Equity investors do not have a lot to like, but that is always the case closer to market bottoms than tops. That doesn’t mean we have to rally in 2023, but just because positives are limited doesn’t mean we have to keep going lower either.

The end of a bear market and start of a new bull market is often a period of intense volatility as stocks shift from steep declines to sharp gains.  The last leg of a bear market certainly inflicts pain.  But the early days of a bull market are just as violent to the upside with double-digit percentage gains consistently over the next one and three months in almost all cases.

One of the debates entering 2023 is whether we have a recession and when it will start (or has it already started?).  The timing of a recession is important because stocks usually bottom before the halfway point of recessions.  The current consensus is that the recession will start this quarter and last the usual post-WWII duration of 10 months.  So that puts the halfway point of the recession about mid-year, when stocks are forecast to bottom.  Maybe the timing makes sense, maybe it doesn’t, but we question investors’ ability to forecast the exact timing of a recession and the market bottom.

Going back to the late 1980s, investors have never been more negative on the stock market than they were in 2022. Bullish sentiment was below its historical average every week of the year.  Sentiment is considered a reliable contrarian indicator, but it clearly missed the mark last year.  It is a reminder that no indicator is foolproof.  We follow sentiment and comment on it frequently, but in down-trending markets like 2022, it provides little insight.

In late 2021, valuations were not only high but near historical extremes.  After last year’s sharp decline in share prices, P/Es have reverted to more reasonable levels.  But while valuations have retreated, the market is still far from ‘attractive’ levels and nowhere near the historical average of 15.8x (trailing) dating back 100 years.  The trailing P/E currently sits at 19.6x.

The graph below shows the tremendous volatility in trailing P/E ratios going back about 70 years.  Notice the spike down in the last two years:


Source: Bespoke Investment Group

While valuations have reverted to their pre-Covid levels, a key difference between now and then is the level of interest rates.  During the post-Financial Crisis period, low interest rates provided a level of justification for higher equity valuations.  That reason (which is shaky to begin with) is no longer valid.

Bottom line:  Equity market valuations are still too high based on either trailing or forward P/E multiples.

TAIL RISKS FOR 2023

There was no Santa Claus rally in December.  The only place Santa was seen was likely on a milk carton.  He was nowhere to be found in the stock market… 2022 was a bust for markets as stocks slid, bonds were hit by their worst sell-off ever, and cryptocurrencies were slammed.  The S&P 500 remains in a clear downtrend as shown by the graph:

Tail risks are low-probability events that are not expected by investors and not discounted in share prices.  If the events occur they are likely to damage stock prices.  One could argue the number one tail risk last year was high inflation.  Many investors believed the Fed when they said inflation was transitory.  When it wasn’t, stocks were hit hard in last year’s first half.  So what is on the list for 2023?

According to a survey of fund managers by Bank of America, the top three tail risks for this year are:

Tail risk events don’t occur every year but when they do corrections or bear markets are often the result – like 2022.  It seems like a lot could go wrong this year.  But that feeling is typical at the depths of a bear market.  Investors are happy 2022 is over.  2023 promises to be an interesting sequel.

 

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Knowledge – Results

Experts in Risk Management

Are you prepared for the next market correction or financial crisis?

Knowledge – Results

Experts in Risk Management

Are you prepared for the next market correction or financial crisis?

Knowledge – Results

Experts in Risk Management

Are you prepared for the next market correction or financial crisis?

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Richard Furmanski

Richard Furmanski

CFA

has been a portfolio manager and analyst for over 35 years. He manages conservative, tax-efficient portfolios for both pre-retirees and retirees. His lower risk approach appeals to investors who want less volatility and competitive risk-adjusted returns.

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Frequently Asked Questions

If you can't find the answer to your questions here, feel free to give us a call at 847-847-2505

Do you manage both stock and bond portfolios?

Yes. We build a portfolio of conservative, high-quality stocks and hold them for the long-term. The average holding period is 4 – 5 years. Our focus is on stocks that are suitable for retirement portfolios.

Our high-quality bond portfolios are designed to provide both income and stability of principal. Bonds provide the anchor for balanced accounts (those holding both stocks and bonds).

What is your investment philosophy?
We take great care in purchasing only high-quality stocks and bonds intent on a multi-year holding period. Portfolio turnover and taxable realized gains are modest in comparison to other active managers. We do not time the market but will become more defensive, in terms of stock holdings, when market conditions warrant.
Will the portfolio be managed in accordance with my financial goals?
Yes. Each of our clients has a custom-tailored portfolio. These custom portfolios are designed to meet specific client objectives with a thoughtful approach to specific constraints such as risk tolerance. And as each client’s situation changes, the portfolio does as well. There is no cookie cutter approach.
What kind of expertise do you have and how can that help me in difficult markets?
We have been working with high-net-worth clients like you since 1982. Over that time we have helped them to navigate several bear markets and financial crises (including the stock market crash of 1987). We hold the Chartered Financial Analyst (CFA) and Certified Financial Planner (CFP) designations.
Are you sensitive to taxes when managing portfolios?
Yes. Our holding period for an individual stock averages 4 plus years which means our turnover is low and realized gains can be carefully managed. Further, where possible, we tax loss harvest small losses as a way of offsetting gains taken elsewhere in the portfolio.
How have you performed?
Results will differ by client and the level of customization but we have provided competitive investment returns for many years.
How do you charge for your services?
We charge a management or consultant fee based upon the size and level of customization of the account. As the account grows, we benefit together.

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