At the beginning of every new year, market forecasts about the year to come start arriving from all corners of the internet. This in itself is unsurprising; a large number of market professionals are in the “prediction business” and are paid to make forecasts about future market prices and the economy. This year is no different, but if you were looking for Elevate’s forecasts for 2023 I’m afraid you’ve come to the wrong place. This is not one of those articles.
As the physicist Niels Bohr once declared, making predictions is hard – especially about the future. Fortunately for us, making good predictions is not required for a successful investment experience. (It is much more important to have patience – and a little education about portfolio structure doesn’t hurt either.) That being said, there is a major difference between “predictions” and expectations. The former is generally conceived by a single forecaster, whereas the latter is based on market prices and is the result of the collective wisdom of all market participants. Using these expectations and some market history as our guide, what can we say about 2023 and beyond?
- Expected returns for the stock market in 2023 are positive. As evidence-based investors, we know that market prices adjust constantly to compensate investors for the risk they are taking. This effectively means that expected returns are positive every single day in the stock market. In fact, history bears this out – from 1951-2021, 53.7% of daily US stock market returns were positive and 46.3% were negative. Importantly, the odds of a positive return increase with time spent in the market. Since 1926, 3 out of 4 full calendar year returns were positive.
- You can expect short-term, high-quality bonds to earn about 4 ½% to 5% this year. These expected returns are much higher than they were one year ago. Actual returns may end up somewhat higher or lower than that, but this is the market expectation. How do we know this? By looking at current bond yields which have generally made very good forecasts for future total bond returns. For example, a one-year Treasury bill is yielding 4.7% today – this is the return you can expect by holding it until maturity.
- Inflation is expected to moderate from last year’s levels. By looking at the different yields among certain kinds of US Treasury securities, you can arrive at the market’s expectations for future inflation (also called the “Breakeven Rate”). The picture that these market prices paint is an encouraging one – over the next five years, the market believes that inflation will average about 2.2% per year, which is in line with pre-2021 rates of inflation.
- The Federal Reserve will likely continue to raise interest rates until the summer, pausing when the overnight lending rate reaches about 5-5.25%. Again, this is not a forecast but rather based on market expectations using prices from the “Fed Funds Futures” market. The same futures market expects the Federal Reserve to begin lowering rates again by the end of the year.
- In 2023, public corporations will adapt and modify to the best of their ability to increase profits. The profit motive is another market constant we can expect – regardless of the kind of economic or political environment we find ourselves in.
- Markets will be volatile and drawdowns will occur. In fact, the stock market experiences drawdowns of various sizes every single year with the average drawdown over the last century being -15.6%. This is true even in years that end up strongly positive.
- We will be surprised! 2022 contained several surprises from high inflation to the war in Ukraine and the midterm election results. We should continue to expect the unexpected for 2023 as well.