Three Themes That Could Define 2023 for Income Investors

For investors seeking income, there are some important ideas worth keeping on your radar.

What You Need To Know

While fixed-income markets have started pricing interest-rate cuts for the cecond half of 2023, we think central banks are more likely to pause rates, not to cut them.
We believe investors should consider keeping their interest-rate exposure relatively low and increase allocations to high-quality credit and defensive equities.
While we suggest a cautious approach to US equities, we also see a potential for a relative recovery in international markets. Consider maintaining portfolio liquidity¹ to take advantage of market dislocations.

With global bond yields up and dividend stocks looking increasingly attractive, 2023 could be a good year for income-seeking investors.

But there are several macro crosscurrents at play, so it’s important to not lose sight of the big picture. With that in mind, here are three broad themes that we think should be top of mind for income investors (actually, for all investors) in 2023.

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THEME 1: Timing the Global Recession
From an economic-growth perspective, a soft and shallow global recession is our base case as of this writing, although we're carefully monitoring both upside and downside risks. On one hand, a more severe downturn could materialize if financial-sector fragilities were to be exposed, including high levels of private-sector leverage, falling real-estate prices, and the risk of permanent capital erosion from write-downs in private investments. On the other hand, a stronger-than-expected or faster-than-projected rebound of China’s economy could provide a global economic stimulant, with increased Chinese demand for crude oil, copper, and other commodities benefitting exporters of such goods. While we believe the true impact of China’s economic reopening is more likely to be felt later in the year (given the recent COVID-19 wave that swept across the country), the actual timeline will be worth tracking.

Meanwhile, global inflation appears to have moderated somewhat, with consumers in many countries now experiencing some relief from the inflationary pressures that had been building for the past year or so. Recent cyclical weakness, coupled with a milder-than-expected winter-heating season in Europe thus far, have led to falling energy and food prices worldwide. Fixed-income markets have recently started to price in interest-rate cuts in the second half of 2023, on the back of lower global growth forecasts. However, we believe economic conditions would need to deteriorate meaningfully for the major central banks to change course on monetary policy. In our judgment, a shallow, soft recession wouldn’t be sufficient to reduce inflation to central banks’ target levels. We therefore think pauses in their interest-rate hikes later this year look more plausible at this point than rate cuts.

Actionable takeaways for income investors to consider:

Keep portfolio duration² (interst-rate exposure) relatively low.
Increase allocations to high-quality, short-duration credit.
Maintain allocations to defensive equities and real assets.³

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Theme 2: "Go Global" in the Search for Return

Concerns regarding valuation and a challenging outlook for corporate profits could remain stiff headwinds for US equities in 2023. While a soft and shallow US recession is our base case, bottom-up earnings estimates look overly ambitious, whereas corporate earnings have historically tended to drop 20% to 30% ahead of recessions. We therefore suggest that allocators approach the US equity market with caution and selectivity, focusing on pockets of opportunity where valuations may be attractive. From a volatility perspective, fears around recession risk often contribute to heightened single-stock volatility (especially within cyclical sectors), even if index volatility reverts back to lower levels.

We suggest that allocators consider approaching the US equity market with caution and selectivity, focusing on pockets of oppurtunity.

Actionable takeaways for income investors to consider:

Look for credit and equity opportunities outside the US, notably in Asia and Europe.
Within the US:
- Favor market segments with cheap valuations, such as small-cap equities.
- Elevated single-stock volatility may enhance income generation from certain options strategies.

THEME 3: Market Fragilities May Cause Further Dislocations
Mixed macroeconomic data and a wide range of potential outcomes, each with associated downside risks, have often led to one-off liquidity events and/or market disruptions on which discerning, opportunistic allocators can seek to capitalize.

For example, consider the turmoil that beset the UK fixed-income market in September 2022. Some income investors used that episode to their advantage by initiating select positions in UK investment-grade corporate bonds with outsized yields and temporarily depressed values. In our view, such periodic asset dislocations are likely to remain a key feature of the global landscape in 2023 and perhaps beyond. They can offer interesting entry opportunities for allocators with ample liquidity who are able to rotate quickly in response to changing market environments.

Actionable takeaways for income investors to consider:

Consider maintaining adequate portfolio liquidity, particularly in fixed-income allocations, to be able to move swiftly to exploit market dislocations as they may arise.

Talk to your financial professional for help with seeking to enhance your portfolio's income-earning potential.

¹Liquidity refers to the efficiency or ease with which an asset or security can be converted into ready cash without affecting its market price. The most liquid asset of all is cash itself.

² Duration is a measure of the sensitivity of an investment’s price to nominal interest-rate movement.

³ Real assets are physical assets that have an intrinsic worth due to their substance and properties. Real assets include precious metals, commodities, real estate, land, equipment, and natural resources.

Important Risks: Investing involves risk, including the possible loss of principal. • Fixed-income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall. • Foreign investments may be more volatile and less liquid than US investments and are subject to the risk of currency fluctuations and adverse political, economic and regulatory developments. These risks may be greater, and include additional risks, for investments in emerging markets. • Small-cap securities can have greater risks, including liquidity risk, and volatility than large-cap securities. • For dividend-paying stocks, dividends are not guaranteed and may decrease without notice. • The value of the underlying real estate of real estate related securities may go down due to various factors, including but not limited to, strength of the economy, amount of new construction, laws and regulations, costs of real estate, availability of mortgages and changes in interest rates. • Investments in the commodities market may increase liquidity risk, volatility and risk of loss if adverse developments occur.

The views expressed herein are those of Wellington Management, are for informational purposes only, and are subject to change based on prevailing market, economic, and other conditions. The views expressed may not reflect the opinions of Hartford Funds or any other sub-adviser to our funds. The views and information discussed in this commentary are not a forecast, investment advice or a recommendation to buy or sell any security and are subject to change. This information is current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management or Hartford Funds.

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Insight from sub-advisor Wellington Management

Peter Wilke, CFA

Portfolio Manager

Jennifer Martin, CFA

Investment Specialist

Scott Chandler, CFA

Investment Director