2023 outlook - inflation, recession and quarterly adaption

2022 in the rearview - thanks goodness

The era of helicopter money marked by expansionary fiscal policies and zero to sub-zero rates . Who slammed on the breaks? The policymakers in the developed world after years of tax cuts and increasing the supply of money (M2) in attempts to combat deflation (low growth), fell asleep at the wheel and when they suddenly woke up they realized that they were steering towards a cliff.

The laws of physics, however, are preventing that car from reaching a complete stop. With its massive cargo of M2 (cash, deposits and savings) standing at $21T that car is not easily going to stop let alone reverse its trajectory. Yet despite of all this, 65% of economists are calling for soft landing in 2023/24. Just have a look at the reports from Goldman, JP Morgan and the likes.

Inflation, production constraints and shrinking population

Historically when the money supply (M2) has been dramatically increased in economies there typically tends to be an increase in prices of goods and services leading to inflation - too many dollars chasing too few goods. The environment becomes particularly challenging when there’s geopolitical turmoil, e.g. Russia’s invasion of Ukraine, and prices of raw materials have run high but subsided towards the end of 2022.

The inflation is also fueled by production constraints, caused by the shift in demand towards goods rather than services during Covid-19. Last summer, I waited six months to replace the roof of my house as materials were unavailable.

To curb down inflation, central bankers have extended restrictive monetary policy and raised short-term interest rates. The Federal Reserve now has the Fed Funds Rate (FFR) at 4.5, up from 0.25 a year ago. FFR, also known as overnight rate, is the rate at which US banks lend to each other in order to keep cash reserves at a certain level. Raising the rate makes borrowing costs more expensive.

FED chairman Powell is determined to win over inflation “until the job is done.” At its December 14th meeting the FED bumped interest rates by 50 bps, down from 75. But there was no indication that the central bank was done. Perhaps such an aggressive stand is needed to “engineer” recession and to tame the explosion of prices.

There’s a tradeoff: a constrictive policy will eminently result in slower GDP growth, likely the new norm. On the back of this are long-term economic constraints - the biggest being the aging population. China’s population is now projected to start declining as early as 2023, according to the latest UN report. Europe is also in bad shape due to a low fertility rate of 1.5 and more than 20% of its population above 65.

The playbook for 2023

The new reality will require a new playbook with at least quarterly rebalancing of an investment portfolio and closely watching volatility.

I like to keep an eye on market’s volatility as measured by the S&P 500 VIX. The fear gauge which measures the expected volatility in the S&P 500 Index ended at 21.67 on the last trading day of 2022. The level translates to expected volatility in the S&P 500 on an annualized basis, measured by 1 std. deviation of the probability curve, of 21.67% in the S&P 500 Index, in either direction.

VIX index 2022. Source: Thinkorswim

The high 30’s level to me represents a rock bottom in equities and therefore a buying opportunity. Therefore, I will be looking for another spike up before I turn more bullish on equities. Conversely if the index dips below its yearly support of 19, I will again reconsider my portfolio balance. That’s it - plain and simple barometer to watch for.

Portfolio for long-term growth

Technology is at the epicenter of my portfolio. Technology as in biotechnology, fintech, clean energy and AI. To balance out this, I will look at healthcare names such as Abbvie (ABBV), a pillar in my portfolio, currently trading at 14 x future earnings versus a group of 17. Its pipeline of products pending FDA approval is deep and includes anything from Botox to tumor treatments. Another star pharma is Novo Nordisk (NVO) which has delivered a superior portfolio for treatment of diabetes and obesity. It holds half of the US market where 42% of adults are considered obese. And that’s no small fries. As with any highly regulated business, the risks are on the table.

Emerging markets - China and India to lead

Other themes: China Internet Services ETF (KWEB). China just opened up from being completely locked down with Covid-19. The economy has suffered and GDP is projected at 3.2 2022, well below its 20-year rate of 9%. The fund is off from its March 2021 peak of $100 and is trading at $30. Click here for more info. India (INDA) is emerging as one of the fastest growing economies. The enormous domestic consumption (and talent), emerging middle class, median age of 28 yrs old, continuous listings on the NYSE and increased venture capital (VC) is propping the economy for long-term growth.

I am also remaining bullish here in the US and will look to add to my long-term core position in the S&P 500 Growth (SPYG). Spyder Biotech portfolio (XBI), Artificial Intelligence and Robotics (ROBO) - think increasingly sophisticated AI used to enable network platforms to social and commercial applications like we've never seen before.

Buying bonds

And what is portfolio without the fixed-income element. An allocation could be corporate bonds with medium-term maturity. The Charles Schwab strategic bond portfolio (SCHI) has some Quality paper that has come off the highs by about 20% with an average yield-to-maturity (YTM) of 5.75%. Finally, looking beyond the smoke of 2022-2023 with the iShares Global Clean Energy (ICLN) portfolio which holds great companies among which are Danish Vestas and Orsted as well as the US-based First Solar.

From financial technology, my number one pick is Social Finance or SoFI (SoFi) which seems to be well positioned to be the bank of the future generation in the US. Best of wishes in 2023!

Legal Disclaimer: Nothing in this publication should be construed as financial advice, nor does any information in the article constitute a complete and comprehensive statement. Please consider your own financial situation, level of knowledge and the risks.