Thoughts for 2023

January 13, 2023







January 13, 2023


2022 was without a doubt a horrible year for the financial markets. For the markets, Growth / Tech stocks got hit hard. The carnage was hidden by the returns in the indexes such as the S&P 500 (SPX) which declined 19.44%, NASDAQ 100 which declined 32.97% and the Russell 2000 (RUT) 21.56%. The reason was that some of the largest growth stocks, such as Tesla (TSLA), which we own fell even more than the indexes. Dividend stocks outperformed other strategies, both in 2021 and 2022, which was why after 2020, I was quite vocal in my writings and personal discussions about moving assets from Growth to Dividend. It paid off. So, is it time to reverse the trade? Read on.

In general, everyone from analysts to investment managers got 2022 wrong. Primarily, the reason why everyone got 2022 so wrong was we never saw the magnitude and headstrong determination of the Federal Reserve Open Market Committee (FOMC) to aggressively raise interest rates and try to destroy the economy which was still rebounding from COVID. However, there were some other unforeseen factors, which contributed to the year’s difficult financial markets:

  1. Inflation, reminiscent of the Jimmy Carter administration, primarily from surging energy prices. This time around, inflation was self-inflicted from poor energy policy, unrestrained government spending and failure to improve the nation’s supply chains.
  2. Vladmir Putin’s invasion of Ukraine. In addition to the humanitarian crisis that the invasion created, the barbaric act further exacerbated commodity price inflation around the world.
  3. Devastation to human life and property caused by Hurricane Ianand the December winter storms across the Northern US states.
  4. That Crypto Currencieswould crater like dotcom stocks in 2000; Sam Bankman-Fried and FTX would swindle billions from investors then turn around and misappropriate the money for personal and political purposes.

Without further ado, I present my Thoughts for 2023:

  1. As is commonplace, Wall Street analysts follow the crowd and the trend, projecting another bad year in 2023. I am going to put forward a somewhat contrarian view to the crowd. Yes, I do believe that the beginning of 2023 could be challenging as the FOMC continues its zealous interest rate tightening and assault on the economy. However, I do believe that when the dust settles, at the end of 2023, the SPX will be higher on the year. The SPX ended 2022 at 3,839.50, which using Standard & Poor’s 500 (SPX) consensus earnings estimates of about 219.49 implies an index price/earnings multiple (PE) of 17.49. From an historical basis, since the financial crisis, the SPX PE ratio ranged from a low of 12.86 in 2011 to a high of 26.88 in 2020 with an average of 18.08. So, we can conclude that the valuation of the SPX at the end of 2022 was reasonable. Interestingly enough, the US Treasury yield of about 3.65% equates to an equivalent “PE” of 27.4 still implies that stocks remain cheaper than bonds. Recall that bonds also had a horrible 2022. Parenthetically, in a year with two negative quarters of GDP (Gross Domestic Product) SPX revenues are estimated to have grown by about 11% and earnings by about 5%. Let’s look ahead to 2023. Wall Street consensus estimates for 2023 SPX earnings is about 229. Applying an average PE ratio of 18 arrives at a target price of 4,122 for the SPX, an annual increase of 7.36%, which is just below the long-term average increase for the index. Now I must throw into the equation some historical data. The SPX lost 19.44% in 2022. In 1974 (a midterm election year) the SPX lost 29.72% and gained 31.55% in 1975. In 2002, (another midterm election year) the SPX lost 23.37% and gained 26.38% in 2003. Finally, in 2008 the SPX lost 38.49% and gained 23.45% in 2009. So, I could make an argument for a reflexive rebound off the 2022 declines such that the SPX gains 20% or more in 2023. Markets do not move in straight lines, and I think that 2023 will have a continuation of the Fed induced weakness in early 2023. The latter half of 2023 will be much stronger. When I throw all the above into a blender, let’s expect the SPX to trade as low as 3,600 and as high as 4,740 and close the year at 4,350, a gain of 13.3% with an implicit 19 PE.
  2. The Federal Reserve Open Market Committee (FOMC) had its foot on the breaks in an attempt to quell inflation. However, the easiest way to lower inflation would have been to produce more crude oil and its derivatives. That is something beyond the reach of the FOMC. The FOMC raised its target Fed Funds Rate by 25bps in March, 50 bps in May, 75 bps in June, July, September, and November, and finally 50 basis points in December. In December, the FOMC signaled that while it would continue to raise rates to fight inflation, it would do so at lesser increments. I expect two more 50 bp increases and two more 25 bps tightening before putting a halt to its attack on interest rates. The fourth meeting in 2023 would take place June 15 and 16. As an aside, energy prices are already on the decline and inventories of goods are on the rise, both deflationary factors.
  3. As for US Treasury securities and bonds in general, the mantra of staying short will still be the case. The short end of the curve, i.e. 2 years and shorter will approach 6% until the Fed begins to pause. The longer end of the curve will peak at around 5%, resulting in a continued inversion of the curve and belief that we are in a recession.
  4. Recession or no recession, that is the question? Many economists are expecting a recession in the latter part of 2023. I learned a long time ago, in college, from a future Nobel Prize winner, that economists are good at explaining the past but horrible at predicting the future. There were two negative quarters of Real GDP (inflation adjusted) in 2022, followed by an increase of 3.2% in 3Q22 as reported by the Bureau of Economic Analysis. As inflation subsides, as I expect it should, the economy will perform better. Mastercard (MA) reported that holiday sales – despite the winter storms – increased 7.6% (not inflation adjusted). As I have written before, regional recessions on a rolling basis occurred in 2022, and might also do so in 2023, but a nationwide recession is not going to occur in 2023. Finally, it is a mistake to assume that Fed tightening cycles end in recessions.
  5. Growth stocks will not have a repeat of the poor showing in 2022 with the caveat that growth will come from stocks other than “FANG” stocks – Meta (the former Facebook) (META), Amazon (AMZN), Netflix (NFLX) and Alphabet (the former Google) (GOOGL / GOOG), whose business models have peaked or as in the case of META and NFLX are fading fast. Growth will come from a new class of stocks and industries. I expect the beaten down software, semiconductor, data and security stocks to spring to life in 2023. All that being said, you must look at Growth stocks within the context that I expect a poor start to the year with a better rest of the year.
  6. Dividend / Value stocks had a strong 2021 and mildly negative 2022. I expect that they will return to historical form and post reasonably positive gains of 6 – 10% on a total return basis if interest rates behave as I expect – some end of the tightening cycle and a signal that rates will begin to reverse downward in 2024.
  7. When you look at a list of the top performing companies in the SPX for 2022, the top 10 were all Energy stocks. Of the top 20 performing companies in the SPX, fifteen were Energy, four were Health Care and one was a material stock. Energy was our best performing portfolio in 2022. It can still be a positive performer in 2023 but we will be selective when choosing an energy company into which invest as I can guaranty that that the Energy sector will not produce fifteen of the top twenty performing stocks in 2023. Healthcare does look interesting and fits into both the Growth and Dividend categories, depending on the individual stocks.
  8. Consumers will continue to spend on discretionary goods and services despite higher prices as their balance sheets are quite solid. Housing will continue its rebound that began in the last few weeks of 2022 as mortgage rates dropped by around 1%. Even if the FOMC raises rates as I expect in 2023, the 30-yr mortgage rate will rise by 1% to 7.5%, exactly where it was a few weeks ago. A note to new or future homebuyers. Expect 30-yr mortgage rates to be in the 5.5% to 7.5% range in the future and by that, I mean the next decade or two. Do not expect rates to drop back down to levels of the last generation. Those rates of 4% and lower were anomalies. The average historical 30-yr mortgage rate was about 7.50%. Plan accordingly.

Best wishes for a Happy and Healthy 2023. As always, please contact me if I can help you with your investment needs.

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