2023 Investment Outlook

2022-12-27, Michael Thompson

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We are wrapping up a tough 2022 in which most assets lost substantial value. Unfortunately, we can’t go back and change our 2022 performance. What we can do is better prepare for 2023. In this article, we evaluate the current conditions and outlooks for the coming 12 months. We include projections from a number of prominent institutions and individuals on stocks, bonds and other assets. Below is a quick summary of the highlights.

• Most sources expect slightly higher interest rates in the first half of 2023, followed by a mild recession with some loosening late in the year.
• From our sources, the average projection is for the S&P 500 to grow 3.7% in 2023. Most expect small cap and international stocks to earn more, but with higher downside risk.
• For Bitcoin, the mean prediction is 50k USD (+300%) and the median is 25k USD. These Bitcoin predictions have historically been wildly optimistic though (e.g. the mean projection for 2022 was over 120k when it actually sank below 17k USD).
• Our sources projected gold to appreciate a median of 4.9% over USD in 2023. The mean projection is +16%, but it’s highly skewed by the highest two predictions.

The article is organized as described below.

• Foreword
• Economic environment
• Stocks
• Bitcoin and crypto
• Bonds
• Gold

Foreword

Please realize that anytime you read an article like this, the information is already “priced into” the assets. Information that makes stock A look better than B is already known and people have already bought / sold these stocks accordingly—there’s no reason to think you can earn an above average (risk adjusted) return with the information herein. If you want to earn an above-average return, you’ll most likely need to accept above-average risk. Keep in mind this is the case anytime you hear investment projections, not just here.

The information can still be useful. For one, it can help set better expectations for overall returns, e.g. if you’re a retiree that needs to set a budget based on your investment returns. It can also help you better see the risks and choose how much risk (or which risks) you’d like to expose yourself to. For example, we’ll see that ex-US stocks are currently priced (abnormally) cheap relative to US stocks. This may indicate that the consensus sees above normal risk in ex-US stocks, and that you can receive above normal returns if you’re willing and able to take this risk.

Economic environment

The consensus for most assets is that interest rates will dominate their performance in 2023. The looser the Fed, the higher the asset price, and vice versa. We found little expectations for high earnings growth, at least in the US. Most expect a Fed funds rate to peak just over 5% in the first half of the year with high, but decreasing, inflation. After that, most institutions anticipate a recession and lowering of rates.

According to recent Bank of America data, households still have more in their checking and savings accounts than they did pre-pandemic, but those savings are decreasing. Consumers are healthy, but if unemployment rises significantly this could be undone in 2023.

The unemployment rate in November was unchanged at 3.7%—very low by historical standards. However, a survey indicated that 98% of CEOs interviewed were preparing for a US recession (and 99% were preparing for an EU recession). This should put an upward pressure on unemployment, and the consensus expects a climb to about 4.6% in 2023.

Stocks

From our sources below, the average expected return for the S&P 500 in 2023 is 3.7% nominal. Predictions ranged from -15% (Fidelity) to +15% (Wells Fargo). Most expect little earnings growth and even a recession, but one that’s priced into the market already. Much of the predicted price movement is attributed to changes in valuations. All expect the Fed to be the dominant player in setting these valuations via interest rates.

Most institutions expect health care and energy businesses to shine within the US. Outside the US, Morgan Stanley, Fidelity and J.P. Morgan expect higher returns in emerging markets and Japan. A simple look at valuations reveals that the S&P 500, while it has dropped a lot in 2022, retains an above-average valuation while small cap and emerging market stocks are priced below long-term averages.

Below are a handful of price to earnings ratios (PE ratios) for various indices and a few surprising companies, as of December 26, 2022. These tell you how expensive a stock is relative to earnings; higher PE ratios mean you pay more money for the same amount of expected 2023 earnings. Like most metrics, you must take them with a grain of salt: e.g. a company that spends earnings generously on research will have a higher P/E even though that research may make them more valuable in the long run.

Small cap, international and emerging market indices are all at humble, below average PEs. For those that would like to diversify outside US large caps, now (like last year) may be a good time to do it (but realize these stocks may be more volatile). The S&P 500, while still at an above average PE, is priced much better than it has been in recent history. Whether this ratio will grow or shrink in the coming years is anyone's guess. Yardeni research recently released a nice evaluation of PE ratios worth further study.

I picked out a few surprising PEs of individual companies. First is Tesla. After years of seemingly astronomic overvaluation, Tesla’s 70% price drop YTD has its PE almost back to Earth, grounded at just 23! I’m not saying buy it, but it’s something I want to keep an eye on throughout 2023. The revelation that Google has fallen to 16.7 was a surprise to me. At first glance, it appears too good to be true, something that needs further investigation.

Bitcoin and cryptos

Bitcoin has lost about 65% of its value YTD in 2022, and it was one of the best performing coins in the industry. More crypto scams were revealed that caused millions of people to lose their investments. At least 17,000 crypto coins exist at the time of this writing, and a scary number of these were likely created purely for pump and dump schemes. It seems the easiest investment decision in 2023 should be to avoid such coins. The industry needs a cleansing, and it’s not yet clear when or how that will happen.

The question is how to tell which coins are useful and potentially worth investing in, versus the scams. Often used metrics on development activity, transactions and users aren’t great in my opinion. For example, it’s been reported that over half of Bitcoin transactions are “fake” (wash trades and the like). A substantial portion of Ethereum usage may be associated with creating ERC-20 crap tokens or NFT scams (I’m not saying all NFTs are scams). I don’t mean to imply Ethereum is fraudulent or is not useful, I’m only saying to interpret usage statistics with caution.

There are crypto platforms that may deliver real utility. Some people think Bitcoin will replace gold as a long term store of wealth. It’s hard to argue against them—Bitcoin seems superior to gold in most respects. For some applications, smart contracts could be of great utility and worthy of investment. Unfortunately, many of these platforms already have lofty valuations and, until regulation (or something) cleans out the messes, it’s difficult to discern “real” usage from the scams.

Below are some 2023 Bitcoin price predictions. Such predictions have been extremely inaccurate historically, so I’d recommend using these for entertainment purposes only—please don’t gamble your savings on these predictions.

Bonds

Bond yields are the highest they’ve been in a decade. If inflation subsides in 2023, bonds could once again earn real returns. Vanguard upped their estimate for bond returns over the next decade to 4-5% (both US and ex-US)—almost double their prediction from just one year ago.

At the time of this writing, a 10-year US treasury yields 3.8%, while 6-month and 1-year treasuries yield about 4.75%. Morningstar projects that the 10-year will average 3.5% over 2023 with a 4.3% Fed funds rate. Like most, they expect that the Fed is close to halting rate hikes and will start easing later in 2023.

Vanguard and most major institutions believe bonds will help weather the likely recession in 2023. Not only can a recession sink stock prices (even below “fair value”), it can cause you to lose your job. In this case bonds could provide helpful income—being forced to sell stocks in a recession can be disastrous.

Many investors were disappointed with the correlation between stocks and treasury bonds in 2022. Most intended for treasury bonds to counter stock market swings, as they normally do, but the two moved in lockstep last year. In 2023, if the focus indeed switches from inflation to recession, bonds should decouple from stocks, as discussed in “Watching Stock and Bond Correlations in 2023.”

The spread between low and high risk corporate bonds has grown over the last year and is well above the 10-year average. At the time of this writing, the Morningstar Corporate bond index is 5.16%, while their high-yield bond index is 8.27%. The market seems to be pricing in higher default rates. Indeed, a recent Washington Post article points out that many businesses addicted to cheap money face a wall of expiring debt in 2024. These companies will need to start refinancing in 2023, and they may find rates too high to stay above water.

For more insights on the 2023 bond market, see Fixed Income Outlook: Bonds are Back from Charles Schwab.

Gold

Like most assets, many say the biggest factor in 2023 gold prices will be central bank actions. All else equal, higher interest rates lower gold prices as bonds become relatively more attractive. It doesn’t end there, though. According to the World Gold Council, central banks bought 400 tonnes of gold in the third quarter, almost doubling the previous record of 241 tonnes during the same period in 2018. Earlier this month, China’s central bank announced it added about $1.8 billion worth of gold to its reserves, bringing the cumulative value to around $112 billion, Reuters reported. So central bankers have two powerful levers to steer gold prices.

A number of predictions for the price of gold in 2023 are provided in the table below. From this table, the mean expected return for gold in 2023 is 16%. However, this is heavily swayed by the largest 2 predictions—the median is 4.9%. Personally, I’m very indecisive. On the one hand, I feel Bitcoin (or another technology) can play the traditional role of gold better than gold, and that the market cap of gold will substantially drop over the next 100+ years. On the other hand, I haven’t a clue when or how this will take place. I do want something less coupled to government and business—like gold—but without the dramatic drawdowns and scandals of Bitcoin.

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