3 Investment Themes for 2023

2023 may be another difficult year for investors who hope to relive the speculative markets of 2020 and 2021. Consensus seems poised for a signal from the Fed that they will lower interest rates which could reignite investors’ interest in more speculative investments.

However, the Fed seems very hesitant to prematurely remove tighter monetary policies. With inflation the highest in 40 years, the entire credibility of central banking is being challenged. The odds, therefore, seem to favor too much tightening of monetary policy rather than too little.

For other investors, however, 2023 could be a rewarding year in the early stages of secular outperformance. Stock market volatility always signals a change in leadership. Prior leadership is typically geared to a specific economic environment and volatility occurs when the macroeconomy changes. Volatility is a changing of the guard during which the old leadership exits, and new leadership emerges that is better suited for the new economic environment.

History shows that investors are usually slow to adopt the new leadership as the economy changes. Rather than repositioning their portfolios for the new economic backdrop, they cling to the old leadership hoping that the economy returns to its pre-volatility state.

Such investor denial seems to characterize today’s consensus. Many investors want the Fed to change course or “pivot” simply because they want low interest rates to again spur speculation supporting the outperformance of investment themes like Technology, Innovation, Disruption, Venture Capital, cryptocurrencies, SPACs, meme stocks, and the like.

Chart 1 below shows that Bitcoin’s performance has been closely tied to Fed policy. When money is free, as it was during the immediate post-pandemic period, investors tend to wildly speculate. However, speculation tends to fade when interest rates increase, and investors are increasingly forced to make rational choices.

Despite significant underperformance during 2022, the Technology, Communications, and Consumer Discretionary sectors still comprise over 40% of the S&P 500®’s weight (See Chart 2) and 38% of the MSCI All-Country World Index. The sectors’ underperformance so far reflects leadership is changing, but it has not changed.