Three Investment Themes to Watch in 2023 – Mar. 2023

Full Episode Transcript

Naj Srinivas

Hello and welcome to the Fisher Investments Market Insights podcast, where we discuss our firm's latest thinking on global capital markets and current events. I’m Naj Srinivas, Senior Vice President of Corporate Communications here at the firm.

And today, we'll be looking at three investment themes that we think investors should pay attention to in 2023: inflation, interest rates and the potential for recession. Topics that are largely talked about today in the news media. We think our perspectives and our thoughts on potential implications for the stock market are a little different than what you may have heard before.

Leading us through these three important topics will be some of the primary portfolio decision makers at Fisher Investments—members of our Investment Policy Committee. They recently held a special video session for clients called the Capital Markets Update—their comments come directly from this video, which was recorded on February 2, 2023.

Before we dig in, I'd ask that if you enjoy what you hear, please take a few seconds to subscribe to our podcast. When you subscribe, you’ll be notified when we publish new episodes. Thanks so much in advance.

With that, let's dive into three important investment themes we think you should pay attention to in 2023.

 [TRANSITION MUSIC]

Naj Srinivas

Higher inflation has been a hot topic for investors since the COVID pandemic. But even though we’ve begun to see evidence that inflation is easing in the first few months of 2023, the topic is likely to be on investors’ minds for much of the year.

To kick off our look at inflation, Jeff Silk, Vice Chairman and Co-Chief Investment Officer for the firm, will discuss our current inflation expectations and what some indicators of inflation are showing today.

Jeff Silk

We would expect inflation to come down and probably come down more than people expect. That should take long-term interest rates and push them lower as well. And the stock market is going to like that.

So let me go through a few components of inflation. First, let me say that we understand how rising prices has the ability to impact people’s personal budgets and how that may be painful. But we’re focused on the impact of inflation on the capital markets. And as we think about the capital markets, it’s important to note the following. Input costs are coming down. Whether it’s energy cost, transportation cost, material cost, food cost, they’re all coming down, leading to final output prices, which will follow. So that’s an important component.

Another component of inflation is that the money supply has fallen. Typically, that’s a leading indicator for inflation. When you look at market-based indicators of inflation expectations, what the Treasury market is pricing in, that all says inflation expectations are coming down. So pretty much wherever you look, you see indications of prices falling. That should have an influence that pushes bond prices up, yields down, and the stock market is going to like that.

Naj Srinivas

Next, let’s hear from Aaron Anderson, our Senior Vice President of Research, as he digs a bit deeper into what’s going on with inflation.

Aaron Anderson

If you look at a headline inflation rate, you look at CPI on a year-over-year basis, the consumer price index, you look at the headline numbers that are thrown on the media, they’ve come down off their highs to be sure. They’re headed in the right direction, but they’re still north of 6%, which is way above where anybody wants to see them, of course. But if you look at just the last six months, what happened to inflation over the last six months of 2022, it was averaging about a 2% rate. Right about where the Fed has wanted it. So already you’ve seen a dramatic improvement in sequential inflation rates. They just haven’t come through to that headline figure yet. But that’s going to be happening as we move forward from here.

We had high inflation in the first part of last year that’s still pushing up that year-over-year number. But actually, as we get into the early months of 2022, it’s going to start pushing that number down. So not only are you seeing the underlying components of inflation moderate or even in some cases actually deflate. But you’re also going to see that headline number tip over because you’re going to start lapping those very high inflation rates of last year, and that’s going to start having those year-over-year numbers that everybody pays attention to start to look a lot better pretty quickly.

Naj Srinivas

When you hear us talking about “lower inflation”—especially from the perspective of an investor—it’s important to understand what that phrase really means. People often hear inflation is decreasing and assume that means prices will soon be lower too.

To close our out discussion of inflation, we’ll hear from Mike Hanson, Senior Vice President of Research, on how the team at Fisher Investments thinks about inflation as it relates to markets and for investors.

Mike Hanson:

When we think about inflation, it is explicitly a rate of change. And I think that clients really need to understand this point because when I go around the country and I speak to them, when I say that inflation is going to fall they intuitively think that the prices are going to come down. Unfortunately, that’s probably not going to happen in a lot of areas. It will in some commodity based goods, things like food and energy and so forth. Those can be very volatile and come up and down. But aggregate prices are very unlikely to fall precipitously unless we get something like a prolonged fall in the money supply or something like that, which right now money supply is basically zero. And it’s one of the reasons why we anticipate future inflation to be very low.

But inflation is always about a rate of change, which means what we’re looking for is, and what economists tend to look for is something like a stable, steady rate of change and not something that zips around so much. What we’re calling for is inflation to come back down to a rate of growth that’s been very normal and low for much of the last 40 years. That’s very different than saying prices are going to fall.

Naj Srinivas

Inflation is often discussed in the same breath as our second investment theme to watch in 2023: interest rates. Specifically, increasing interest rates and their potential to affect the stock market.

With the Federal Reserve’s moves to increase rates in the United States, some investors worry that higher rates will deter bank lending, which could stifle consumers and shut off a source of money that businesses need to grow, thus sparking a recession and potentially tanking the stock market.

Executive Chairman and Co-Chief Investment Officer, Ken Fisher, gets us started with his thoughts on the state of bank lending and how he looks at interest rates’ potential to affect the stock market.

Ken Fisher

As we speak, bank lending year-over-year in the United States of America, the land of the free and the home of the brave, is up 11 and one half percent. You cannot have bank lending across the world at a very high level and go into recession at the same time. Those two just don’t fit. People don’t borrow money to sit on it. They borrow money because they got something they want to do with it.

The banks are eager to lend because their cost basis on their loans has nothing to do with the rate that the Fed’s hiking or that central banks overseas are hiking, albeit at lower levels. There’s just a disconnect there and people don’t get that.

The loan base in America, on average, is costing the banks about a third of one percent, and they’re lending at long-term rates, so they’re picking up a 4%-plus spread no matter what. You have a spread like that, they’re going to keep lending borrowers, keep borrowing. The rate doesn’t stop the borrowers. They’re eager to do it or we wouldn’t be having this volume and that money’s going back into the economy.

If you want to see that deep recession, you better see the lending stop. As long as that lending is flowing heavy, it’s just like a big hose pouring gas on a fire. You’re not going to get a recession with heavy lending. So you want to keep your eye on the lending as opposed to all this other stuff.

When I was a young guy, back when dinosaurs are still floating around commonly in the neighborhood, Milton Friedman would say it’s not the interest rate, but the quantity of money and the amount of lending. People then and now can’t get their eyes off interest rates and focus on the lending.

The fact is, the interest rate isn’t what’s important. What’s important is the amount of the lending. They just can’t focus on that. It’s easy. You can, if you want to, do a Google search today and see that. But almost nobody does. Nobody’s looking for it.

To me, I find this baffling because it’s always been known that the price of the money wasn’t as important as the amount of the money. Yet, still today, you turn on the idiot box and you watch people yakking. What are they yakking about? The rate, the rate, the rate. The Fed, the Fed. Oh, it’s not the Fed, it’s the ECB, if you’re in Europe. It’s the Bank of England, if you’re in Britain. But it’s always about the rate. It’s not about the amount.

The amount is more important than the rate. That they can’t get that is part of what’s still the same, not different. It’s just the mechanics, as you point out, Aaron, of what happens in the way how the pipes are connected, that’s different.

The fact is, the Fed can’t control long rates. Right now, they can’t control short rates. All they can control is the overnight lending rate that banks charge other banks for borrowing overnight reserves. That’s what they raise. In today’s world, that impacts parts of the world, but it doesn’t impact most of the world. Most of the world isn’t actually directly connected in any regard to that rate. Therefore, there’s this feature that goes on in our culture, which is, in my mind, just crazy, where people say over and over again “it’s the Fed, it’s the Fed.” And because everybody says it, we believe it must be true.

The fact is, the Fed today is pretty feckless, as evidenced by the fact that they keep raising the rates on short-term overnight bank loans, but the loan base that banks lend off of is so much cheaper and hadn’t really budged. It’s that spread between that and the long rate, the ten-year rate or whatever long rate you want to contemplate, because could banks borrow short-term to lend long, they aren’t impacting that spread.

Naj Srinivas

Part of what guides our thinking on the connections among interest rates, the banking sector and the stock market is rooted in how those elements and their connections have evolved over the years—something that many investors don’t often pick up. Here’s Aaron Anderson again to explore that idea.

Aaron Anderson

There’s a very famous saying in our industry we very much subscribe to. It’s that the four most dangerous words are: “This time is different,” but that doesn’t mean things aren’t different at times. I think this is a key area where there are differences.

Just the nature of banking regulation, how interbank lending works, is very different today than it has been historically. I take the whole notion of excess reserves. Excess reserves used to be a function of the banks having a reserve requirement ratio and any reserves that a bank had above that reserve requirement were considered excess reserves. That doesn’t exist anymore. There is no reserve requirement ratio any longer.

We talked about interbank lending. That used to be one of the primary tools that central banks used to dictate monetary policy, adding or subtracting to the interbank market to raise or lower interest rates. Almost no banks use that anymore because, they’re so flush with deposits, so flush with reserves. I think many folks that are assessing the economy are still kind of stuck in this traditional way of thinking about banking and monetary policy, when indeed this is one of those areas where there are differences. It is playing out much differently this time around than it has historically. That’s why you’re seeing bank lending, net interest margins, profitability reacts so differently to the yield curve and interest rate environment this time around than you’ve seen historically.

Naj Srinivas

To round out our conversation about interest rates, here’s Mike Hanson to summarize our thoughts on how and when rising rates could affect the stock market.

Mike Hanson

If you’re talking about a recession here and now, that effect is going to take quarters, if not years, to play itself out because of how flush the big money center banks are with deposits. So, the race to get rates higher, if, in fact, the Fed can do that at all, to Ken’s point, is going to take even much longer than usual.

I always like to say to clients: “Do you remember the days when you could go to your regional local bank and they would offer you 3.5% percent on your checking and a toaster?” Those days are gone now. There’s just so much deposits in the system that, if there is any effect of those short-term interest rates rising, that’s going to take a very long time, certainly not within the span of time people are calling for recession here and now.

Naj Srinivas

Our first two themes, inflation and interest rates, relate directly to our third investment theme to watch in 2023: the potential for recession. We’ll start with Jeff Silk to introduce how our investment team is currently thinking about the potential for an economic recession.

Jeff Silk:

Right now, sentiment is fairly low. Most people have a negative outlook. Some of our sentiment indicators, when you look back in time, are at historic lows. The bottom line is, for the most part, we believe that current conditions are much better than the negativity that’s out there right now. So, a little better report or not-as-bad report should have a positive influence on pushing stock prices up.

In my 40 years of working here, never before has so many people have asked me, is this going to be a big recession? Is this going to be a little recession? Are we already in one? How long will it last for? The world right now is focused in on a recession. It’s so well telegraphed, it’s just unbelievable.

We have this notion, which is: anticipation is the best mitigation. What I mean by that is, if you’re a corporate CEO and you’re hearing recession, recession, recession, you’re already making adjustments to your budget and to your plans in anticipation of slower economic times ahead. Another way of putting it: if we do get a slowdown, it’ll have a much smaller impact on the global capital markets than in the past.

I want to add a historical context to recessions and the way people think about recessions. It used to be that a recession kind of came out of nowhere and it was tied to excesses. So immediately you had to adjust your budgets and your spending. And then that created another downward spike. But if you think about the economic impact of that particular environment, of a very big economic contraction coming out of nowhere, that had a pretty negative influence on stock prices. That’s not what’s going on right now, because obviously recession, no recession, big recession, little recession, that’s pretty well telegraphed. That’s not the way a recession typically hits the capital markets, where it’s out of nowhere. Didn’t expect it. Got to make some real quick type of adjustments and then stocks fall. That’s not what’s going on now.

Naj Srinivas

With more on the historical context of recessions, here’s Aaron Anderson.

Aaron Anderson

I think that historical context is very important because it’s been a long time since we’ve been through a mild recession that was accompanied by a mild bear market, if indeed we get a recession. If you go back to the last few big economic downturns, you had 2020 with the COVID lockdowns that were so severe and you had a big economic contraction and a decent sized bear market, it came and went quickly, but it was significant. The prior one was the global financial crisis, all the way back in 2008. And there you had a big protracted recession with big financial firms getting bailed out, all the economic tumult that went along with that. You had a big bear market as well. Even the one prior to that, you go all the way back to 2001 when you had a mild recession. But that’s coming off the heels of the Tech bust. So you had a big bear market associated with that, even though it wasn’t so much about the economy, it was more about coming off this euphoric peak. That was a significant period as well.

So a lot of recent history has featured either big recessions or big bear markets around recessions. But if you look at prior periods, it’s not at all unusual to see a mild recession accompanied by a mild bear market that the market starts to look past pretty quickly. Go back to 1990 as an example. You had a little recession, barely got into bear market territory, and that led you into the 1990s. Now, I’m not forecasting that we’re going into another 1990s period here, but I think it does show you how with a mild recession, if indeed we get one, I’m not saying we necessarily will, but even with a mild recession, the impacts on markets for 2023, considering that we’ve already been through a bear market that at least had to partially discount those recession expectations we’ve been talking about. Frankly, our view of what the markets might do this year isn’t so hugely influenced by whether we get a recession or not unless you get that big, bad and ugly one, which is really hard to see right now. I think the market’s ready to move past a little bit of market economic volatility.

Naj Srinivas

Next, we’ll hear from Ken Fisher how he thinks about recessions and potential for one in 2023.

Ken Fisher

Whenever you have a downturn in the economy, the market moves down first and it bounces up while the economy’s going down. It’s important to make that distinction. Most people can’t keep that straight in their mind. Secondarily, when you think of recession, the whole purpose of recession in the first place, the reason recessions exist is to correct the excesses of the prior expansion, wherever, however they were. But, when you get this kind of long anticipation, the businesses and people engage in that correction activity, eliminating, as best as they’re able, those excesses before you get to recession, which, then, either eliminates the recession or minimizes it.

The fact is that if you look at all kinds of surveys and other measures by any standard that I can measure, this, if we actually have recession, will have been the most widely anticipated recession ever. And to a point Jeff made earlier: Anticipation is mitigation in whole or in part. As people and firms prepare for tougher times ahead, by, if you will, getting their house in order. Corporations have laid people off, but more so all around the world, hiring freezes have been huge. You can’t measure that precisely, but anecdotally we can see that over two-thirds of firms, extant among major firms, have put in hiring freezes.

Hiring is down among those firms while the economy continues to grow and the labor market is tight. But if you look, for example, at American CEOs, by survey, 99% of them expect a recession. 99% of them expect a recession in Europe. And they expect that one to be worse. So if you think about the multinationals, and that’s a multinational CEO survey, they’re all doing stuff to prepare.

I made the point in my Christmas Day New York Post column that in so many ways, too, that 2022 was reminiscent of 1966 and its bear market. Starting at the same time, bottoming. Both of them were bear markets, but they were more like cub bear markets. They were little bear markets by bear market standards. They ended within a couple of weeks of each other. We had that, we had the Fed in both cases hiking up rates. We had a midterm election year. You can just go on and on and on, on the things that are similar. There are a lot of people and we don’t do partisan politics at this firm. But intuitively, there’s a lot of people that like the current president that we have. But there’s also a lot of people that don’t. And the people that don’t have made up names about him and what have you. Very reminiscent from 1966 about views about Lyndon Johnson. The process is very much what we saw in 1966. And oh, by the way, then that 1966 market led to a strong fourth quarter and the beginning of a midterm miracle with the next nine months being positive, as it almost always is, coming off of the midterms. And the third year of the president’s term, which is what we have in 2023. This year should be, in my mind, very parallel to that. Of course, I’m old enough to remember all that stuff.

So from all of that, the reality is, this thing that I’ve long labeled for decades, the pessimism of disbelief, is a function which parallels the legendary wall of worry that bull markets must climb. It’s not the exact same thing. It’s a different thing. It’s a thing that as that bull market takes off, people go yeah but, yeah but, yeah but, yeah but, and they deny, deny, deny, deny. It’s a form of denial where they’re still hung up on the fears they had in the past and they can’t look forward correctly and see that those fears by now, by then have all been priced. And you move to a better world ahead. So we’re actually in that better world now. It just doesn’t feel that way because at the beginning and early phases of a bull market, it never feels that way.

Naj Srinivas

Here’s Mike Hanson to wrap up our discussion on recession, and some reasons that investors can be optimistic about 2023.

Mike Hanson

What does all this sum up to? I mean, what does it all mean? We have these concepts, anticipation as mitigation. We talk about the market as a forward-looking indicator. Well, to me, it all sums up to one primary lesson that I think people have difficulty with, which is that the market, the economy extant is an adaptive mechanism. People are resilient, people will respond to things. What I find is that when people talk about the economy, they talk about it as if it’s a machine. And if you pull this lever, then you get this result. That’s not how it works. And when we say things like anticipation is mitigation, what it means is that there’s a basic resilience to the way humanity is. When we see problems upcoming, we actually react to them. That’s one of the things that prices do in a forward sense.

So I just think that in general, the attitude that, well, danger seems to be coming, there are signals for it, is actually something to be optimistic about because it gives everyone a chance to be resilient and to solve problems rather than to just say, well, you know, something’s happening, therefore we’re going to get that output. Just one quick example would be Europe right now. They knew they were going to have energy problems given the Ukraine-Russia conflict. With enough lead time heading into the winter, in fact, they adapted to that very quickly. Energy prices today are lower than before the conflict began and Europe is completely topped off in terms of its energy needs at the moment. That’s resilience, that’s adaptation. That’s what capital markets and economies do. They’re not a machine.

Naj Srinivas

Now that we’d discussed three of the big investment themes to watch in 2023, the logical next question is how should investors position a portfolio with that outlook. Here’s Jeff Silk again.

Jeff Silk

2023 should be a very strong year for global stocks. There are so many forces right now that point to a good year in the market. We have this notion that what falls the most, bounces the most. It’s kind of like a spring effect. You push down on a stock from the selling, you release the selling and it springs right back. So, when I think about our portfolio positioning and our market forecast, we’re well positioned for the market spring back, the bounce back. We think that should last for some time. We know it doesn’t last forever, so we’re putting time and effort into our research process to figure out what are the next leaders going to be in the market, what are the next important cycles that we need to position for.

Naj Srinivas

If you’re an investor who’s expecting that bounce from a bear market into a new bull, it’s important to prepare early, rather than waiting for wider confirmation from the stock market. We’re gonna wrap this episode up with Aaron Anderson to explain why we believe that’s the case, and what might come next.

Aaron Anderson

We do think that we are in those early stages of a rebound off the bottom of a bear market, which means we’re entering into a new bull market or one has already begun. I would say this is both a very interesting and very critical period for investors. This is just such a powerful period for the market. When you get the rebound off the bottom of a bear market, returns can be quite tremendous. And we’ve seen that so far since the October low up to where we are now. It’s been a very robust recovery, but also a very typical early bull market recovery. What we’re seeing now isn’t it all abnormal. What you hear in the press a lot is markets getting ahead of itself. It’s coming too far, too fast. This is exactly what happens in the early stages of a new bull market.

But when I say it’s interesting, you have a couple of forces at play in terms of the types of companies that are doing well and those that are maybe not doing as well, the leaders and the laggards. We mentioned a few times the bounce effect, where the categories of stocks that get hit the hardest as sentiment gets to be so excessively negative. Certainly, in points last year, you saw sentiment about as negative as you’ve ever seen it, which, I think is particularly compelling given the economy actually grew last year and corporate results were pretty good. To have that type of negativity so disconnected from reality, I think really sets the stage for a lot of upside surprise and that new bull market taking hold.

As mentioned, the parts of the market that get hit the hardest in the downturn are usually the ones that rebound most. If you think about what got really hard last year, it was Technology, growth stocks, generally, things like e-commerce stocks and entertainment-oriented stocks and so forth. We want to make sure that we still have a fair amount of that in portfolios because those got depressed. We think they’re going to bounce back. They certainly have so far, so we want to make sure that we’ve got a fair amount of portfolio exposure to those hard hit categories, which tends to lean a little bit into those growth areas of the market, like Technology, Communication Services, parts of Consumer Discretionary and so forth.

But it’s also true that, if you think of a typical early bull market period, it’s actually a different type of company that does well. It’s a more cyclical type company, maybe a little bit more value tilted, certainly smaller in cap. So we want to be adding some of that to portfolios as well. (14:55)

So, I think we’ve got right now portfolios well positioned for both the early stages of a new bull market, but also in a way that will take advantage of that bounce effect we’re talking about.

I don’t want to project too far forward from here, but I could see potentially, as we get deeper and deeper as that bounce starts to run its course, as maybe a transition into a more traditional old early-bull-market-type period, that we want to continue that process of neutralizing some of our style bets, maybe bringing down the cap of the portfolio a bit.

I don’t want to project too far because, of course, we’re going to have to evaluate that as the year goes along, but that wouldn’t be an atypical type of change for us to make as we get deeper and deeper into the early stages of this bull market.

TRANSITION MUSIC

Naj Srinivas

That’s it for this episode of Market Insights featuring three investment themes you should be paying attention to in 2023. A big thanks to Jeff Silk, Aaron Anderson, Michael Hanson and Ken Fisher for their thoughts.

If you want to learn more about some of the topics we discussed on the podcast, the MarketMinder section of our website—fisherinvestments.com—is a great place to check in regularly. That’s where we post all of our latest capital markets insights.

You can also subscribe to our weekly digest, which will be sent to you weekly so those insights will be in you inbox.

And if you have questions about investing or capital markets that we can cover in a future episode of Market Insights, email us at marketinsights@fi.com.

We’ll answer as many questions as we can in an upcoming Listener Mailbag episode.

Join us for our next episode. Until then, I’m Naj Srinivas. Be well and stay safe.

Disclosure

Investing in securities involves the risk of loss. Past performance is no guarantee of future returns. The content of this podcast represents the opinions and viewpoints of Fisher Investments, and should not be regarded as personal investment advice. No assurances are made we will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. Copyright Fisher Investments, 2023.