CNFR - Forecast 2023 - Likely More Of 2022

Summary

• 2022 provided long only investors with poor returns, both in equity and fixed income markets.
• With M-2 money supply growth slowing and a profits recession on the horizon, 2023 is likely to look a lot like 2022, particularly in the first half of the year.
• My portfolio allocation heading into 2023 reflects a bearish view.

Introduction

2022 was a difficult year for investors, particularly long only investors, as fixed income and equity securities have, on balance, fallen materially. For example, for 2022, per Doug Noland's invaluable weekly commentary , the S&P 500 was down almost 20%, the Dow was down almost 9%, the small cap Russell 2000 was down almost 22%, and the Nasdaq100 was down roughly 33.0%, while in the bond space, 2-year Treasury yields rose 370 basis points (" bps "), 5-year Treasury yields rose 274bps, 10-year Treasury yields rose 237bps and 30-year Treasury yields rose 206bps.

Unfortunately, heading into 2023, with respect to equities, I expect more of the same (i.e., downward momentum) -- at least for the first half of the year as the superbubbles continue to unwind (more on that below).

For bonds, while I am starting to sniff out some value at the shorter end of the curve and in low duration corporate bonds, what comes next, for me at least, is hard to discern. As a consequence, I am waiting and watching and focusing on underfollowed areas of the bond market, including baby bonds. Longer term, I don't see how Uncle Sam solves its debt problems without trying to inflate the debt away; thus, I am wary of intermediate and long-term bonds (except for a trade).

Bubbles

Thanks, in part, to the overwhelming monetary and fiscal response to the COVID-19 pandemic, we underwent a massive technology/crypto/VC/ everything bubble and historically bubbles of this magnitude take time to unwind. It took the Nasdaq 15 years to regains its 2000 bubble highs. Of course, this bubble is much larger than the technology bubble of 2000-2001, and I suspect most investors are not old enough to remember that bubble. With M2 money supply growth going to zero, however, a lack of "bubble memory" is likely a huge disadvantage in the current investing landscape. Perhaps this explains why so many investors are clamoring for Jerome Powell to pivot and have not otherwise accepted that the outlook going forward is likely to be nasty.

In short, heading into 2023, I remain cautious and that cautiousness is reflected in my current portfolio allocation, which is outlined below.

Portfolio Allocation

My portfolio, as of December 31, 2022, was allocated as follows (with representative holdings noted), and a bearish outlook served me well on a relative basis in 2022:

Compared to my portfolio reported in October 2022 , the notable changes are

(1) An increase in cash and cash equivalents from 29% to 36% as money market yields in excess of 4% have become enticing;

(2) An increase in Commodities from 5% to 9%, particularly an increase in my allocation to precious metals (I am bullish on precious metals for the reasons noted in this recent article );

(3) My equity exposure was 54% hedged in October and at the end of 2022 my equity exposure was 62% hedged;

(4) Equity exposure was also reduced from 37% to 29%; and

(5) A bitcoin short was also added to hedge my dwindling bitcoin exposure (dwindling due to price depreciation not sales).

Six Month Outlook

In thinking about the next six months, it is worth carefully reviewing the words of Jeremy Grantham:

Only a few market events in an investor's career really matter, and among the most important of all are superbubbles. These superbubbles are events unlike any others: while there are only a few in history for investors to study, they have clear features in common....

The U.S. stock market remains very expensive and an increase in inflation like the one this year has always hurt multiples, although more slowly than normal this time. But now the fundamentals have also started to deteriorate enormously and surprisingly: between COVID in China, war in Europe, food and energy crises, record fiscal tightening, and more, the outlook is far grimmer than could have been foreseen in January [2022]. Longer term, a broad and permanent food and resource shortage is threatening, all made worse by accelerating climate damage.

The current superbubble features an unprecedentedly dangerous mix of cross-asset overvaluation (with bonds, housing, and stocks all critically overpriced and now rapidly losing momentum), commodity shock, and Fed hawkishness. Each cycle is different and unique - but every historical parallel suggests that the worst is yet to come. "

[Emphasis Applied]

If history is any guide, the future will likely bring with it a profits recession and one or more credit events, in part, because Jerome Powell is currently serious about keeping rates elevated for longer, and, in larger part, because the bubble that has popped was, as Mr. Grantham put it, a superbubble.

While Powell may fold (i.e., turn dovish), it will only be after much more pain in my view (I am taking him at his word and suspect you should too), and while inflation may be decelerating, growth is likely decelerating even more (China's recent trade numbers were horrible with both imports and exports falling for the world's second largest economy).

In summary, be careful out there! If you're still not bearish (enough), maybe this early 2023 Mike Taylor interview will change your tune!

Happy 2023!

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