(Non)Predictions For 2023 | Seeking Alpha

As we transition to a new year and 2022 becomes visible through the rear-view mirror, it’s time to lay out the macro, hone in our ability to make accurate forecasts and invest accordingly.

Ehm, no.

Better yet would be to find the long lost crystal ball, polish it, and together with the tea leaves, see what is in store for the markets and invest accordingly.

Or to get out the dart board, aim, and see if that helps.

A slightly tongue in cheek introduction, but though I am an avid reader of various “predictions” put out by various service providers, they are all taken with a pinch of salt. The future is uncertain, with gazillions of different moving parts, all interacting at varying degrees of speeds, directions and volatility, with myriads of paths along the way. And even if one would know ahead of time with 100% accuracy what a particular data point will be, one cannot know how everyone else is likely to react to the same data point. However, predictions definitely serve a purpose, as they portray current expectations of an inherently unknowable future. I believe there is a degree of educational value, in the sense that one can look back at their previous predictions, and at the very least, if they were wildly inaccurate, they may come to serve as a reminder that new predictions will likely be just as hard.

Before we look forward to 2023, let’s have a quick recap of 2022. Not many people will be sad to say goodbye to a year where just about every asset class had a material drawdown and suffered several bouts of meaningful volatility. Although looking back at calendar year returns is the conventional norm, there is no particular reason for looking at the period Jan – December over and above any other 12 month period. That being said, 2022 was actually one of the worst calendar years ever for stock market performance, and indeed the very worst year ever for the bond market.

At their lows, market indices were in a 25%-30% drawdown at their November lows, before recovering a little bit at the end of the year.

I used seekingalpha.com for the following charts:

VEA (Global Developed Markets ex US) -15.34%

S&P 500 (US) -19.44%

Stoxx 600 (Europe) -12.9%

VWO (Emerging Markets) -17.98%

In the Fixed Income market, the Bloomberg Aggregate Bond Index, which includes both Government and Investment Grade bonds, was down 13%. Its previous worst calendar year return (going back almost 50 years) was down 2.9% in 1994.

Barclays AGG: -13.02%

Short Term Treasuries (1-3 years) SHY: -3.88%

Long Term Treasuries (20+ years) TLT: -31.23%

Investment Grade Credit LQD: -17.92%

High Yield Credit HYG: -10.98%

EM Bonds EMB: -18.63%

So much for diversification! However, the basic principle behind diversification is that almost by definition, diversification can only work in the long term, if you are willing to accept that over shorter-term time frames, each asset class will go through periods of underperformance.

Why were markets down so much this year? Well, there are a myriad of reasons that every man and his dog could give. Inflation went ballistic, central banks hiked rates at the fastest pace ever and are probably amongst the most common ones. However, if one were to lengthen your time horizon just a bit, one answer that probably stands truer than most (though typically less acceptable) is that in the previous years, markets just went up too far too fast. More than what could be fundamentally justifiable. And along comes 2022, to remind everyone that yes, one can make long term healthy returns, however equities are inherently risky, and comes with a lot of risk attached. 2022 was the markets way to ensure that in order to enjoy long term gains, one has to accept short term pain. 2022 is the price one has to pay as a long term investor, to enjoy gains that have been on offer in recent years.

• 31.49% in 2019
• 18.4% in 2020
• 28.71% in 2021

One cannot enjoy these mammoth up years without accepting 2022 style losses in the interim.

And what about 2023? Well, if we were in the job of forecasting, a good starting point would be to assume that we would be in for an “average” year. An average year in the stock market is typically thought of a return between 8% and 10%. Fun fact – markets are typically never average! Assuming one has a sufficiently long enough time horizon, one’s actual return has indeed equated with circa 8%-10% annual returns. And thus would be a justifiable assumption for the year ahead 2023 return. Nonetheless, in almost 100 years, the S&P 500 has only been up between 8% and 10% ONCE, in 1993. And even then I’m cutting it a bit fine, as the actual return was 9.97%. Check it out yourself! (Historical Returns on Stocks, Bonds and Bills: 1928-2021)

If one is in wealth accumulation phase, then one should be thankful that valuations have come down significantly over the past year. And though they may and are likely to get cheaper still, for long term investors, one has the opportunity to accumulate stocks at more attractive prices. The stock market is unique in the sense that the more aggressive/enticing the sale, the harder it is for people to buy. One way that may be helpful in thinking about losses generated over the last year is that they can be considered a sunk cost. The past is the past is the past and cannot be changed. Looking forward, future growth prospects are enhanced given the more attractive starting position.

I mentioned earlier my preference not to make macro predictions. But if we’re not going to be predicting macro variables, how should we be relating to the macro data? Personally, I prefer to look at the surrounding macro as different weather elements and environments that will need to be navigated.

In general, (I think) ducks prefer rainy weather to humans. But that’s not to say that all ducks like the rain, and all humans dislike the rain. Some humans do like the rain. Many have some degree of tolerance, but that depends upon the extent, degree or harshness of the rain. For some, it will depend upon the availability of coats, umbrellas, and wellies. And possibly a good drainage system. Some will run out into the muddy field, dance with glee and have mud fights. Others will fall, unable to get up, become drenched in bleurgh and reeks of cowpat. (There is no comeback from there)!

I don’t want to become bogged down by the rain (pun only half intended), but the point is that (using rain as an analogy for recession) there will be companies/sectors that thrive in the rain, and companies that will struggle to survive. It will have little to no effect on others. And the knock-on effects on various non-directly weather-related industries will all be affected to a greater or lesser extent. So rather than focusing on the fact that rain may well be on its way (that in of itself may or may not happen, or only later than expected), I’d rather build a diversified portfolio and invest with a higher weighting to those companies/markets/regions that are likely to do better in such an environment, with a lower weighting to those that are less likely to do well in such an environment. All the while remembering that the rain may not even come. Rather than trying to outsmart the market, on the assumption that one has an appropriate time horizon and ability to see through shorter mark to market volatility, my preference is to “ride” the market, tweaking the allocation to have a slightly higher weighting to sectors/regions/asset classes that are more likely to do better in the current environment.

Some examples of data points that will help build our picture includes (in no particular order):

• Funding – the extent to which (mainly) smaller companies are able and willing to receive credit from the banks
• Inflation – data that will indicate whether it will continue to subside, whether it will stabilize at higher rates than it has done in the past, and whether there is reason for it to continue higher
• Rates – how far the Fed will be able to continue the unprecedented rate of rate hikes thus far, and the degree with which it will subsequently be lowered. Will something break in the interim?
• Labor market – whether the layoffs that has thus far largely been confined to the tech sector will spillover to other sectors
• Housing market slowdown and the degree to which it has knock on effects to other industries
• Earnings – data that will support whether or not the deteriorating macro picture is reasonably reflected in future earnings estimates. Will investors be happy to pay the current multiples, or are there signs that margin pressures will increase?
• Relative performance – is the correction in stock prices reflective of deteriorating outlook or merely the function of a higher discount rate?

If 2022 was anything to go by, 2023 promises to be just as exciting!

Stay tuned!