“Yet we still live in a troubled and perilous world. There is no longer a single threat. There are many. They differ in intensity and in danger. They require different attitudes and different answers.”
– Lyndon B Johnson
It’s always difficult to come up with a yearly forecast for the economy and the stock market. These are dynamic situations that can change in a month, and it is for that reason I believe I prefer to take the year in three to four-month increments. Putting together a forecast in December that covers the next 12 months given these “unknowns” wouldn’t seem to be a logical strategy, yet that is what many research firms do every year at this time. Similar to 2022, this year, 2023 represents a big challenge. The dynamics of inflation and interest rates will determine the path of the stock market going forward. However, I can see a shift from concerns over those two issues to a focus on the economy. So at the outset of the year, we could see all three impact the price action. Bottom line – the headline-driven market stays with us into Q1 ’23.
I rely on many factors to develop a strategy and unlike many analysts who speak to the “issues”, I meld the basic fundamental and technical backdrops to come up with a plan. The latter is a “key” that so many research firms ignore. As the scene unfolds, there are always updates to areas of the initial forecasts that are tweaked in response to events that take place.
Let’s take a very quick review of what we experienced in ’22 as an example of trying to deal with unknowns that we will now face. In February 2022 I recognized a change in the market backdrop (the BEAR market was launched) and believed a change in strategy was needed.
The big change was a normalization of monetary conditions as announced by the Fed in December ’21.
That was a game-changer. At that time it was obvious that we had entered a new era of investing. Gone were the days of an accommodative Fed with plenty of liquidity, and the “buy-the-dip” mindset had come to an end. Instead, interest rates were going to rise for all the wrong reasons as inflation was moving higher. That meant less liquidity with a Fed that wouldn’t be so accommodating. It became a time to start reviewing portfolios and changing strategies. Just as I didn’t want to “Fight the Fed” and avoid the stock market in a BULL trend, I don’t want to Fight the Fed now and be overcommitted to stocks in a BEAR trend. That change proved to be a turning point in 2022. Instead of buying anything in any sector, it was BUY ENERGY with both hands. While the BEAR was launched in the general market a new BULL market emerged in Energy. The other sector that was holding up well in a changing environment was Healthcare and that too became a favorite.
For the year, the equity markets had to deal with war, inflation, an oil price shock, rising interest rates, a recession risk, and a political division. That provided a difficult backdrop leaving the equity markets down for the 4th worst performance year since 1945. I can’t promise investors that I have all the answers for 2023, but I can promise them entertaining, thought-provoking, and logical data to help position portfolios as we navigate the new year.
I haven’t changed my CORE principles. The following will explain why it is important to keep an open mind to ALL possible outcomes and stay flexible in your approach.
One year ago the Federal Reserve was forecasting that real GDP would grow a strong 4.0% in 2022, that PCE prices would be up a relatively moderate 2.6%, and we should expect a total of three 25-basis point rate hikes by the end of the year. Instead, it looks like real GDP will be up about 0.5%, PCE prices will be up 5.6%, and we had the equivalent of seventeen 25 bp Fed rate hikes, finishing the year at 4.375%.
That explains why I am not interested in conjuring up an ANNUAL Outlook in December. Just think back to a year ago. I remember seeing a lot of fancy, colorful presentations that made many a graphics department smile but can’t recall any that predicted a major war between two European nations, the Fed hiking the Federal Funds rate from 0% to 4.375% in less than a year, and more than half of NASDAQ stocks being at least cut in half from their former highs.
The Crystal Ball Approach
Without fail, around this time each year, I am asked what my “target” is for the S&P 500 by the end of next December. I simply say I don’t have one. It is great to have contests to see how good or bad our guesses can be, but Year-end targets are right up there with the Easter Bunny and Santa Claus, and we stopped believing in them when we were kids.
The concept of a year-end “target” wouldn’t bother me so much if they were widely treated for what they are – educated guesses that are highly subject to change. They are little more than a dart throw and a board that is constantly moving. It’s another reason why take my market approach in smaller increments.
End-of-year targets also tell us nothing about the possible path to get to that target. A target of S&P 3700 is wonderful but if the index rose to 4700 or dropped to 2700 before ultimately getting to my target, I doubt that really helped anyone. It’s all about how we navigate the middle. Trying to predict where the market will be a week from now is difficult enough; the ego required to believe that any analyst can predict where the S&P will be a year from now is monumental. Yet research firms are already out with their 2023 S&P 500 forecasts.
It’s ok to have sort of a general concept to provide a framework as we head into 2023. But as 2022 demonstrated an Open Mind is a requirement in an uncertain environment. Remember how we started 2022 with new market highs? By February 24th the S&P was 10% lower. As we head into 2023, I still believe we’re likely going to need to maintain a similar mindset and be prepared for volatility on both the upside and downside. The “predictions” that I have the most confidence in for next year is something I’ve already written about – the belief that the market will soon stop being singularly focused on inflation/Fed and will instead start to put more emphasis on the health of the underlying economy. Second, it will all come down to earnings.
The only expectation we should have for this year is that events will occur that will surprise everyone because that is what happened last year and happens just about every year. Attempting to make all sorts of predictions and basing decisions on them or trying to decide this December what is likely to have outperformed by next December, should be left to others. I believe we are better served by remaining flexible and preparing to adjust along with the market no matter what happens.
The transition from BULL to BEAR last year taught us that, and the “mess” that is the economy and the markets continues into 2023.
The Week On Wall Street
A new day, a new week, and a new year. We turned the page on the calendar but the same patterns prevailed. Right out of the gate on Monday we saw rallies being sold. As trading continued into Wednesday and Thursday it was roller coaster-type moves that continues to confuse investors. Similar to last year every headline was picked up and the hourly trading swings kept everyone guessing.
The US dollar and interest rates fell on Friday and combined with a “goldilocks” jobs report, buyers entered the picture. All of the indices reversed the mid-week losses, and all posted gains for the first week of trading in the new year.
The economic data coming out of the Eurozone continues to show economic contraction. Despite that, it’s been a strong start to the year for European equities with the STOXX 600 sitting on a 3.5% gain as of this morning. That is the best start since the 7.3% gain in the first three trading days of 2009; only 1999, 2003, and 2009 have had stronger starts for the index than the one currently underway.
Historically speaking, strong starts have led to further gains. Every year where the first three days have seen gains of more than 1.75% has seen a positive return for the remainder of the year. Is there a message here? At the moment it sure appears that the Euro markets have priced in their bad economic scene. That makes me wonder if the US market will now start to respond in the same way and lead to a Q1 rally. Of course, the other scenario says the EU markets have once again gotten way ahead of themselves, and are set up for Phase 2 of their declines.
JOLTS – Job openings dipped 54k to 10,45k in November after sliding 175k to 10,51k. It is the fourth straight month below the 11 M mark but remains at levels that leave economists questioning the entire employment scene. There are some 1.7 available jobs per unemployed worker. Quitters jumped 126k to 4,173k after falling 13k to 4,047k in November. The quit rate, also an important indicator for the Fed, edged up to 2.7% from 2.6%, the first increase since February. And it was at a historical high of 3.0% in November 2021.
This Friday’s non-farm payroll announcement was a “Goldilocks” report. Decent (but slowing) job gains with non-farm payrolls rising by 223k.
The pace of wage inflation slowed with average hourly earnings rising at a moderate 0.3% down from last month’s 0.6% rise. The labor participation rate is up to 62.3%
Manufacturing woes in the US continue and indicate a recession in place, BUT there is a bright spot. The “Prices Paid” component indicates slowing inflation.
The ISM manufacturing index slipped 0.6 ticks to 48.4 in December after falling 1.2 points to 49.0 in November. This is the second straight month in contraction and is the lowest in 31 months. The string of declines is the longest since 1974-75.
Today’s ISM Manufacturing report contained positive news related to inflation as the Prices Paid index dropped from 43.0 down to 39.4, which was the lowest reading since the depths of the COVID lockdowns. Over the last nine months, the Prices Paid Index has declined from a post-COVID peak of 87.1 down to 39.4.
That may be a signal that the next CPI/PPI reports might come in cooler than expected.
US manufacturing operating conditions deteriorate at the fastest rate since May 2020. The seasonally adjusted S&P Global US Manufacturing Purchasing Managers’ Index posted 46.2 in December, down from 47.7 in November.
At 49.6% ISM Services joined the manufacturing report in contraction territory. That is a 6.9% drop from the November reading of 56.5%. The composite index contracted for the first time since May 2020, when it registered 45.2%.
The Managing Director of the International Monetary Fund declared that approximately 1/3 of the global economies would be in recession this year.
The year ahead is going to be tougher and slower for the US, European Union, and Chinese economies.”
However, the IMF sees a glimmer of hope in the resilience of the US economy that could help the global economy trudge through the blizzard of recession in 2023.
This announcement fits my outlook, suggesting the EU will suffer economic damage this year. As far as China, it will come down to the ongoing COVID issue.
Global Manufacturing PMIs
The downturn in the global manufacturing sector continued in December, adding more evidence to the global recession outlook.
The J.P. Morgan Global Manufacturing PMI fell to a 30-month low of 48.6 in December and remained below the neutral mark of 50.0 for the fourth straight month. Excluding the lows registered during the early months of the global pandemic, the current PMI reading is the lowest since the first half of 2009.
While the Flash reading for US manufacturing PMI for December made new lows and a range of others have as well (Australia, Japan, Myanmar, Vietnam, Malaysia, UK, Brazil) there are more optimistic trends in others. Taiwan’s spiked sequentially to an impressive degree (though the level of the reading is among the lowest in the history of the dataset), while India’s is among the highest in series history.
Poland’s PMI has been trending higher for months now, a notable development given its sensitivity to EU manufacturing activity; prices rose at the lowest rate in two and a half years. Similar upturns appear to be more nascent but underway in the Czech Republic and Eurozone more broadly. To be sure, many global manufacturing PMIs are below 50, indicating contraction, but sequentially readings are showing signs of starting to improve. Eurozone manufacturing PMI respondents noted softening supply chain pressures.
The headline au Jibun Bank Japan Manufacturing Purchasing Managers’ Index dropped to 48.9 in December, down from 49.0 in November to indicate a second consecutive deterioration in the overall health of the Japanese manufacturing sector. The latest reading remained mild overall but was the lowest since October 2020.
The headline PMI figure fell for the third consecutive month, posting 50.3 in December, down from 50.7 in November. Though manufacturing firms across the ASEAN region reported an improvement in operating conditions, thereby extending the current run of expansion that began in October 2021, the reading pointed to a further loss of momentum at the end of the year.
The seasonally adjusted headline Caixin China General Business Activity Index rose from a six-month low of 46.7 in November to 48.0 in December. While the sub 50.0 index reading indicated a fall in Chinese service sector activity for the fourth straight month, the rate of decline was only modest overall. Lower output was often linked to the impact of COVID-19 containment measures on operations, including temporary business closures, and customer demand. However, some companies indicated a relative improvement in conditions compared to November.
At 49.9, compared to November’s 48.8, the headline seasonally adjusted UK Services PMI Business Activity Index improved in December though remained below the 50.0 no-change mark for a third month in a row.
The seasonally adjusted Eurozone Composite PMI Output Index registered in sub-50.0 contraction territory for a sixth consecutive month in December, signaling a sustained downturn in economic activity across the euro area.
Eurozone Composite Output Index at 49.3 (Nov: 47.8). 5-month high.
Eurozone Services Business Activity Index at 49.8 (Nov: 48.5). 4-month high
Germany Factory Orders: Order volumes continue steep declines in the European factory heartland that are consistent with a broader European recession.
The lone bright spot in the December global scene.
The seasonally adjusted India Services PMI Business Activity Index rose from 56.4 in November to 58.5 in December, highlighting the strongest rate of expansion since mid-2022. Companies commonly linked the upturn to robust intakes of new work and favorable market conditions.
The 118th Congress still does not have an elected Speaker of the House after at least eleven votes for the first time since 1847; under current House rules, an outright majority of members is required, and ~20 breakaway conservatives are digging in their heels to prevent the election of Kevin McCarthy (R-CA). As long as those ~20 (who are voting instead for Jim Jordan, R-OH) refuse to support McCarthy, he cannot achieve the majority vote required and is unable to muster as many votes even as the senior Democrat Hakeem Jefferies (D-NY).
There are a range of paths forward from here, including but not limited to a fold by the conservatives voting for Jordan (electing McCarthy), a withdrawal from the race by McCarthy (though who he would be replaced by is unclear), large numbers of Republican members sitting the vote out in protest (which would lower the threshold for a majority and might lead to Jefferies, the Democrat, being at least temporarily elected as a minority Speaker), or the introduction of a non-member Speaker (which hasn’t been the case in over a century but is allowed under House rules).
The most likely of those are the first two, and ultimately who the Speaker is will be much less important than what the whole exercise illustrates: the GOP House caucus is not currently unified and its slim majority will likely have a difficult time moving legislation of any kind. After two years of rapid-fire legislation under single-party control in DC, the prospects for bills of any kind to move through both the House and Senate and then receive the President’s signature are dim at best, regardless of the subject.
From an investor’s perspective, this isn’t necessarily a bad thing; as shown in the chart the 5 terms of Congress with the highest enacted legislation count (as measured by bill numbers) also have the lowest average S&P return.
That said, the chart to the left does establish that gridlock in a do-nothing District of Columbia doesn’t necessarily mean bad returns for the stock market.
While all of the near-term shenanigans will have a low impact on the markets it continues to show total dysfunction in D.C. at a time when leadership is most needed.
Any chance for a more conservative approach to offset the anti-business backdrop is all but gone as the Republicans can’t even elect a spokesperson. That dysfunction is now loaded with economic negatives, and it will continue to add to the challenging backdrop.
Food For Thought
The “mess” that is demonstrated by policy mistake after policy mistake continues. Another round of taxes is being imposed in a slowing economy. Here’s A List Of Biden Tax Hikes Which Took Effect on January 1st.
From the sublime to the ridiculous as the insanity in the global economic “mess” continues. European Union officials announced a plan in December to impose a tax on imports based on the greenhouse gases emitted in making them. It’s called a carbon border adjustment mechanism, and it would be the world’s first tax on the carbon content of imported goods.
Ultimately, this discourages the importing of cheaper, energy-intensive goods from places like China and the U.S. because firms in those countries will be hit with this new tariff. Some 11,000 industrial operations in the EU, such as oil refineries and steel mills, as well as aluminum, metal, cement, and chemical companies, already have to pay levies on their CO2 emissions above a certain level.
This tax is tantamount to extortion in the name of the “climate”. It will be another burden on business that keeps the slow/no growth economy in place in the EU. When other global corporations have to “pay up or else”, then it has the ability to disrupt the entire trade scene.
Policy mistakes like this will exacerbate the secular decline in growth and keep this economic “mess” with us for longer.
The Daily chart of the S&P 500 (SPY)
It isn’t just the economic and political scene that is a mess. The technical picture continues to leave everyone guessing as to what comes next. Up until Friday the S&P spent the prior 12 trading days in a sideways pattern gaining a mere 10 points.
Friday’s rally moved the index to the top of that trading range and right up to resistance. “Sideways” price action tends to get very messy when trying to figure out if the S&P will break higher or lower from here. On the one hand, the index has been rebuffed at overhead resistance 4 times since last April. While the 3790-3800 range has seen the S&P bounce off of that near-term support in the last two-plus weeks.
Last week we reviewed the results for 2022. It was a highlight reel that was full of negatives. Topping the list, four popular ETFs, Nasdaq 100, Consumer Discretionary, Communication Services, and Long-Term Treasuries were all down 30+%. Some would believe it to be unthinkable to watch the Nasdaq 100 and Long-Term Treasuries both lose 30% of their value in a year.
Now we wonder if the weakness seen in December will beget more weakness in Q1. One week doesn’t confirm anything as the back and forth market action has not left the scene. Entering the first trading week of the year there was a setup that looked promising for the BULLS to mount a defense. That led me to believe we had to give the Bulls the slight benefit of the doubt in terms of near-term direction.
The fact that the start of a new year didn’t produce a wave of new buyers di raise dome red flags for me. At the beginning of every month, all of the new equity inflows hit the scene, which typically leads to a quick bounce. Tax selling is over and investors should be positioning for 2023. Until the Friday rally, it seemed the majority was in a sell mode. However, this headline driven market continues to make it difficult for both the BULLS or BEARS to have a lot of conviction.
To sum it up, the “tactical buy” setup that was presented is in question. Stocks now need to see strong follow-through in the days ahead to show that the BULLS can mount a solid defense in Q1 ’23.
Thank you for reading this analysis. If you enjoyed this article so far, this next section provides a quick taste of what members of my marketplace service receive in DAILY updates. If you find these weekly articles useful, you may want to join a community of SAVVY Investors that have discovered “how the market works”.
The 2023 Playbook is all about stocks in BULL uptrends.
If a stock isn’t in the Energy, or Healthcare sector, then it is in a BEAR market trend. That leaves investors looking for near-term “long” opportunities with a very limited playing field. However, I am starting to see some decent short term setups that could offer near term opportunity.
If you find what is presented here every week to be useful, the analysis and presentation to members of my service are complete with charts that zoom in on the critical pivot points for each group. A picture is worth a thousand words.
This group was destroyed last year losing 37%. It’s not easy to step up and recommend any stock in this sector when the economy is weakening but I was able to uncover a name or two that ‘outperformed’ the group last year. Unless the next leg of the BEAR market strikes in ’23, these “special situations” have the ingredients to perform. Then there is one “gem” that was destroyed last year that made my favorites list for’23.
Analysts tell us this group is considered “defensive” offering a “safe haven”. No doubt this group will attract attention in this slow growth economy, However, they too are SLOW growth and they are selling well above their historical norms. I’m not interested. Short-term Brokered CDs offer a better return with NO risk.
Another group that was decimated last year. I’ll gladly take AT&T (T) and Verizon (VZ) at these levels with their outsized yields and I’ll take my chances in the BEAR market backdrop in Q1. But wait, there is more. I have a stock in this group that is set for a January “effect” bounce that could start the year off on the right foot.
Outside of Energy, commodity stocks were taken to the woodshed in December as the commodity ETF (BCI) lost 22% in December. That represented the entire year’s gain. Nat Gas (UNG) was the chief culprit losing 37% for the month. It is now back to the lows last seen in December ’21 and January ’22.
I’m now uncovering breakouts in some of the commodity names that warrant attention. Please Beware. If an investor can’t deal with volatility, this isn’t their sector.
The clear undisputed “winner” in ’22 was Energy (XLE) leading the market with a 57% gain. While I don’t see those types of returns this year, I believe there is enough left in this trade to keep a large part of my holdings dedicated to this group.
Back in mid-December, the group (XLF) as a whole failed miserably to overcome its BEARISH downtrend. A poor omen for the sector and possibly a bad sign for the general market as well. I’m not in the “Financials are a must-own in ’23” camp while they are in a BEAR market trend. While they may be “cheap” I’d rather wait until I see a BULL trend emerge. The opening week’s action gives me some hope as I watched the XLF easily outperform gaining 2.7% and extending the weekly gains to three.
A BULL market uptrend is hard to find, and this sector (XLV) is one in which I had an overweight position last year, and see no reason to change that outlook. This group has the ability to stave off a weak economy better than most others.
A group of stocks (XBI) that has been on my favored list since June of 2022. The sideways trading range continues and with so many other sectors posting large losses last year, Biotech continues to outperform.
While China comes with many “issues’ it is the cleanest dirty shirt in the global laundry bin. I realize investing in “anything China” is controversial for many investors, and so it may not be for everyone. For those that can look past the controversy, I believe China can be an outperformer in ’23. It surely crushed just about every other trade in the November/December time period.
ETFs like (ASHR), (FXI), (KWEB), and (MCHI) are favorites to gain exposure to China. Gambling stocks that are advancing on the news that China eventually reopens, like (LVS) and (WYNN) are now back in BULL market trends. I was early when I added them last September but the wait was worthwhile.
All of these have outperformed in the last 2 months and I see this continuing in Q1. As an indication of how much these China ETFs have sold off, they are just getting back to their COVID LOWS!
The technology ETF (XLK) was an area of the stock market that suffered through a stinging BEAR market last year. Other than a trade here and there, I’m not inclined to go rushing back into that fire.
The same can be said for semiconductors (SOXX). If an investor is nimble enough there will be sufficient bounces offering opportunities to make money. Make no mistake, the longer term trend for Technology and associated sub-sectors is DOWN.
These sectors have outperformed for years and when “reversion to the mean” takes place, that could mean they underperform for years.
Cryptos followed equities falling into the end of the year with the world’s largest cryptocurrency, Bitcoin, down 1.5% in the final week of the year. That erased nearly two-thirds of its value in ’22. Following these declines, the technical pictures of many of these largest cryptos have only worsened. Similar to the stock market, volumes have been lighter. For crypto, it is likely a combination of decreased interest in cryptocurrencies given the past year’s events as well as seasonality for the muted activity.
Looking into Q1, cryptos have plenty of headwinds to fight headed into 2023 including lackluster technicals, fundamental concerns and diminished trust in the space, and an overall shrunken market in terms of size and volumes.
The trend is down.
My “short” position using the ProShares Short Bitcoin Strategy ETF (BITI) remains in place.
The bulls are licking their wounds after a rough 2022 and are looking for a good start. But the issues that plagued markets last year – inflation, the Federal Reserve’s rate hikes, and concerns about an impending recession – are still pressing. Just about every analyst, pundit, market technician, and research report that I have come across is on the same page. The predictions for a weak stock market in the first half of the year followed by a better second half are everywhere.
“If everybody is thinking alike, then somebody isn’t thinking.”
Many research firms are targeting the 3200-3400 range on the S&P as a potential Q1 target zone. Since that is the case, I’m not going to join them just yet. However, I will need to see some evidence to warrant a more cautiously optimistic view in the near term. The noise will continue. We are going to hear about the rate of inflation, how the Fed has lost control of the situation, and WHEN the Fed is going to end raising rates. I’m not going to spend a lot of time on that now. 2023 is going to be about the mess that is our economy. The scene is ever-evolving and we could see a change come about that either reverses or enhances the negative issues that have us in this BEAR market.
Similar to the beginning of last year, I want to read the market’s message. Doing so will tell me if the “issues” are going to be in place for a while longer. Regardless of what anyone is forecasting, it’s been my view that Q1 ’23 will revolve around the economy and an earnings season that starts next week. For that matter anyone who wishes to make things very simple, and avoid all of the debate, the entire year is going to depend on where S&P earnings settle.
Therefore, I am not going into 2023 with any strong conviction about anything. I have no idea where the S&P 500 finishes the year, but the good news is I don’t have to know in order to make money. I believe the markets could very well continue to struggle in ’23, but as I have said all along, I am also prepared to defer to the balance of evidence of the market should it begin to suggest otherwise.
We are going to find out soon enough just how much pressure the equity BULLS are willing to endure from signs of weakening in this “messy” economy.
Please allow me to take a moment and remind all of the readers of an important issue. I provide investment advice to clients and members of my marketplace service. Each week I strive to provide an investment backdrop that helps investors make their own decisions. In these types of forums, readers bring a host of situations and variables to the table when visiting these articles. Therefore it is impossible to pinpoint what may be right for each situation.
In different circumstances, I can determine each client’s personal situation/requirements and discuss issues with them when needed. That is impossible for readers of these articles. Therefore I will attempt to help form an opinion without crossing the line into specific advice. Please keep that in mind when forming your investment strategy.
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Best of Luck to Everyone!