Big Brain Thoughts on 2023
🎄Happy New Year, everyone 🎄
I hope this holiday season brings you joy and peace. I am grateful for each and every one of you and for your continued support.
Investing in public markets is not easy. It requires a substantial amount of time and research. Patience to watch your ideas play out and the guts to trust your analysis when a theme turns against you.
It was a tough year, but I’m grateful for sticking with my conviction and so our outperformance came from investing in Energy, Aerospace & Defense, Metals & Mining, Health Care, and Dividend-oriented ETFs and distractors came from bonds and investing in the broad market index S&P 500 and internationally.
Here is a detailed recap and how I think 2023 year will play out.
What happened in 2022 is the bottom fell out of the capital markets and the startup and tech sector more broadly.
Back in January 10, 2021, I wrote a post called “Last year it was about T.I.N.A, this year might be a different”
In it, I wrote:
Last year: T.I.N.A. = Can’t invest in bonds, Can’t invest internationally, U.S. companies earnings continue to recover and grow so There Is (was) No Alternative to the U.S. Stock Market. But this might all change in 2022 due to inflation.
Can T.I.N.A. continue? What stops this party?
Less money in people’s pockets: Fiscal support is declining after the unprecedented stimulus of the last two years. Money is relatively more expensive: Fed increases interest rates 3-4x this year because inflation is not just temporary. This hurts long dated expensive tech stocks. Peace gets interrupted: Russia goes after Ukraine and China goes after Taiwan. Headwind for stocks: Higher interest rates means tighter financial conditions.
Well, all the above happened in 2022 except China didn’t go after Taiwan, and I didn’t expect inflation to be so persistent, and neither did The Federal Reserve.
Let’s review what happened in 2022.
Rising prices changed everything — from moods to markets.
High-risk appetite to low-risk appetite.
Why it matters: To understand what happened to the economy, and personal finances, look no further than rapidly rising Consumer Price Index. CPI peaked at 9% year over year during the summer — the highest since 1981 — and is now 7.7%.
The big picture: The Fed's aggressive rate hikes — meant to cool the economy, and thus, consumer spending — rippled through the markets and upended the way investing has worked since the financial crisis in 2008.
Rock-bottom interest rates since 2008 had driven investors to take bigger and bigger risks — pushing stocks to record highs. When money is cheap and plentiful you get a high-risk appetite from investors to bet on a company like Telsa, for example.
Raising interest rates, on the other hand, was like turning the lights on at the bar at 4am. Investors looked around and thought: This all looks terrible, time to go home. Today, given more expensive money, if another Elan Musk came about, no one would fund another Tesla 2.0.
And everyday Americans, most of whom have never experienced high inflation, lived through something that felt eerily destabilizing just as they emerged from the COVID crisis. Inflation is scary.
The impact: Stealing the title from one of the year's big movies, rate hikes hit everything everywhere all at once.
What’s the big lesson in all of this? Respect the capital flow cycle.
Now that money is more expensive, everyone has to be more disciplined.
Companies have to be more disciplined. Tesla and other big tech giants like Meta, will no longer blow money on moonshot experiments.
Big tech giants also are facing competition. Think of all of the streaming services we have available to us now.
Growth at all costs has turned into firing and laying off folks to right size cash flows and more importantly, increase productivity.
A bit of history on the cash cycle:
Back when energy companies, for example, Exxon, Chevron, were cash-rich 10 years ago, they blew their money on big risk, expensive exploration projects. When oil prices crashed, energy companies found religion and cut capex massively.
Bottomline: Low prices cured low prices. This means markets will rebalance themselves over time.
Big Tech companies, that were overfunded with cheap capital, are now needing to find religion and cut back on growth and innovation.
Capital has moved away from growth and towards value-type stocks, which were starved of capital during the Tech boom. It pays to respect the cycle ;-).
Energy has already gone through its cleaning process 2014-2020. Now they are lean and mean and cash flow producing machines.
Established firms like oil companies and also industrials which produce real cash from old legacy assets are now more valuable in today’s “money is more expensive” market.
Lastly, another reason why old incumbents like GM for example, are more valuable is that they can’t get disrupted by a new innovative company. Why? Because VCs won’t fund it in this new world where money is more expensive.
So now let’s turn to 2023. Summaries come from one of my favorite analysts Howard Marks of Oaktree Capital, Jeremy Segal of Wharton, Charles Schwab, KKR, and The Economist.
Key to our thinking:
Inflation has peaked, though it remains quite high but the ‘tug of war’ between falling housing prices and rising labor costs now better reflects the Fed’s intentions to cool the economy. As Chairman Powell said recently, rates are ‘getting close’ to sufficiently restrictive levels.
A tailwind for the economy is lower gasoline prices. And we may be seeing the fruits of falling gasoline prices in the consumer sentiment data, which is starting to turn higher.
Fiscal spending and infrastructure: Russia’s war against Ukraine highlighted national security vulnerabilities in the energy sphere, and China’s lockdowns disrupted the flow of vital technologies.
New infrastructure projects will be at the center of efforts to create:
Self-sufficiency in key areas such as increasing energy capacity in the United States and Europe.
Improving transportation and trade routes as countries reposition factories, enhance communication technologies, and expand electrification capabilities to meet climate goals.
Nuveen’s global investment committee highlighted public infrastructure investments as its highest-conviction preference in 2023, noting, “regulated utility revenue tends to be relatively decoupled from the economy and can experience growth from rising capital costs and policies related to energy transition and the Inflation Reduction Act.
Potentially more government spending will quietly surprise on the upside in 2023. initiatives like the Inflation Reduction Act (IRA, which KKR thinks could be closer to $700 billion versus the ‘headline’ of $370 billion) and EU Recovery Budget (€1.8 trillion over 2020-2026) will result in more spending than many folks think.
Meanwhile, spending on military budgets is increasing around the world, as geopolitics is no longer a discretionary line item in most government budgets these days.
4. China reopens and further stimulus is gaining momentum to offset the headwinds created by recent property developer defaults, which will be positive for energy and metals and mining.
5. Time to Invest in Bonds. Sea Change from growth to value (bonds). Howard Marks has been investing for 53 years and has experienced a number of economic cycles, pendulum swings, manias and panics, bubbles and crashes, and he sees today as a sea change. "High yield bonds offering roughly 8% are likely to deliver equity-like returns, sourced from contractual cash flows on public securities. Credit instruments of all kinds are potentially poised to deliver performance that can help investors accomplish their goals.”
No doubt, we still think the macro environment remains challenging, but we now feel more emboldened as we think about deployment entering 2023.
Now the new buzz is ….TARA, or “There Are Reasonable Alternatives,” is the new mantra, taking the place of TINA, the “There Is No Alternative” approach to investing.
Happy New Year!
Please reach out! I always love to catch up!!
Your Friendly Wealth Engagement Guide,
Disclosures: Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. Forward-looking statements cannot be guaranteed.
This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy. Investing involves risk. Principal loss is possible.