At the start of each year, everyone is clamoring to figure out what the next 12 months will be like when it comes to the stock market and investment outlook.
At the start of each year, everyone is clamoring to figure out what the next 12 months will be like when it comes to the stock market and investment outlook. Although we’ve definitely all had some surprises, the partners at Wall Street Alliance Group have some ideas about what the economic outlook and what sectors to keep an eye on when making allocation decisions.
1. A different cycle
After the past decade of low interest rates and low inflation, we’re looking at a very different future. Persistent inflation rates and federal fund rates both hovering near 5% seem to be the story of the current cycle. The economy will face challenges from the employment sector as the labor market adjusts to shifts in immigration policy and other factors that hinder labor supply. Employer costs will rise as employers offer more incentives and higher pay to obtain and keep workers. The days of inexpensive manufacturing are over. High-profile companies are moving production out of China as the country undergoes turmoil.
What does this mean in the financial arena? Large banks are drawing benefits from the higher net interest margins with the rising rates coming from the Federal Reserve. Companies that pay dividends are also finding footing in this type of economy, whereas on the other end of the spectrum, companies that are considered high growth are losing their place because their lack of earnings cannot support the trading activity that had been propping them up previously.
2. Inflation fears persisting from the geopolitical environment
It’s not only the situation in China that is driving U.S. companies such as Apple to move their facilities out of the country, ending the time of cheaper production. The ongoing war in Europe, which has had a negative impact on energy supply and driven inflation fears, is another example of the type of turmoil that is building inflation concern. Low worker participation rates in the U.S., which as previously mentioned has compelled employers to offer higher wages, is another factor that leads to these higher prices. All of this has created a tenacious period of inflation and fear of inflation.
3. Value stocks and opportunity
This type of financial environment is bringing back an interest in Warren Buffett’s style of value investing. Because large banks are benefiting from the higher interest margins, portfolios that hold related positions are able to thrive. Although there has been some interest in moving away from fossil fuel reliance, the shift is slow, and we believe that the OPEC cuts as well as other international tensions will mean a lower oil supply. However, the world economy is expected to double by 2045, which won’t come without an increased demand for energy. As expected, Buffett is also buying into big oil companies. This isn’t a time to waste opportunities; many experienced buyers have purchased stocks over the past year, particularly in these sectors and those that are dividend payers.
4. Time for revenge spending
After having survived the COVID-19 shutdown, Americans are ready to cut loose and spend. We see this trend being strong throughout 2023, as people spend in areas they weren’t able to previously, particularly for travel, because so many were denied the pleasure of it during the pandemic. Even with Americans’ drive to get out and see the world, particularly with international travel, airlines have not been winning friends. Rising fuel costs have driven up the cost of airline tickets, and airlines have been hit with a number of other issues, including trouble retaining employees. Nevertheless, travel will continue to increase, and there could be some benefit to credit card companies that will make a hefty sum on international transactions.
5. Market leadership changes
The past five years have seen technology lead the market; however, we feel that that’s about to change. Over the next five years, look to see leadership coming from the energy, pharmaceutical and financial sectors. As we wrote previously, the demand for oil in a growing economy will stay high and get higher and supply constraints will drive up prices, benefiting the big oil companies with the most holdings. More access to health care and a global population boom mean a broader market for pharmaceutical companies, and large drug manufacturers will benefit from both. Lastly, although recession seems inevitable, we don’t believe that it will be long or severe, looking at the current stable condition of banks (as opposed to their vulnerability in 2008). The 2022 federal stress test was no challenge for larger banks, and they stand to benefit greatly from those federally raised rates we discussed before. These three sectors will lead the way in the coming years.
6. Range-bound market
Whenever talk of recession creeps up, the specter of 2008 looms. However, we don’t believe the U.S. is in the same position as it was then. Consumer spending remains strong, even with inflation rates rising, and although there have been layoffs in the technology arena, other industries, including hospitality and leisure, are employing workers at a rapid pace. The housing market has slowed but not stopped fully, even with mortgage rates doubling over the course of a year. The Federal Reserve is aware of the course it’s charting through a guided recession, which means a range-bound market. That indicates that there are areas of vulnerability as well as opportunity, and although a passive strategy with a focus on sectors such as technology has worked in the past, this is not likely the best move going into the new market era. Active management with rebalancing as a frequent activity will be more suited to the market to make sure to provide exposure on dips and a bit of removing positions when on the upswing. The basic aspect of this is to acknowledge that there is a bit of a holding pattern and to take what opportunities are there while waiting.
7. Bull case for fixed income
It’s no secret that large banks are raising their rates as inflation persists at a level that we haven’t seen in years. These higher rates are also increasing interest rates for domestic and international bonds. Although current bond investors are feeling the pressure, we think the coming decade will be one that has a better forecast than others have predicted a year ago. We believe that there will be a return for U.S. bonds of 4.1% to 5.1% per year, as opposed to other predictions that set the return at 1.4% to 2.4%. International bonds won’t be left out in the cold either. We believe that the coming decade will have returns at nearly the same rate.
8. Alternative and real assets as inflation hedges
Fighting inflation isn’t the same game it was 20 years ago. Another strategy for hedging against inflation is to invest in real and alternative assets. Real assets have a stable historical value in times of high inflation. Although they may not be the first things you think of in periods such as this, it may be time to invest in commodities such as precious metals and oil, or even real assets such as antique paintings or other treasured items. These assets are noncyclical in nature and can provide a different kind of stability to a portfolio.
9. Time for Roth conversions and tax loss harvesting
Though this tip seems to go against the usual advice of not selling during a down market, not all stocks have the capacity to recover even with a market rebound. By selling underperforming stocks now, we believe that those losses will lower taxable earnings and save investors on taxes. To take the advantage further, cash from the sales can be used to purchase stocks from companies such as Amazon that will more likely rebound quickly on an up market. It’s also an opportune time for Roth conversions, because individual retirement account values have been lowered with the heavy losses in the equities market. Doing a Roth conversion now means the account holder will be able to pay lower taxes at the time of the conversion while benefiting from the tax-free growth and tax-free withdrawals at a later date.
10. Gifting depreciated stocks to children
It’s a fact that stock gifts to children mean the child, who has little to no income of their own, will pay considerably fewer capital gains taxes. If stock gifting is part of your legacy planning, the depreciated value that stocks have now make it an ideal time to put this in place. As of 2023, you can gift up to $17,000 in stocks without paying gift taxes or even reporting the gift. Another way of transferring these depreciated value stocks from quality companies out of an estate is to open a SLAT (Spousal Lifetime Access Trust). Once the assets have been transferred into the trust, they can continue to grow estate-tax free.
Although there is no way to predict with pinpoint accuracy what the economy will do over the next year, five years or decade, we believe that trends can be identified that give us a good idea of what we’ll see in the future. By incorporating these guidelines into your financial planning and keeping these projections in mind while reallocating your portfolios, you may be able to make the most of a challenging year.
Syed Nishat, BFA, and Aadil Zaman , MBA, are partners and fiduciary financial advisors at Wall Street Alliance Group. Securities offered through Securities America, Inc., member FINRA/SIPC. Advisory services offered through Securities America Advisors, Inc. Wall Street Alliance Group and Securities America are separate companies. Securities America and its representatives do not provide tax or legal advice; therefore, it is important to coordinate with your tax or legal advisor regarding your specific situation.
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