Investor outlook 2023
Updated: Dec 27, 2022
The English macroeconomist John Maynard Keynes (1883-1946) is a villain to some and a hero to others. Keynes was a charismatic pragmatist believing in decisive government intervention over free-market capitalism. His thinking may have brought the right solution for the 1930s, but not for today. Politicians still celebrate Keynes because he serves the intellectual justification to spend money they do not have. Unfortunately, Keynes' followers and modern progressive politicians have grossly distorted his ideas to promote reckless government spending. Western economies are today suffocating from the weight of growing debt burdens.
The Bretton Woods conference of 1944 was predominantly a clash between two nations - the indebted and weakened former British empire and the rising American economic empire. The conference established the USD as the global reserve currency pegged to gold at 35 USD/ounce while other currencies were pegged to USD.
The system worked fine in the first decades after WW2, but the French criticized the system calling it “America’s exorbitant privilege”. In short, the wars and welfare prompted Americans to cheat by printing more USD than was backed by gold.
Consequently, the French and other nations started to swap dollar reserves for physical gold. This was effectively a traditional bank run, and when also the British followed suit on august 12, 1971, President Nixon panicked and defaulted on US obligations three days later. He took the US off the last vestiges of the Gold Standard. The president was reported to have smiled with relief, expressing, "we are all Keynesians now". Although his decision was meant to be temporary, he must have known that he had removed the only protection able to secure future fiscal and monetary discipline. Leaving the gold standard laid the foundation for a future Western economic decline.
Financial experts are still debating what level of government debt is critical to the welfare of a nation. Some researchers have suggested that passing the 90% is where economies cannot recover. Other schools of economic thought, like the MMT (Modern Monetary Theory) guys, think there is no limit to the amount of debt a sovereign nation can sustain – governments can print themselves out of any problem. MMT is Keynes' ideas on heroin – primarily dismissed as a scam but fervently applauded by liberal politicians aiming to buy voters by perpetual excessive spending. If money printing were a solution, 1920s Germany and today's Zimbabwe would be shining examples of successful economies with soaring GDPs and strong currencies.
The US Government Debt to GDP has since 1971 risen from 34% to 138% today. The debt is today almost 32 trillion USD. That leaves the USA the 10th most indebted nation in the world, with failed states like Lebanon, Venezuela, Eritrea and Sudan. The picture looks even grimmer when adding unfunded liabilities to the equation. Estimates vary between 90 and 250 trillion in liabilities. For the argument, let us consider a conservative number of 120 trillion. That sums the US debt to 660% of the 2021 GDP. It does not take a professor to comprehend that such debt levels are absurd and will never be paid back, at least not without destroying the USD.
Germany and the Scandinavian countries seem to be the only exceptions to debt-ridden Western nations. Still, Germany's industry faces a decline from a decade of failed energy politics based on climate ideology over pragmatism. The recent sanctions on Russia will accelerate the decline.
Scandinavia fares better. Despite having high public spending on welfare entitlements, the government debt to GDP is still much lower than the dominant G7 countries. The economic output per citizen is also considerably higher than most Western countries. Norway, the "Saudi Arabia of Europe", has the 5th highest GDP per capita in the world. Egalitarianism and a less authoritarian response to the Covid pandemic partially explain the Scandinavian successes. Moreover, contrary to popular belief, the Scandinavian private sector is based on free-market capitalism, not socialism.
Hysteria and Madness
Due to easy credit, the global financial system was on the brink of collapse in the 2007/2008 Global Financial Crisis. Politicians and Central Banks then had a chance to let the free markets fix things by letting failed businesses go bankrupt. However, quite the opposite happened. Governments intervened and bailed out "too big to fail" corporations. Instead of resetting financial imbalances, they reinflated and created more asset bubbles by artificially low-interest rates and quantitative easing programs.
Most Western economies followed the US-led initiative and pumped liquidity into the markets. Now, most of the Western world is in dire straits. Record debt levels, populations increasingly dependent on handouts, and most asset classes in bubble territory have caused political, social, and cultural turmoil. What happens next is anyone's guess, but do not expect good decisions to be made. Collective hysteria seems to be the driving force of most political decisions.
Other signs of madness are tech companies rapidly quadrupling in value, far from ever creating positive cash flows. FTX may be the pinnacle of investor hubris. The business model was dubious at best, and led by kids without experience or motivation to run an honest business. The CEO was a master of false virtue, pretending to care only for the welfare of others. The company has no board of directors and the income statement was in the mind of the proprietor. All alarm bells were ringing. How reputable institutional investors found it OK to “invest” billions beats me. It is a stark reminder to never invest in something you do not understand. We as investors must always act as the first line of defense.
Over the last decades, our elected and unelected elites have turned our once-great Western societies into national despair. We face social disorder, economic and cultural decline, and the death of meritocratic order. Vital supply lines are permanently disrupted due to Covid restrictions and sanctions against Russia. These are unprecedented acts of self-harm caused by collective hysteria generated by the media. Our political elites panicked and proved unwilling to defend civil rights. They introduced and celebrated authoritarianism to crush dissenting views on politics.
When did we last hear a politician reject spending by the magic words "No, we cannot afford it". To my knowledge, it hasn't happened in decades. We should therefore expect the Fed to pivot monetary tightening when the economic pain becomes unbearable for the political class.
The Federal Reserve is supposed to be an independent institution and do what is prudently right for the long-term interests of the population. Still, the chairman is elected by the US President and will eventually be strongarmed to comply with the bidding of politicians. Hence, central banks will manipulate interest rates and debase currencies. Politicians will continue reckless spending until we face a crisis of such epic proportions that there is only one solution for national survival. If that is our fate, we face mass unemployment, hyperinflation, or major shooting wars.
The following chart illustrates that central planners doubled down on failed policies after the 2008 crisis.
Prime Minister Winston Churchill said during WW2 that the Americans would always do the right thing, but not until they had exhausted all other opportunities. A prophetic description of American politics, more relevant today than ever before. Sadly, the statement is equally valid for British MPs and Brussels authoritarians who are politically inept – possibly to such a degree that they cannot turn the tide of political mismanagement.
So, maybe there is a great reset after all? Klaus Schwab may get his opportunity and realize his wet dream where ordinary hard-working people are "happy to own nothing" as plebians to the privileged elites.
Firstly, I will state that there is no reason to believe politicians or central bankers. They will not tell you what they actually think - they will tell you what they want you to think. Hence, economic projections are always more positive than reality. We haven't had an honest prediction since newly elected PM Winston Churchill in 1940 promised the British "Nothing but blood, toil, tears, and sweat".
What will happen to markets in 2023? The honest answer is – I do not know, and neither does anyone else. My advice is to exercise caution. Trust no one but yourself. Do your own research and make your own decisions. Remember, there are no guarantees on stock market predictions, only probabilities.
When writing this article, the forty-year declining interest rates bottomed out at zero and have now ended. In dominant Western countries, inflation is between 6-11%, but the principal market fear seems to have shifted from inflation to recession.
Equity and bond markets have been propped up by massive stimuli over the last 14 years, while wage earners' real income has remained essentially flat. By most evaluation metrics, equity markets have come down from an all-time high but are still expensive compared to the historical mean. Nasdaq and S&P 500 were at an all-time high about a year ago but have deflated YTD by 31 and 19%, respectively.
The European markets are doing better. The Euro 50 index is down 11%, while the UK FTSE has slightly declined -1%. The Norwegian index has returned almost 3%.
Surprisingly, investors are wary but with no sign of panic. Bear market rallies fool many into thinking that a new bull market is imminent. However, no fundamental indicators are suggesting better times anytime soon. Markets are still expensive and volatile. Global supply lines will probably remain disrupted for decades, and rising debt burdens predict depressed growth for years to come. Investors should also remember that bear markets can take years to bottom out from the first crash. More pain is likely. Unless you are a risk junkie, it is duly time to risk off until the financial sky clears.
A fed pivot will reinject liquidity and rapidly boost investor confidence. Another positive can be a peaceful solution to the NATO-provoked Russo-Ukrainian conflict. However, the positive effects on markets will probably be short-lived. Remember, our elected officials have no incentive or brainpower to fix anything, least likely the social, cultural, or economic decay they have created by failed policies.
The Wilshire 500, also known as the Buffet indicator, suggests we are still in a well inflated bubble. Bubbles will eventually burst to cause financial dominos to fall with unpredictable long-term consequences. Over 50 years, we have seen quick recoveries when markets crash. However, the global debt burden may prevent fast recoveries - even with new liquidity injections from central banks. Let us not forget that Japan pricked its financial bubble in 1989, and the stock market has still not recovered 30 years later.
Be critical of large mutual funds, like Vanguard and Blackrock. They have fallen victim to leftwing talking points and ESG investing. Funds committed to "environmental and social issues" and "sustainability" are clearly not taking their fiduciary responsibilities seriously. Furthermore, a Harvard Business School study concluded in June 2022 that ESG funds underperform financially and charge higher fees. In my opinion, the only objective of mutual funds should be to maximize returns to investors, not promote social or political agendas.
Future success will likely lie in traditional stock picking based on fundamental analyses. I have for many years favored "boring" companies with strong balance sheets, positive cashflows, and predictable dividends. The same philosophy proved successful through the 2000 and 2007 crashes.
Investing in real assets over financials is traditionally a good hedging strategy in inflationary environments. Nevertheless, prepare for bumpy rides ahead and the return of deflation when/if central banks have crushed the demand. I dismiss investment opportunities on the European continent because Brussels is all about regulation and higher taxes, definitely not a positive environment for economic growth or entrepreneurial effort.
Despite negative real interest rates on savings, a large portion of my portfolios is in cash. It serves two purposes:
a) as a hedge against a looming recession and
b) as dry powder when new and cheaper opportunities arise.
Investors with marginal loss tolerance should take down risk, not leave the market entirely. Leveraged investors and those close to retirement are particularly vulnerable to market corrections and should rebalance their portfolios accordingly. This common sense approach has saved many from financial wipe-out through economic downturns.
I think future success will likely lie in traditional stock picking based on fundamental analyses. Understanding valuation variables will yet again be fashionable among successful investors. Now, if the debt supercycle is replaced by a commodity supercycle investors will turn their attention to real physical assets. Hence, I still favor "boring" companies with strong balance sheets, positive cashflows, and predictable dividends.
The key weapon against poverty is cheap energy. Western governments have aggressively decarbonized our energy SUPPLY but failed dismally to reduce DEMAND. Global energy demand shows long-term strength, indicating that we are far from peak oil. China, India, and developing nations crave fossil energy and do not commit to the Western green agenda. Hence, oil and energy stocks may be an excellent place to be for years to come.
Of course, true diversification is a no-brainer for prudent investors. Please note that "true diversification" means a mix of asset classes: For instance, stocks, real estate, cash, and precious metals. Having 10-15 stocks is not true diversification because it is still only one asset class.
In closing, ponder Warren Buffet's wise words:
"Successful investing takes, time discipline, and patience. No matter how great the talent or effort, some things take time. You cannot produce a baby in one month by getting nine women pregnant".