January 2023 Update

Welcome to 2023!

The outlook for this year, like any year, is hard to predict. But the across the board general consensus is it will be a better year than 2022. We will still likely see a lot of volatility in the market as inflation and recession fears are still very real and top of mind for investors. However, both the overall market dynamic and investment options are a lot more conducive this year to a manage our way through it. Let’s start with the overall outlook.

2023 Outlook

We are sticking to our view from late last year that the first half of the year has the potential to be quite weak and the second half of the year has the potential to be quite good. We will have a much clearer view of the yearly outlook once earnings for the Q4 2022 begin posting in late January. Earnings for Q4 will be important, but even more important will be the company’s guidance for earnings in 2023. Our expectation is that earnings will be worse than anticipated due to the unprecedented Federal Reserve interest rate increases in 2022. If that is the case, it is hard for me to envision a market that doesn’t retest the lows from October and if earnings are way worse than expected, break through the lows.

Realistically, a breakthrough the lows in the first half of the year is probably the most ideal scenario. Another 15% or so down in the first half sets up a big recovery in the second half and then also possibly a strong 2024. In our view, the market needs to flush down another time before we can realistically move on higher on a more permanent basis. The longer that flush out is postponed, the longer it will be until we can feel confident that any market rally will be sustained. If we do not get a larger pullback in the first half of the year, then it will likely happen in the second half of the year. If that is the case, we think upside in the first half will still be quite limited and then the market will likely turn down and close lower for the year.

Below is the chart image from our December update when the market was sitting just under the long-term trend line.

This is how the month of December actually played out.

As you can see, the trend line held firm and the market was not able to break through. Now we are halfway between the trend-line on top and the market lows below. It’s a coin flip where the market goes short term, but our belief is that it continues its downward momentum until it eventually breaks through the low end of the range and makes new lows.

Strategy

We believe that a large cash position as well as overweight sectors like Healthcare, Utilities, and Consumer Staples is the proper allocation for a market like this. We will be avoiding economically sensitive sectors as well as technology for the time being. Most importantly, a large cash position will help to dampen the downside volatility of the market while also leaving us fresh capital to deploy when the environment becomes more suitable.

We will know more about how the rest of 2023 may play out as January unfolds and comes to an end. Mega Cap companies like Microsoft and Apple will begin to report earnings in late January and early February. The quality of those earnings will have a major impact on the direction of the market.

Drew Sweetman CIO - Element Squared Private Wealth

Sources: Marketwatch.com, WorthCharting.com, CNBC.com, SeekingAlpha.com

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