I admit that I read very little mainline news, including business news. I decided long ago that most business news (Bloomberg, Forbes, Barrons, WSJ, et al) was either regurgitated, half-understood information from lazy journalists or worse, intentional narrative shaping by market power brokers. I read almost exclusively economic reports that I pay for, so that I know there is no agenda, and so that I’m hearing from respected economists with a solid track record.
So, as I sat down to write this year’s 2023 outlook, I decided to quick and unusual read of the 2023 outlook from the mainline sources. Here is what I found:
Stagflation Will Rule 2023, Keeping Stocks in Peril, Bloomberg, November 27, 2022
Outlook: 2023 Recession Likely Deeper and Longer, Forbes, December 31, 2022
Brace for a Recession Next Year. But the Outlook Isn’t All Doom and Gloom, Barrons, December 22, 2022
Wells Fargo Investment Institute 2023 Outlook: A Year of Recession, Recovery, and Rebound, WSJ, December 9, 2022
My quick perusal confirmed what I have been hearing from my clients and what I am seeing in the investor surveys - there is a tremendous amount of pessimism in the market right now.
To be fair, this is an incredibly risky time. In response to inflation levels last seen in the 1970’s the Federal Reserve raised interest rates at an unprecedented pace over the past year and has signaled that it is not done. The latest Federal Reserve Minutes set an expectation for another 0.75% increase in the Fed Funds rate during 2023. The battle against inflation still rages. What happens in the economy and market in 2023 will depend, in large part, upon the path of inflation.
The bearish case, those that believe the market is heading for a deep recession, argue that inflation will not recede unless the Federal Reserve forces a recession. So, the logic follows that the Federal Reserve will be forced to keep raising rates longer than expected, and that good economic news will inevitably be bad news because inflation will not recede without some sort of ‘pain’ in the economy and job market. The bear’s assumption is that inflation cannot be broken unless there is a recession like that of the 70’s, or worse.
The more optimistic case is that inflation is already receding and will continue to recede as the effects of the previous rate hikes, and quantitative tightening filter through the economy, and as the hangover from excess Covid stimulus fade. If inflation comes in lower than expected, the Federal Reserve can end its interest rate hikes and the market could finish with a ‘soft landing’ in 2023 and growth in 2024. The stock market, always forward looking, could rally on the expectation of 2024 growth.
The truth is that no one really knows which of these two scenarios will play out. The stock and bond markets have been whipsawed over the past year, rallying on falling inflation numbers, falling on Federal Reserve statements, hanging on every release of inflation data or Federal Reserve news release. In this environment it is easier to sell the negative case.
Yet, there are good reasons to be optimistic. First, inflation is coming down, though from very high levels. Secondly, consumers are burning through their excess savings built-up from Covid stimulus. Lastly, the labor market remains strong, but wage growth is slowing – a good combination for a soft landing. Given the amount of pessimism in the market I lean toward the optimistic case.
Of course, given the amount of uncertainty in the outlook, this is no time to take excessive risk. We continue to like bonds as a hedge against a recession, and the now higher interest rates provide investors with a solid interest income. We continue to favor the U.S. stock market and have particular emphasis on small and mid-size companies that are very cheap at this point, apparently already priced for a recession. We added a specific position in United States semiconductor manufacturers to most of our portfolios, as more semiconductor manufacturing moves back the United States. Overall, we seek to maintain good diversification while focusing the portfolios to the areas of the market where we see the best opportunity.
We enter 2023 already in the midst of a storm. I’m sure that 2023 will have it’s own surprises, but we remain committed to long term strategies that will help us weather what may come.
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