Quarter Four Market Recap & Deep Dive on 2023 Market Outlook
Overview
The second half of the 2022 year was mildly better than the first half. While the extreme selling in the market was subdued the overall investor sentiment didn’t improve with continued interest rate hikes and the official end of the zero interest rate policy, sustained elevation in inflation, and the looming ‘recession’ in 2023 adding headwinds to any rally the market could muster. I remain confident that there are great investment opportunities going into 2023 and will keep an aggressive stance on portfolio positions as we look to maximize returns this year.
Deeper Dive
Let’s start by looking at the current market conditions:
While the first half of the year was marred by extreme selling and declining prices in the market, the second half of the year moved into a chart pattern that we refer to as “sideways” or what is often called “market chop”.
You’ve likely heard me talk about the 3 directions that the markets can go in: up, down, and sideways. Everyone understand price moving up or down, but I often find it difficult to provide an example of sideways price action. Well, here it is:
While there’s lots of up and down movement, there’s a lack of definitive direction and if you look closely, you can see that after 7 months the market is back where it was mid-year. And by chopping into the end of the year, the S&P 500 and Nasdaq closed out their worst year since the 2008 Financial Crisis at -18% and -32% respectively.
A Closer look
I believe it's helpful to understand the underlying fundamentals that created this challenging investment environment. Rather than rehash the inflation (cost of goods and services) narrative that we're hearing about all too often, the real and simplest explanation for the current market condition is purely the result of the cost of money (interest rates) increasing at the fastest pace since the early 1980s.
The purpose of central banks is to help support economies. So, at the beginning of the pandemic when the Feds decided to start printing money, the intention was good, it was meant to support those employees who would lose their jobs working for companies that could not support employees working from home. However, when very few people we're out of work, the Feds support plan backfired and markets received an overwhelming influx of liquidity (cheap money) into the system.
As a result of this the trading mantra of “buying the dip” (which has served market participants well for 15 years) continued to reward investors and further condition an entire generation of market participants that things only go “up”. And this conditioning is understandable. When I jokingly ask my younger investment clients if they were concerned that their home was losing value in 2008, they respond: “uh no. I was still in high school.” So that means that anyone under the age 40 has basically spent their entire adult life (so far) only seeing one possible market condition with absolutely everything going straight up in cost and value.
None of these investors have experienced the adverse consequences of extreme inflation and tightening monetary policy and the affect that it can have on stock/commodity/home prices. And an extended period of fearful media, gloomy outlooks, and poor self-directed annual performance will likely cause them to be sidelined and miss the coming opportunity.
The outlook for 2023
On a positive note, the end of the fed's tightening cycle is insight which may present an extraordinary opportunity for low risk high probability profitable trading opportunities for those investors that are patient and know what to look for in the new year.
If you consider the benchmark interest rate on mortgage approvals, it gives an indication of where we are and what we can hopefully expect in the new year. When applying for a new mortgage, lenders will income test applicants at a rate of 4.99% (the benchmark rate). What this does is allow the Feds to raise rates all the way to that rate without homeowners defaulting on their mortgage payments.
As The Bank of Canada’s interest rate rises, we’re now approaching this benchmark. The current rate is set at 4.25% which puts the 4.99% benchmark within arm’s length now and this gives us a good indication that future rate hikes in 2023 are likely going to slow and/or stop in the near term. How do we know that? Because the BoC is pinned in a corner here. They raised rates aggressively to stave off inflation, however, if they continue to raise rates they will run a serious risk of homeowners defaulting on their mortgages (not to mention the tidal wave of defaults on homeowners that are currently underwater on their mortgage. Check out the Q2 market recap (PUT A LINK HERE) for a deeper dive into that) which puts the banks and financial institutions at risk, or they hold rates where they currently are, allow this monetary policy to permeate the economy and personal financial budgets. Their pace of increases are too high, too fast. It’s unsustainable.
If the cost of borrowing money is increasing than that should have a direct effect on consumers purchasing goods, or more simply put, people should have less money for spending on things like Christmas presents as more of their monthly budget goes to higher mortgage payments, but that’s just not the case. Look at 2022’s Black Friday sales records:
“Online shoppers spent a record $9.12 billion on Black Friday, up 2.3% compared with 2021. With inflation top of mind, U.S. consumers sought deeper discounts and flexible ways to pay, leading to an increase in buy now pay later payments.”
Instead of tightening personal budgets, people are spending money at a record rate never seen before in the past. And this is even more evident in the increase of US Credit Card Balances returning to near record highs while US Personal Savings Rate Percentages are nearing record lows.
These insights show that the tightening on monetary policy hasn’t yet been felt by households or effected household budgeting decisions. It takes time for higher rates to impact the economy and in 2023 we’ll likely begin to see the lag-effect begin to be reflected in the economic reports. A weakening economy will usher the way for lower interest rates which could further prompt the Fed to pause or even reverse future rate hikes.
Where are the opportunities?
To answer the question of where the best opportunities are for 2023, it really depends on what your savings objectives are. I’ll do my best to simplify the opportunities into these 3 different risk categories: conservative, moderate, speculative risk takers.
Conservative
If you would call yourself a conservative investor because you don’t handle market movement very well or possibly, you’re in the phase of life that is focused on capital preservation more than portfolio growth then I’ve got some good news for you. Savings accounts have suffered over the past few years from next to 0% interest rates and as rates rise, so do rates inside your savings accounts. Many financial institutions are starting to offer midrange single digit returns in short term GIC accounts. So, if you’re approaching retirement or have already been living in retirement, now might be the time to reconsider adding annuities to your portfolio for decent returns and security on a portion of your portfolio.
2. Moderate
If you’re like most and call yourself a moderate risk taker, then there’s a good chance that medium risk portfolios will perform well in 2023. With conservative holdings in mixed portfolios returning steady numbers from higher interest rates, the equity portion of portfolios will get a lot of value from portfolios with banks or mortgage backed securities. Bank stocks should show strong performance with higher interest rates along with mortgage-backed securities as committed monthly payments increase.
3. Speculative
For those looking for high growth opportunities or for those with a high-risk portion of their total portfolio (if you don’t have a portion of your portfolio that is dedicated to higher risk taking for speculative growth opportunities then connect with me today and let’s find out if the Exactitude fund is right for you) the elevated levels of volatility in the market will produce great opportunities this year. In particular, the commodities market. With the bond and DXY markets (which affects dollar pairings and precious metals) being so tightly dependant on monetary policy announcements, their trade opportunities have become limited to calendar appointments and rate announcements, however, the energy market and Nat Gas more specifically have provided many widespread market moves and could be on the cusp of entering a super cycle. The grains market is also poised to possibly make some sizeable moves in 2023. And after a year of widespread negatives in 2022, many markets are set for recovery rallies this year.
Summary
While many market conditions remain in place heading into 2023, the reasoning for our aggressive stance in the market hasn’t changed much since Q2 2022 when we initially made the change to portfolios. The continued confidence we have is that clients of Lane Cuthbert Financial avoided the mass selling that was seen in the broad markets during 2022 and that better positions us to take advantage of future opportunities.
While most retail investors are fearful to stop further losses and pain from ensuing in their self-directed portfolios, other advisors are starting to really “sell” the recession storyline, and most will be spending all their efforts recovering what they’ve lost; we will be maximizing returns because we minimized losses. I thank you for your continued support and look forward to another year of serving you and your family’s wealth accumulation goals.
I thank you for your continued support and look forward to another opportunity to serve you, and your family’s wealth accumulation goals.
If you would like to book an appointment to review your personal portfolio or discuss your savings goals in more details, please send an email to Lane@LaneCuthbert.com to schedule a time.