2022 has mercifully come to an end, and we’re all still standing. Last year, we did anticipate things to improve with supply chains and the incoming reopening of the world. We did not see how much that rush to reopen caused inflation in almost every other aspect of our spending. No one had any indication of risks with Russia/Ukraine. Now that’s the past and we need to look ahead to 2023.

Here are some of the most discussed predictions for 2023, none of which have yet to become reality. 

The US will enter a shallow recession

This is a Fed induced recession where hiking rates have slowed spending and borrowing. Interest rates on used cars have gone as high as 10% and car buying has slowed as a result. It is slowing enough to where some car dealers are offering discounts to try to rekindle demand. Tesla has missed 4th quarter car deliveries by 25k cars and has recently cut car prices in China and the US. 

Our chart below from JP Morgan shows the breakdown of inflation over the last year. Cars (the red section) were a mighty contributor to inflation, now is the smallest inflationary category. That’s what high interest rates can do. 

Essentials have also crowded out discretionary spending. As housing and food become more expensive, people will have less to spend on cars. The Fed simply pushed affordability over a cliff. 

Consumer spending is the largest component of the economy. When we slow spending, the economy will contract. 

Quality growth companies will win the year

As a result of a poor 2022, growth companies look appealing again. After some very lofty valuations in 2021, last year served as a slow correction to more palatable values. Historically, growth stocks have not done well in a rising rate environment, and we think the Fed is done raising rates by the second half of 2023. 

This doesn’t mean the Fed will lower rates. We think there will be a pause and rates will stay where they are. Even in a recession, the Fed will focus on unemployment rate where it is viewed as “much too tight”. A good economy has a 5% unemployment rate. As of this article, we are at 3.5%. 

Once investors see a pause though, they’ll try to get ahead of an eventual rate cut, which have historically benefited growth companies. 

Bonds will hold up after a historically bad year

We’ve touted bonds in the last few months and still believe they are a vital part of any portfolio, especially in a recession. The biggest difference this year is coupon payments on all bonds are much higher than a year ago. 

The bond market is already ahead of the Fed by pricing in lower rates in the future. Investors can receive 4.5% coupons on short term bonds compared to 3.5% on mid to long term bonds. Why are investors getting more yield with less time commitment? The longer I loan out money, the higher interest I want in return. But there’s been more demand for longer maturity bonds with institutional bond investors wanting to lock in a known yield. 

If there is a recession, the demand for safety in US treasuries historically goes up. That increased demand will bring yields down. This isn’t isolated to US investors or a US recession. Global investors have the ability to invest in US government debt and a rush to safety already has shown plenty of demand. 

In case we are wrong

Always be diversified. Just because there’s an expectation of where a market is heading, doesn’t make it happen in real life. Any tilts should not be so overconcentrated that a wrong assumption blows up the whole portfolio. 

Proper diversification means holding assets that move in different ways in all kinds of markets. Say our recession assumption doesn’t hold and the US beats inflation without entering a recession. Interest rates should tick back up for longer term maturities, which would hurt certain positions. But most of the portfolio would greatly benefit because of being invested in stocks. Keeping exposures to assets that are seemingly out of favor can sometimes do very well when we least expect it.  

Every asset class will fall in and out of favor. Rebalancing is a systematic way to buy things on sale while selling some winners. If there’s a need to change the plan, ask for another opinion. As a part of our investment process, we constantly have third parties review and stress test our portfolios. 

Disclosures: 

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

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