2023 Stock Market Outlook – OK To Hope For Best, But Prepare For Worst

Each economic report and stock market wiggle now generates hopeful discussions about 2023’s outlook – like falling inflation, soft economy landing, Fed interest rate pivot and consumer spending strength. The hope is that the risks being tossed about (stagflation, recession, much higher interest rates and consumer spending pullback) will be avoided. However,…

… the risks discussed exclude worse risks whose probabilities have increased

These other risks are rare, but they are here now. They result from the abnormal investor behavior (both individuals and institutions) that has led up to the current combination of economy and financial issues. While the economy and financial situation are today’s focus, the adverse investor actions are beginning to be noticed.

Note: I discussed those latter concerns and the likely fallouts in these two articles:

MORE FROM FORBESStock And Bond Investors: Markets Headed To Shakeouts – Raise CashBy John S. Tobey

MORE FROM FORBESHere Comes A Rare Event: A Stock Market WashoutBy John S. Tobey

How to prepare for the worst

First off, realize that being fully invested all the time is not a recipe for maximum return. Instead, it’s a commitment to ride unshielded through the worst times the market dishes out. Why focus on the worst? Because that’s when emotions most easily overwhelm any promises to oneself that thou shalt not sell. Breaking that promise likely means locking in miserable returns.

So, what to do? It’s an easy step in this market. Raise some cash and invest it in a money market fund that is now – finally! – paying a decent interest rate.

What if the stock market rises? No problem. The amount still invested in stocks rises, and the cash is available for investing in new opportunities as the risk dissipates. However, that question is misleading when dealing with today’s abnormal risk. Instead, focus on the dual benefits of raising cash now: (1) Protection against emotionally-charged selling at the wrong time; (2) Availability of funds for investment in opportunistic times.

How much cash to raise? That is a matter of personal preference. Ten percent seems to be a minimum amount chosen. Above that, whatever seems (and feels) appropriate.

Note: 100% is my preference, and that is how I am invested currently. It’s how I have invested for 58 years after reading Gerald Loeb‘s excellent book, “The Battle for Investment Survival.”

But isn’t that just “market timing,” a proven losing approach? No. Market timing attempts to do the impossible – forecast both the what and the when. It can be done rarely, but it cannot be done regularly. Instead, the raising of cash when risk rises is dealing with probabilities – that is, the likelihood of something going amiss that creates a buying opportunity. When? Who knows? It’s simply a recognition that something must give. And that’s where we are now with the U.S. stock market.

But the market’s already down, so isn’t now a buying opportunity?

Perhaps, but those added risks are still not incorporated into investor thinking. If the risks of a shakeout and a washout dissipate, then selecting buying opportunities would be appropriate. However, when shakeouts and wipeouts hit, they usually infect most stocks, and that means even better buying opportunities arise.

As to the depth of the current market’s decline, it has removed the 2020-2021 index differentiation and put all three major indices back to their pre-Covid level (inflation-adjusted), when optimism reigned.

Note: For the nearly 3-year period, the annualized returns (excluding dividend income) are Nasdaq 5.4% (0.6% inflation-adjusted), S&P 500 6.0% (1.2%), and DJIA 5.2% (0.3%).

The bottom line: Investing in cash is never a mistake

Cash is both a salve in tough market times, preventing panic selling, and a benefit in opportunistic market periods. The realization that a higher return could have been earned is labeled an opportunity loss, but that’s incorrect. Nobody can correctly identify opportunities in all markets.

Instead, we must pick and choose those opportunities about which we are most confident. If an opportunity works out, great. If it doesn’t, we sell and move on. Being an investor means never standing still or reaching the end. “Winning” means surviving, and surviving means never getting carried away by fads or fears.