On My Radar: 2023 Investment Outlook - btbirkett@gmail.com - Gmail

On My Radar: 2023 Investment Outlook - btbirkett@gmail.com - Gmail

2023 Outlook

• We are on the back end of the first in a series of inflation waves.
• The Fed funds rate, currently at 4.5%, will peak in 2023 at 5% or 5.25%.
• Due to high debt levels, the impact of higher interest rates, combined with high inflation pressures, will cause a recession in 2023. It won't be your garden variety recession.
• We’re in for a hard economic landing - immediately ahead. Access to liquidity will worsen, and defaults will rise. This will set up the best-in-a-generation opportunity in high yield bonds and distressed debt. Think yields in the low 20% range.
• Inflation will decline to 3.50%, giving the Fed cover to pivot.
• The median stock market decline in a recession is -38.5%. An additional stock market decline of ~20% from the current level of 3,830 will take the S&P 500 to ~ 3,000.
• We'll look at the year-end valuation metrics next week, but an early peak at Median PE on the S&P 500 Index puts "Fair Value" at 2,970.32. That squares nicely with the median stock market recession decline data.
• Recession and investor pain will provide the backdrop for the Fed to pivot. The Fed will respond aggressively by lowering rates and injecting liquidity into the system.
• Bearish first half of the year for U.S stocks. Bullish outlook into 2024 tied to / dependent on the Fed and probable legislative responses.
• The recession call is bullish for 10-year and 30-year Treasury bonds. The 10-year yield may decline from 3.80% to 2.50% in the first half of 2023, creating a trading opportunity for bond investors. The 40-year bull market in bonds is over. Trade bonds, don’t buy and hold.
• For single and multi-family housing, the supply and demand mismatch (very low and very high, respectively) will remain the fundamental bullish factor in the housing market. Rising mortgage rates are the bearish factor. If I'm right about recession, easing inflation, and declining interest rates, expect mortgage rates to move to 5% by January or February 2023. (Hat tip to good friend and Real Estate guru Barry Habib for this one.)
• Over time, the supply-demand mismatch, and longer-term inflation pressures are positives for single and multi-family housing. Remain bullish on housing.

As we enter 2023, inflation is no longer a potential problem. It is the major problem. It continues to call the Fed’s hand, requiring continued quantitative tightening. It's important to remember that markets bottomed after the first Fed interest rate cut, not the last hike; one or two more hikes are a reasonable probability. If I’m correct in my view that inflation, rising rates, and debt issues will lead to a meaningful economic slowdown ("stagflation"), then 2023 will remain challenging. Another -20% market decline is probable.

If correct, the Fed will reinstate QE, we’ll bottom, and we’ll be off to the races again into 2024 and maybe 2025. Liquidity is intoxicating. I’d rather the system clear, but I don’t believe the Fed will allow it.

A few more bullet points on the coming year-plus:

• Bullish dollar first half of 2023, as higher U.S. yields, the global slowdown, and market turmoil favor a strong dollar.
• Longer-term: bearish view on the dollar, but to which other currency, I don't yet know. The developed world is collectively debasing currencies as well.
• The outlook for gold is the opposite of the dollar. Long-term: very bullish on gold with a target of greater than $5,000. Short-term: neutral.
• Bullish on commodities, agriculture, uranium (nuclear fuel), and oil for the foreseeable future.
• The geopolitical challenges remain. Tensions between China and the U.S. keep increasing. The shifting and reshoring of supply chains continue. Priorities are no longer the lowest cost.
• Higher costs either are pushed onto consumers (inflationary) or impact corporate earnings—or both.
• The first phase of the correction was a leverage adjustment, and margin debt has indeed come down.
• The next phase is an earnings correction. Once Wall Street lowers earnings expectations, we’ll see a negative impact on equities.
• The fundamental environment is stagflation.
• Best guess is a series of inflation waves over the balance of the decade, much like in the 1970s. We are on the back end of Wave 1.
• The Fed pivots, injects liquidity, resumes bond-buying programs, and expands to buy corporate securities to support risk assets.
• Inflation Wave 2 follows, and we repeat the pattern.
• Expect an up-and-down stock market over the balance of the decade.
• We'll look at valuations next week as they tell us a great deal about coming 10-year returns. They will be better, but expect flat returns from current levels.
• There will always be opportunities and ways to earn high, single-digit to mid-teens returns. Traditional buy-and-hold from current levels and 3.85% 10-year Treasury bonds won't do it.
• A meaningful correction to 3,000 in the S&P 500 will mean that coming 10-year probable returns will be in the 10% range. That will be a much better point to consider traditional equities.
• If you must be in stocks due to capital gains and investment mandate, I concluded with the same message concluded with a year ago. It’s Time to Hedge.