Will 2023 Sweep Out the Bear and Bring in the Bull?

It has been a terrible year for stocks, and it has been a terrible year for bonds (just look at the chart below).

In fact, save for energy, oil and a few outliers, most of the market this year was downright ugly. Fortunately, today is the final day of the year, and optimists are hoping that the turning of the calendar will sweep out the old bear and usher in a new bull.

Yet as we all know, hope is not an investment strategy, and it’s going to take a few big trends to go just the right way for the bulls to wrestle control away from their adversaries.

So, what are some of those key trends, and what possible reasons do we have to feel optimistic about the year ahead?

To answer this question, I am going to borrow a selection from this morning’s Eagle Eye Opener (if you aren’t a subscriber, you need to be). This is my daily market bulletin publication designed to provide key insight into what you need to know that day, and, in this case, what you need to know as we enter 2023.

First, the market is no longer overvalued. It may seem like a lot longer than just a year ago, but stocks ended 2021 and started 2022 at nosebleed valuations. However, currently the S&P 500 is trading at approximately 17.1X 2023 S&P 500 earnings per share (EPS) of $225. Now, certainly that number can go lower if a full-fledged and deep recession occurs (it can fall to 15X or below), but at the same time, there’s also legitimate upside if a “soft landing” does occur (up to 18.5X).

Second, for the first time in a year, there actually is positive progress on inflation. Now, hopes of a sharp drop in inflation that brings it back to 2% likely aren’t realistic. The days of sub-2% Consumer Price Index (CPI) that we enjoyed from ’08-’20 likely are gone, possibly for a long time. But inflation could fall far enough (3-4%) for the Fed to essentially think it has accomplished its mission (although it won’t say it directly as the target is still 2%), but for all intents and purposes, we could exit 2023 without a material inflation problem.

Third, it is undeniable that the economy is slowing and that there will be an economic loss of momentum, but it doesn’t automatically mean a horrible recession. Yes, history is not on the Fed’s side here (I have never seen a “soft landing” successfully executed, and I don’t think anyone else has either). But this is not a normal time. The pandemic stimulus and lockdowns essentially supercharged the economy and personal balance sheets.

Employment remains absurdly strong and, while rates are high, they are still just at levels those of us who are older remember as “normal.” The point being, we’re not talking about 18% mortgages, we’re talking about 6-7%, which until 2008, wasn’t a terrible rate.

Finally, geopolitics are admittedly a mess. But if there’s a lesson for every global troublemaker from 2022, it’s that causing mayhem isn’t worth it. Putin’s invasion of Ukraine has proven to be a massive mistake. Yes, in the end Russia may well seize a bit more Ukrainian territory, but it will come at a fantastically high cost. Meanwhile, Europe, Russia’s main energy market, has essentially replaced Russian supply and long after the conflict has ended that will have negative implications for the Russian economy.

To be clear, I’m not trying to put on rose-colored glasses on the last day of an awful year. But I cannot help but notice the total 180-degree sentiment change from last year.

A year ago, stocks were going out at all-time highs and optimism was palpable. The good times, it seemed, didn’t need to end. Now, with the S&P 500 ending the year down just under 20%, sentiment is as negative as I have seen it since 2009. And while I can’t say with confidence the bottom is in (it may not be), I can say there’s a legitimate path to a rebound.

It is not an easy one, but it exists, and that’s worth something as we start the year.

Have a safe and happy new year.

Jim Woods