I started 2023 with an unavoidable feeling that a next shoe is about to drop in the markets. Last year equity markets had a 20%+ correction, but still the drop seemed very orderly. The Fed kept on increasing rates, liquidity kept dropping and it impacted long duration assets. However, there does seem to be a bit of a rebound happening in the market in the first 3 months even after some tumultuous regional bank crisis. The real question now is whether the market continues its growth path forward or do we see some declines on the horizon.
With all the appropriate caveats, I think my view is that markets (SPY) will see a dip to 3200-3500 in the next couple of months before really taking on a mother of all rallies in the 2H/4Q of 2023. My grand plan was to start getting positioned on a number of incremental positions as we start to touch 3600.
So, here is the my “Base Case” is the following:
1) Next couple of months: Something breaks in the next couple of month as debt ceiling gets in place, and liquidity gets out of the syste
2) 2H and 4Q 2023: Fed steps in and we get mother of all rallies after that
Basic backdrop of the macro situation is that finally inflation has started to ease and leading indicators (esp. housing rent) point towards continued decline, and job losses are starting to pile up. People were expecting Fed to pause rate hikes especially during the latest regional bank turmoil, but now it appears there may be a couple more rate hikes on the table now. Liquidity getting some positive inputs as debt ceiling prevents Fed from issuing more debt while treasury continues to spend money. Earnings seems to be stable or slightly declining.
1) Next couple of months: Going forward, there may be a few things that we can expect to see: 1) raising debt ceiling which might drive liquidity down, 2) logical progression to lower earnings/job cuts, (and recession?), 3) continued inflation, 4) impact of fast fed hiking showing up somewhere – not sure where. NY Fed currently Recession probability of >55%. Remember recessions bring 30% of so of declines in indexes (through a combination of multiples and earnings). So, overall, these items point towards additional headwinds for the market in the short term, where something breaks again.
2) 2H and 4Q 2023: OK – so after something breaks and we get one more final dip, I believe we get a big rally. If liquidity is what is driving the market, I believe that real liquidity infusion is still ways off, unless fed starts to cut rate. I think Fed would probably cut rate when something breaks. I also think that the inflation is likely coming into phases with the first phase declines already happening – this will enable Fed to take a more dovish approach.
Regarding, asset allocations targets:
For the next couple of months: I think only bonds seem interesting to me to increase position into across the whole duration. There is no reason to keep cash vs. say an instrument like BIL with its relatively high yield. One could think of very short term bonds (VGSH), and then also think of IEF, intermediate term bond ETF. This seems to be a good time to DCA into bonds until you get to about 10% of your asset allocations into it. I am also thinking about Municipal Bonds too (e.g., MUJ). The thesis is that given near term economic slowdown I would expect fed to cut rate impacting short term yields and I think the longer term yields could also come down at some point. Not sure, if I would think about investing into anything else for now, given the near term headwinds.
If something breaks in the market, and we hit a bottom: Here are a few assets I would like to consider. Of course, no one can time it – so we will just have to see when Fed starts to turn around – that will be my signal for entry. The theme here will be interest rate sensitive instruments, like Tech (QQQ), Crypto and Gold. I think gold seem pretty good right now for a long term buy and hold. It has really regained its high level, and I think there are only additional tailwinds as we think about additional fed easing. However, having gold allocation.
So here is my take on asset allocation in the two time frames that I have outlined:
| Asset Classes | Near Term Outlook (Next 2 months) | Longer term outlook, after Fed starts easing (2H/4Q 2023) |
|---|---|---|
| Traditional Equity – USD Exposed, (Long term target: 30-35%) | Hold, May be some minor position increase in XLF or KRE as they seem to be suffering. If needed to invest, possible position for recession (Healthcare and Consumer Staples) | Buy, Tech all the way (QQQ). Even thinking about ARKK. |
| International Equity (long term target 5-10%) | Hold, I am continuing to lose faith in emerging markets or Europe. Might even sell – target closer to 5% range vs. the 10% of asset allocation range, move international positions to US equity markets. | Hold, Only emerging market that I am considering is India (EPI) or Brazil (EWZ). I will also look to reduce China holdings and move to these countries. |
| Precious Metals (Target:10-12%) and Commodities (Target: 8-10%) | Hold, Commodities will get impacted if recession fears start. If dollar becomes stronger, and dips happen due to a broad based sell-off, that might provide opportunity for long term hold | Buy, buy gold in case there is an additional dip; We are at the end of the long term debt cycle – debt levels vs GDP are currently so large that in order to reduce them, monetary denominators have to be increased. Supports bull case for Gold |
| Cryptocurrencies (Target: 5%) | Hold, I typically don’t sell crypto due to tax reasons and given I have a longer term outlook. However, my near term view is that there will be a dip that is coming, here. | Buy (Only BTC) I think the dynamics here are similar to gold. Plus there is scarcity factor. |
| Total Bonds (Target: 10-15%) | Buy and DCA to 10-15% of portfolio, the long duration yield increase has diverged from economic indicators like ISM – may lead to yields dropping shortly. I think 0-10 years duration is where I am looking to DCA into. Need to be positioned correctly for the upcoming dip. | Hold – but look at inflation trends closely, once you have built up your target, then I think you just rebalance. The only concern here would be if inflation starts to raise its ugly head again. I do think inflation may not be dead and once this short term cycle ends, it comes back in phases. Hence, if we start to see inflation ticking up again in 2024, then we need to be in a position to Sell at that point. |
| Real Estate (Target: 15%) | Underweight, I would expect housing market to correct significantly due to higher mortgage rates. Everyone is talking about commercial real estate cracking. Personally, I will just hold here. | Hold, if the long term interest rates dip, aggressively refinance your positions, and then consider expanding your position in this asset class |
| Cash (Target: 5-10%) | Great option to move to BIL, or even to Apple Savings which is giving a 4.15% APY | Keep close to your target |
Good luck navigating this market! Again – this is more of my framework, not an investment advice.
Macroeconomic and investment musings 