminate the risk of losses nor assure the likelihood of a gain. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn or volatility in the market. Refer to the Legal & Disclosures section for additional disclaimers and disclosures regarding performance, risk, and investment process.

Information presented is for informational purposes only. It is not intended as investment advice nor an opinion or a recommendation as to the appropriateness of investing in any particular security, asset class, strategy, or product. Nothing in this publication is intended to be relied upon as a forecast or research; legal, tax, securities, or investment advice. Nothing in this publication is a solicitation of any type.

This commentary contains Pugh Capital’s opinions based on the information available at the time of the analysis. Opinions, outlook, and strategies are subject to change without notice. Statements concerning financial market trends are based on information available and current market conditions which will fluctuate. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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Source: Pugh Capital, Bloomberg, and Bloomberg Indices.

As of December 31, 2022.