The end of a year invariably brings forecasts of how the economy and markets will perform in the coming year. The forecasts include estimates of gross domestic product growth, the price level equity markets and interest rates in twelve months. There has often been a wide range of predictions, but unfortunately, the accuracy of these forecasts has been poor. Predictions for 2023 began to arrive in November; recent forecasts are essentially the same as most forecasters are calling for a recession this year. The recession, if it happens, will perhaps be the most anticipated recession ever, and will be caused by the interest rate hikes by the U.S. Federal Reserve, which started increasing rates in March 2022. With forecasters being so wrong in the past, could they be wrong again?

Forecasts for 2022 were mostly positive with a return to normal following two years of pandemic. The U.S. and global economy were expected to expand, and equity markets would rise, and interest rates would increase modestly. Instead, the U.S. economy suffered through two quarters of negative GDP growth, equities around the world plunged for the full year and rates increased significantly. A quote from Yogi Berra comes to mind: “It’s tough to make predictions, especially about the future.” While his quote is funny, he also supplies a mountain of truth. The predictions about the future are so difficult because events happen that are unpredictable. This was true in 2022 as well. Two events that were unpredictable were the Russian invasion of Ukraine, causing a short-term spike in energy prices and central banks around the world increasing rates by a multiple of eighteen in less than a year in response to inflation. In comparison, the previous biggest increase in the Fed funds rate was a multiple of about 5.5 over five years in the late 1970s and early 1980s. These events disrupted the best forecasts for 2022.

We should then take the forecasts for 2023 with a grain of salt because there will be events this year that make most predictions wrong. What is called for is an outlook that includes a range of possibilities for the coming year with a large degree of flexibility. This way, we reduce our bias of holding onto an outlook that is likely to prove obsolete and allow us to take advantage of opportunities as unforecastable events materialize.

What is our outlook? We believe that the most likely path for the economy is a recession. The eighteen-fold increase in the Fed funds rate will cause a slowdown in both consumer and business spending, which was already strained by the higher inflation. Further, as of this writing, we believe the recession is likely to be milder than many past recessions but may be longer in duration. Feeding into this outlook is first, corporations outside the tech sector are still hiring overall, despite the announced layoffs. Tech sector companies are announcing big layoffs following years of headcount increases, but many of those laid off are getting jobs quickly. Second, since the start of the pandemic, the money supply in the economy has increased dramatically, and even though money supply has declined the last 12-months, it remains elevated relative to the level at the start of the pandemic, which should lend support, as illustrated in the graph below.

We believe that equity markets are likely to struggle for perhaps the first half of the year because the lower consumer and business spending will likely reduce earnings growth rates. However, as in past recessions, we believe the struggles in the equity markets will end before the economy bottoms and stocks should then post nice gains. The Fed rate increases hurt the fixed income markets and since we believe the Fed is close to ending the increases, we believe fixed income markets will be more stable this year and should post positive, albeit low returns overall. Remember though, there will be events that take us by surprise, and as the facts change, we will invest according to the altered investing environment.

Our clients’ portfolios performed well in both the fourth quarter and for the full year 2022. Capital market performance in the fourth quarter was strong with U.S. large cap stocks rising 7.56% and fixed income up 1.87%. Allen Trust Company equity holdings performed better, rising 9.58% and fixed income up 2.24%. Overall, Allen Trust Company clients’ accounts were up an average of 6.19%, net of fees, compared to a blended benchmark return of 4.95%. For the full year, the results were good on a relative basis. U.S. large cap stocks declined 18.11% for the year, compared to Allen Trust company equities decline of 15.70% while bonds dropped 13.01% compared to our bonds decline of 8.01%. This results in a blended performance of -15.12% for the benchmark while Allen Trust Company clients’ accounts performed -11.80%.

The change of the calendar to 2023 brings optimism; optimism that the capital markets will be positive this year, and the economy will be expanding for the year. We reiterate our outlook that the economy and at least the equity markets will struggle for part of the year, but we do see positives within any headwinds out there. The declines in 2022 and any declines this year are creating buying opportunities that we will work to take advantage of for the benefit of our clients. What we of course do not see is the events that will derail, either for the better or for the worse, our outlook. As it stands, we believe investors are likely to be a bit happier about the level of their accounts on December 31, 2023, than they were on December 31, 2022. We will endeavor to continue to generate solid performance on a relative basis, but more importantly we would like the absolute returns to be positive this year. We expect to be ready regardless of economic and market conditions.

Optimism in an Unforecastable Future