2023: The Year Of Real Assets

From decades-high inflation and rising interest rates to a collapse in the stock market, 2022 has not been for the faint of heart. And, as we head into 2023, questions remain about the future of the economy – both within the US and across the globe.

With even the most experienced investors looking to help safeguard their portfolio from future risk, let’s take a closer look at the economic events that transpired in 2022 and explore where investors might find refuge in the new year.

2022: A Tumultuous Year

Inflation

Inflation became a dominant concern for consumers in 2022. Americans had more disposable income as the economy reopened – the result of monetary policy enacted during the Covid-19 pandemic – which placed upward pressure on the price of many goods. Meanwhile, global lockdowns and worker shortages derailed supply chains around the world, further driving up prices. As a result, the Consumer Price Index (CPI) peaked at 9.1% in June, sending prices to their highest levels in 40 years.

Despite inflation cooling to 7.1% in November, many essentials, like food and shelter, continue to experience price increases. Looking ahead, some experts worry that China’s pullback on strict COVID-19 testing and quarantine requirements may cause a rebound in global inflation in the new year.

Tightened Monetary Policy & Rising Rates

In an attempt to deflate price growth, the Federal Reserve increased its trend-setting rate at one of the fastest paces in modern history. In February 2022, the effective Federal Reserve rate was just 0.08%. At the time of writing, this rate has soared to 4.33% – and with further rate hikes expected going forward.

With rates on the rise, intermediate-term bond prices have been plummeting, down nearly 13% through the end of November. The Fed has also eased bond purchases, reducing its balance sheet from almost $9 trillion to $8.5 trillion, further dropping bond prices. As a result, companies shied away from creating debt instruments, and the issuance of U.S. non-financial investment grade bonds dropped 32% in 2021 and 28% in 2022 through October.  

As the Fed raises interest rates, mortgage rates have jumped as well. The one-year adjustable mortgage rate has more than doubled to 5.6%, while the 30-year mortgage rate topped 7%, hitting a 20-year high.

Market Turbulence

2022 was a brutal year for the stock market, driven in large part by soaring inflation and the Fed’s aggressive response. All three major averages are on pace to post their worst year since 2008; the Dow is down 8.15% for the year, the S&P has shed 18.63%, and Nasdaq has plummeted 31.55%. Meanwhile, U.S. small-cap stocks touched a year-to-date loss of 27% in both July and September. As of mid-December, the S&P Small Cap 600 was down nearly 18% for the year.

Year-over-year corporate earnings per share grew just 2.1%, a figure substantially lower than the 5-year average of 8.7%. Moreover, just 71% of companies are beating earnings estimates – 6% less than the 5-year average.

Against this backdrop, many predict that the stock market will continue to struggle through 2023; the average price target for the S&P 500 next year is roughly 4,000, implying stocks will rise just 4%.

Global Challenges

Many economies have been hit with rising prices in the wake of the pandemic. U.K. inflation, for example, hit 11.1% in October, a 41-year high, while Germany topped 10%. As a result, many major central banks are rising interest rates at rapid rates, sending global markets into distress. As of mid-December, the EURO STOXX 50 Index was down over 11%, while the Chinese and Hong Kong exchanges were also down double-digits.  

Meanwhile, the ongoing Ukraine-Russia war is perpetuating supply constraints around the world. Year-over-year Ukraine grain exports this summer were down 46% (roughly 2.6 million tons). Meanwhile, Russia had been exporting 560,000 fewer barrels of oil per day compared to before the war. As a result, commodity prices remain elevated, with the cost of food up 11.2% from last year and energy up 19.8%.

How To Help Safeguard Your Portfolio in 2023

Investing in tumultuous times can be a stomach-churning exercise. With continued inflation and market turbulence all but certain in the new year, investors far and wide are looking for new ways to protect their portfolios from potential risk.

Here are four reasons why real assets might be the solution you’ve been looking for:

1. Diversification

The classic portfolio mix calls for a 60% allocation to equities and a 40% allocation to fixed-income securities. However, with both stocks and bonds experiencing massive sell-offs this year, the traditional portfolio allocation may not offer the hedge against volatility it once guaranteed.

Thus, 2023 might be an opportune time to rebalance your investments. Investment vehicles like ETFs or mutual funds, for example, can help reduce the volatility of investing in individual stocks. Stocks within the healthcare or energy sectors, which tend to have reliable revenues throughout the economic cycle, can also help stabilize an investment portfolio.

However, those looking for independently-moving assets may want to consider real assets, like real estate or farmland. Because they are not often exposed to speculative trading in public markets, real assets have historically low or negative correlations to traditional stocks and bonds, as well as to each other. In the last three decades, farmland, for example, has had a -0.06 correlation to stocks and -0.24 to bonds.

2.  Stability

For many investors, “boring” is better. While these investments, such as high-yield savings accounts, money market funds, and government bonds, aren’t likely to deliver market-beating returns, they can help buoy your portfolio during volatile periods.

But with the unpredictability of both the stock and bond markets today, these formerly reliable investments are anything but boring. Some alternative investments, however, can help bring stability to a portfolio, even in today’s adverse conditions.

Real assets, in particular, are not likely to experience swings like those seen in the markets. Regardless of macroeconomic conditions, the demand for these assets, such as shelter, food, and energy, is inelastic, meaning it tends to remain consistent throughout the year. From 1991 to 2021, average annual real estate returns had a standard deviation of 7.73%, while farmland’s standard deviation was just 6.75%. In comparison, the S&P 500’s standard deviation topped 16%.

Many real assets have proven to be comparatively resilient during market-wide recessions, too. During the 2008 Great Recession, stock prices dropped 52%. Though global bonds posted a positive return, high-yield bonds lost 26.2% while emerging market debt lost 12%. Meanwhile, farmland yielded a positive quarterly return of 7.33%.

Today, despite stocks and bonds on track to finish the year in red, both farmland and real estate are expected to post net positive gains in 2022. Year to date, the NCREIF Real Estate and Farmland indices have returned around 9% and 6%.  

3.  Long-Term Fundamentals

Investing in stocks is one of the best ways to grow wealth over the long term; over the last 30 years, both the Dow Jones Industrial Average and S&P 500 have grown in value.  

However, as we’ve just discussed, stock market returns can vary widely in the short term. The performance of a particular stock is dependent on a number of unpredictable factors, ranging from market demand to the underlying value of the company. And, as we’ve witnessed over the last few years, the value of stocks can drop just as quickly as they rise.

For investors nearing retirement, or for those who simply can’t stomach potential losses, this year might be an opportune time to seek assets with a steadier history of appreciation.

Real asset returns are driven by several long-term structural trends that may be beneficial for investors. On the demand side, a growing global population is fuelling continued demand for real asset products such as timber and food. Yet, the supply side is limited, given the finite availability of many of these resources. Driven by this stable supply-demand dynamic, real assets are well-positioned to increase in value year after year.

Home prices in the US, for example, have more than doubled since the early 1960s.

4.  Inflation-Hedge

Real assets have provided a historically strong hedge against inflation over the last several decades. This is because the value of real assets is derived from their underlying products, which, unlike stocks or bonds, are more likely to retain value in inflationary environments.

Farmland returns, for example, are inherently tied to food prices, which tend to rise in conjunction with inflation. As a result, rising inflation tends to result in higher farm incomes, which, in turn, can lead to higher land values.

With food prices 10.6% higher than they were last year, average net farm income increased by 5.2% over the last year. Meanwhile, farmland real estate values topped $3,800 this year, up from $3,160 in 2020.

A look Ahead

Coming off a year of instability, disruption, and economic volatility, the new year represents a fresh start. And while 2023 is likely to be driven by continued surging inflation and interest rate hikes, there may be an investment opportunity in real assets.

With the potential to help enhance diversification, preserve capital, hedge against inflation – and in some cases – boost overall portfolio value, 2023 just may be their year.