More supply-chain challenges, inflation, a labor shortage, a war in Ukraine — plus inflation and the fear of recession. All of that led to a stock market year almost everyone will be glad is over.
The Star Tribune gathered six Twin Cities investment professionals in early December to talk about how to emerge from a year that left little choice but to absorb losses in both equity and fixed-income markets.
This year was the hardest in decades for the industry, and our Investors Roundtable guests are ready to turn the page and move on. They expect more market volatility but also see opportunities in 2023.
Last year, our roundtable was on Dec. 7, when the S&P 500 was at 4,686. Our participants at that time had anticipated a rocky year but modest growth. Russia's war with Ukraine turned the tide. Picks that day were for the S&P 500 index to finish 2022 between 4,800 and 5,150.
What a difference a year makes. This year's discussion touched on the markets, the economy and where to look in 2023 to find positive returns. It has been edited for length and clarity.
Meet the roundtable
Lisa Erickson
Senior vice president and head of public markets at U.S. Bank
Craig Johnson
Chief market technician at Piper Sandler
Jim Paulsen
Chief investment strategist at Leuthold Group
Martha Pomerantz
Portfolio manager and head of the Minneapolis office of Evercore Wealth Management
David Royal
Chief investment officer and chief financial officer of Thrivent
Roger Sit
Chief investment officer of Sit Investment Associates
Why did the market sink in 2022?
Jim Paulsen, chief investment strategist at Leuthold Group: In a simple way it was just nothing more than overheat. Your classic overheat. It was a product of a number of things, but certainly the severity of the pandemic and its uniqueness and how frightening it was. It caused people to over hoard and policy officials to over stimulate.
I think the big thing that really tipped it, that wasn't there at the end of last year, was the war. Which probably elongated the peak of inflation that might have been earlier had it not been for that.
Lisa Erickson, senior vice president and head of public markets at U.S. Bank: I think if you see 2021 as the year of reopening, 2022 is really the year of inflation.
Inflation just ended up more sustained than most believed it could have been. And as a result of that you had a repricing as central banks really had to pivot and tighten policy. And that caused multiples to fall in the U.S. equity markets.
Roger Sit, chief investment officer of Sit Investment Associates: I'll take it one step higher. The problem with the market this year has been the fear of going into a recession. And it is because the central banks — and not just the U.S. but all around the world — have become much more aggressive in terms of raising rates. Because of inflation, because of the war, because of other geopolitical issues.
And everyone is afraid that we're going to have a policy mistake done by the central banks around the world that's going to throw us into a deep recession.
Craig Johnson, chief market technician at Piper Sandler: I remember at the start of the year everybody talked about inflation being transitory. And then you pretty much figured out that it wasn't transitory — that it was more of a wage spiral. And then the Fed jumps all over this and starts raising rates very, very quickly, leading to the scenario of hard, soft, violent landing. Nobody really knows at this point in time.
Martha Pomerantz: portfolio manager and head of the Minneapolis office of Evercore Wealth Management: The Fed raised rates so quickly, so much. And when they do that, it totally changes the dynamics. So the multiple that you're willing to pay on stocks simply goes down.
The reason that the FANG stocks — these are the technology-orientated stocks — came down is because they had the highest multiples. It's growth-oriented stocks, technology stocks or long bonds that come down the most because they're the most vulnerable when this happens.
Equity and bond markets were down in 2022. What are the implications?
David Royal, chief investment officer and chief financial officer of Thrivent: This was the worst year for a 60/40 portfolio [60% equities and 40% bonds] since 1931. Investors were shocked — I own bonds; I thought I was safe.
This is probably a time when you want to be finally adding some duration, if rates really are peaking. The first thing I learned about investing was when you have a recession, you've got to add duration.
Sit: The whole reason we had this crappy bond market on top of an equity market, which hasn't occurred since the 1930s, is because we we stole from our future with all this quantitative easing. Remember, we had a 16-plus-year bull run where we had artificially low interest rates around the world, because it was staggered, everyone cutting rates. At one time, we had more than 70 percent of GDP in a negative interest rate environment.
I think this is reaching a point where it is now appropriate to have a more diversified portfolio of both bonds and equity, depending on your time outlook.
Pomerantz: Now is a better time to be a bond investor, because yields are up, so you can actually buy something and you can [earn interest] on it; it's no longer this "there is no alternative." There is an alternative. Now you can own bonds instead of owning stocks. And with anything, we think the interest rates will be peaking at some point, because we think we're beyond inflation rising. The period ahead is a lot more positive than it has been.
Johnson: I asked a friend of mine, Sam Stovall, over at [investment research firm] CFRA, what the forward returns are when you have a negative return in your 60/40 portfolio. And he found that going back since 1972, a year after those negative returns, your portfolio is up 13.1 percent. And it's higher 78 percent of the time. So to your point, now is the time to be leaning into the market and buying investments.
Erickson: We would encourage investors to consider alternative assets. Things like real estate or global infrastructure, because when you have a difficult period like this, having diversified income streams from a number of different sources can be really helpful to provide that balance to the portfolio.
Cryptocurrency also crashed in 2022. Can it still become a regular part of investment management?
Sit: I've never been a believer in the cryptocurrency. I believe in the technology. I believe in blockchain. But I've never been a believer in this cryptocurrency, and it's because I believe that you need a sovereign body backing it.
Paulsen: There's this thought that crypto is collapsing in a way that it has never done before. It's down 70-some percent from its high. There are two other periods where it went down 80 plus over a one-year period. So I don't know if crypto is doing anything different than it's done the whole time of late.
Johnson: A couple of things on the crypto landscape. Number one, Fidelity has come back and said that it is going to continue to keep moving forward with trading of cryptos and putting it into 401(k)s. They're still believers from that perspective.
Second thing is that cryptocurrencies are a way for people to do transactions. There are more people that have internet connections in the world than have bank accounts. What is going to ultimately make this a more investable asset class? It's going to take more rules, more regulations, and it's going to take the adults to come into the room.
Royal: We learned a lot about Bitcoin by how it behaved last year. It has been the opposite of an inflation hedge. Bitcoin has behaved like an extremely long duration asset where your entire bet is on the terminal value. But generally speaking, if I'm going to take a bet on a really long duration asset, I'd rather buy into a profitable software or biotech company, where I can at least kind of value that in my head.
Investors have been beaten up in 2022. How should they approach 2023?
Pomerantz: I think it's the same investment principles. Whether it's a bull market or a bear market — it doesn't really matter. The most important thing is to focus on what your long-term goals are, and not be so focused on the short term. Setting an asset allocation that's appropriate for each person's personal circumstances is more important than anything else, making sure you're diversified and own high-quality holdings. Make sure you know that these businesses are going to be around, that they really have a stream of income that you can depend on.
Sit: It is coming back to security selection — a stock-picking market. That's where you have to find those companies that have a real product or real service that can grow their sales line. Hopefully they're of that high quality and they get pricing flexibility. You want companies that are scalable, so when they get the volume and sales, that leads to exponential improvement in margins, and that leads to better earnings per share growth.
Paulsen: I think people have been through a lot of volatility, a lot of disappointment, a lot of fear. When people are really fearful, that's when you want to go the other way. And when people buy anything with a dot-com, that's when you want to get out.
What market indicators should investors pay attention to in 2023 and why?
Royal: One that I think hasn't gotten as much attention recently as much as I think it deserves is the decline in productivity. Productivity is down three-and-a-quarter percent so far this year. These are volatile numbers, but they are probably directionally related to the fact that real wages are down roughly 3 percent year over year.
If you had a persistent decline in productivity, perhaps due to COVID's lingering effects, what would you have? You'd have strong labor demand because you need more people to do stuff. You'd see inflation, you'd see a decline in real wages, you'd probably see things that look like supply-chain issues as various inputs got stress throughout the whole process.
Erickson: Probably the number-one indicator is going to be inflation, because that's what's really driving the more restrictive policy, whether it's monetary, and even, of course, a lot less emphasis on fiscal support as well. A second key indicator is the direction of monetary policy, and when the Fed can start taking the foot off the gas pedal, in terms of being very restrictive on rates.
Johnson: What I like to do is simply come back and look at the charts. One of the indicators I'm going to be looking at is going to be market breadth. And right now that's expanding, and the numbers of new highs in the market are expanding.
Pomerantz: All of these things are focused on domestic issues. But a big thing for us is what happens worldwide. What happens with the war with Russia and Ukraine? If there's a cease-fire, and they figure this out, that's going to make a big difference, because that's going to alleviate supply issues, pricing issues for oil. In China it looks like they're starting to lessen some of their zero-COVID policy. If they really open that up again, and we end up with another growth engine, it totally changes the dynamics here.
Where should people invest in 2023, and what is your S&P 500 prediction for the year?
Erickson: We're more cautious right now and advise a more defensive positioning for investors on the back of still-elevated price pressures, monetary policy that's restrictive and the fact that we're seeing slowing growth momentum, both in the macro indicators as well as what companies are saying. And so that really leads us to be de-emphasizing, on a relative basis, equities — both international, developed and U.S. — and emphasizing things like higher-quality, fixed-income and real assets. As far as where we see the U.S. equity market hopefully ending up 2023, our forecast is 4,275.
Pomerantz: We continue to think good diversification is the most important thing for your portfolio. And it's really based on what each individual investor's long-term goals are and what their personal situation is. And when it comes to equities, we look for high-quality companies, the solid balance sheets and the reasonably valued. There's a lot of opportunity to take advantage of volatility that's going on currently, and also to possibly manage for tax advantages. And we think fixed-income with higher yields — it's a great time to own fixed income.
Our long-term estimate for equities over time will annualize at a rate of about 10 percent a year. I'm simply using that estimate for next year. I would say 4,400.
Johnson: I've titled our 2023 outlook report "A Hop, A Drop and A Pop." I do think we've got a little bit of a hop going on right now. I think it's going to carry on probably into the first quarter. But when the Fed is ultimately sort of done raising rates, I wouldn't be surprised if they go a little bit too far and perhaps kill the patient to a degree. And then they've got to come back and restimulate, and hence later on in the year I think the pop can kind of play out.
We like U.S. equities. We like the energy sector. I'm also starting to see meaningful improvements in the industrial sector with the reshoring-theme stocks. I'm also seeing positive things happening in the financials, not necessarily banks per se, but a lot of the insurance companies.
As I do my same bottoms-up methodology that I have done for years, I'm looking for 4,625.
Sit: First, I think the market is discounting a recession already, not a soft landing. But I think in 2023, the second half of the year, it's realistic to say that we are going to see an improvement in the economy relative to this year. It's going to be a stock-picker's market. We'd be focused more on the secular growers, tech health care and health technology, as well as financials and the cyclical growers in industrials.
We believe you should have some quality international companies — that hopefully their marketplace is not just their home market of Japan, or China, but they're selling globally, so they can weather the storm as well. Volatility is here to stay for a while. In terms of our S&P forecast, we're seeing around 4,350.
Paulsen: I think we're not going to have a recession. And if we do, it'll be very mild. And I think earnings do far better than what people think and hold their own overall. There's also some really good things already happening here, and we've talked about consumer confidence starting to come up.
Whatever you have in cash, you might want to stick some of that in bonds for the first time in awhile. But I would still overweight equities right now and bring down my cash in particular over that period of time. And I do like cyclicals, particularly industrials and financials. And my favorite sector is consumer discretionary — the one sector that's hurt the most by inflation. I also would have a small cap tilt. I think there is a lot of interest in smalls, and I'd have some overseas.
I think we have a huge year, I think 5,100.
Royal: Focus on asset allocation this year. This isn't a year to stray too far from your long-term target allocation — whatever that is. We will start the year modestly overweight on equity, nowhere near what I would view as a max overweight, but we will be overweight equity.
Within fixed income, we are looking for quality fixed income. With the possibility of recession out there, I'd rather go longer duration but stick to the higher quality.
On the equity side, there are two themes: I like some of the quality large growth names, and we talked about technology. Those stocks are down quite a bit more than the broader index. And then I think small caps are interesting here. You wouldn't normally want to get overweight on small caps if you thought there was a possibility of recession because small caps could considerably feel a recession. But valuations are pretty attractive. I think they have a little bit of cushion.
For my year-end number, I polled our team and got a variety of numbers. I was going to say 4,500 but one of our quantitative analysts said 4,503, so 4,503.
2023 S&P 500 predictions
Lisa Erickson: 4,275
Senior vice president and head of public markets at U.S. Bank
Roger Sit: 4,350
Chief investment officer of Sit Investment Associates
Martha Pomerantz: 4,400
Portfolio manager and head of the Minneapolis office of Evercore Wealth Management
David Royal: 4,503
Chief investment officer and chief financial officer of Thrivent
Craig Johnson: 4,625
Chief market technician at Piper Sandler
Jim Paulsen: 5,100
Chief investment strategist at Leuthold Group
Portraits by Carlos Gonzalez, Star Tribune