Happy 2023. I planted a footprint on the backside of 2022 and don’t have the mental energy to analyze all that went wrong last year. Here’s to better times for you and yours, starting now.
Like most years, I resolved to get in shape and read more books and less financial stuff in 2023. Mixed results so far. Santa brought a new elliptical machine for Christmas and then I immediately wrenched my back trying to undo years of inactivity in one twenty-minute session. It’s feeling better now but led to a 10-day stint on the disabled list.
I did pick up an excellent non-financial book this month and couldn’t put it down until it was finished: Devil in the White City by Erik Larsen. It tells two remarkable contemporaneous stories, one about the Chicago World’s Fair of 1893 and the miracle that architect Daniel Burnham accomplished by building / running the fair, overcoming seemingly insurmountable challenges. All the while, one of history’s most notorious mass murderer - H. H. Holmes - was killing and dismembering hundreds of people in a nearby hotel that housed fair visitors. A surreal and fascinating historical read.
Larsen is an excellent writer and I’m just now starting his book about Churchill and the London bombings. I’m excited he is the featured history speaker at a York County History Center event in downtown York in April. You should go, I’ll see you there.
As hard as I try, I have to harken back to 2022 a little to make heads-and-tails of the investment landscape entering 2023. After a ridiculously strong year for stocks in 2021 riding the zero-interest rate policy wave for one final turn, both stocks and bonds were routed in 2022, starting in the first trading days of the year.
By December 31st, US stocks and bonds posted their worst combined performance year ever! It was a bloodbath, triggered by runaway inflation and the Fed Reserve awakening from a slumber then sprinting to catch up. They struggled all year to corral a nasty inflation contagion using violently higher interest rates as their lasso.
Bonds and growth stocks really don’t like inflation or rising interest rates and it showed in 2022. Starting early in the year, the Fed Reserve aggressively hiked short-term rates higher and faster than any other time in its history – and longer dated financial assets got walloped as a consequence.
Heading into 2023, the out-of-control inflation crisis is subsiding and recent better inflation data is encouraging. How far and fast inflation falls in 2023 will be a function of tighter monetary policy, recession risk, commodity prices and the labor market, all of which are unknowable factors.
While stocks have enjoyed a welcome rally this month, it’s an open question how serious investors are factoring in a meaningful recession in 2023. There are definitely signs the economy is losing steam. Some sectors, like housing, have hit a wall at full speed due to the spike in mortgage loan rates.
When you consider that the Fed really wants a recession and sees employee layoffs as an antidote to inflation, it’s a given they won’t stop raising interest rates until they get their wish. It’s a tightrope walk trying to smother inflation without causing a deep economic contraction.
Remember the game of tug-of-war? I almost referred to it as a child’s game but it’s still played by grown men and women. Professional adult tug-of-war leagues and even a world championship event exist. Too much strain for my lower back, but I like the conflict metaphor when thinking about investment drivers in 2023.
Case in point, there’s real tension now associated with several factors that determine investment performance:
Recession or “soft landing”?
Inflation or disinflation?
Value or growth stocks?
Large or small stocks?
International or domestic stocks?
Investment grade or high yield bonds?
Fixed or variable interest rate credit?
Russia or Ukraine?
Strong or weak US dollar?
Our take is that the stock market is complacent at the moment, assuming inflation is a rear-view risk, interest rates are flattening and corporate profits won’t fall materially in ’23.
Our strategy in early 2023 is to remain balanced and to keep suppressing the urge to market timing. More clarity is needed on the various “tug-of-war” factors before tactical portfolio shifts make sense. For example, value stocks had a relatively strong year in ’22 compared to growth. Is this finally the start of a new style trend, similar to the deep bear market in growth stocks in the 2000s? Too early to say.
We have a foot in both the growth and value camps awaiting signs that we can act upon in client portfolios.
We believe the Fed will get what it wants and fosters a US recession later in 2023. Due to the extremely tight labor market, we don’t see massive layoffs coming and thus a mild recession. The headline job loss announcements in 2023 have been mainly tech companies that over-hired before / during the COVID crisis.
To be sure, some 4Q22 corporate earnings reports are disappointing analysts and thus 2023 will likely see its share of market volatility.
Two future events would actually trigger market rallies in 2023: A resolution of the Russia / Ukraine war and the Fed announcing a cessation of its interest rate hikes.
Longer term, we’re bullish on small cap growth equity and emerging market equity; both asset classes are historically undervalued. We still see the value in several alternative investment classes and view crude oil as a fat pitch due to lack of drilling and China emerging from COVID lock down in 2023.
We see the US dollar entering a long-term bear market period - it may have already started - which bodes well for international investments. If that’s true, it also suggests that fixed rate bonds will suffer an extended period of lackluster performance.
A thousand words and yet you leave wanting more clarity about the 2023 investment outlook. Welcome to my world!
Until next time, be well…Tim