The Market Outlook 2023
As the year begins, market behavior is still erratic as volatility prevails in both the stock and bond markets. Volatility seems to depend on news announcements, triggering mood swings switching between good and bad.
In short, the bulls have taken on a speculative mind set focusing on the Federal Reserve’s interest rate strategy. The bulls are expecting a change from tightening to loosening in interest rates policy, which in turn, should propel the stock market to new highs. The bullish case is based on how much rates have already moved during the full year 2022. The bears, on the other hand, seemed focused on actual inflation and the economic news that prevails rather than speculating as to how high rates will go and when they will hit a peak. As no one knows how high or when rates will peak, the mood swings only seem to further confuse the issue and emotionally charge the environment.
Our strategy is to judge what we know and refrain from speculating or anticipating the timing of the Fed’s moves. We lean toward fact-based expectations and accordingly are looking at an inflation rate last reported at 7%. We have seen the inflation rate drop steadily for three months, but we also realize that the Fed’s inflation target of 2% is still a long way from 7%.
The bond market seems confused as the 30-year Treasury yield is 3.85%, while at the same time, the 30-year mortgage rate is 6.25%. Which one reflects the true cost of borrowing for 30 years? Remember that our monetary system only works if lenders receive a yield that covers inflation risk and taxation. Bonds suggest an inflation rate of 2–2½%, while mortgages are expecting inflation to come in at 3½–4%. Both readings seem too optimistic, especially when we are looking at 7% today.
We also realize that President Biden’s use of our emergency petroleum reserves helped bring us to the 7% number and this reserve is no longer available to suppress future oil price increases that can be triggered by an increased demand. These will likely come as the economy strengthens.
The Fed has helped us over the last few budget deficits by printing the money needed by the Federal Government. That game is over as Fed. Chairman Powell has declared an end to that practice. Instead, the Treasury must borrow the deficit and pay lenders an interest rate that will cover inflation, credit risk, and taxes. 3.8%? —I don’t think so. Instead, we will plan to lend at 4½% for the short term (months, not years!). Accordingly, the liquid portion of our portfolios will continue until we have new and different data on interest rates and/or inflation.
The economy went through a shallow recession in 2022 and has been on the mend since. We seem to be tracking at a 2% growth path and think there is enough here to call for some moderate equity exposure. As interest rates rise, the risk of a recession increases, so we will be conservative about our stock market exposure. We like companies that will benefit from a weaker dollar, so you will find a sprinkling of commodity producers, multinationals, and large defense contractors.
The Ukraine war has shown the world how inferior Russian arms are. American arms have proven to be the best and this should help our arms manufacturers as time goes by. The weaker dollar is a new and recent trend so you can expect us to add new equities as the downtrend becomes more entrenched. In this regard, we recently added Barrick Gold, a premium gold producer, to our list of companies.
In short, you can expect us to be on top of market movement in a very deliberate way. We plan to keep an anxious eye on China as the global environment remains fragile and Taiwan is the recognized flash point.
Our own political process will change as the Republicans do their thing with budgets and money. There will likely be some kind of effort to “free” American petroleum production emanating from the new leadership.
We are looking for a year of transition to a more determinable environment. We wish you the very best in that transition and thank you for your continued loyalty.