Complex Uncertainties Make 2023 Stock Market Outlooks Unreliable

What do we know for sure about 2023? Only that the extensive unknowns mean we are probably in for dramatic surprises. There are simply too many interlocking risks and uncertainties to allow for even quasi-accurate forecasts.

Yes, all new years have mysteries, but 2023 is special. It has a diverse flood of rocky trends from the past two years. Moreover, there are significant, yet indeterminate, economy and financial developments ahead.

The New York Times described this situation well in “The Bull-and-Bear Case for 2023” (Dec. 27). (Underlining is mine)

“Market watchers look for optimism amid the gloom”

“Tech stocks, Treasury bills, cryptocurrencies, real estate. The great market sell-off of 2022 has been indiscriminate. wiping trillions off the stock market capitalization of risky and not-so-risky assets, and taking a huge bite out of average investors’ retirement plans.

“Despite the carnage, many investors are sticking with their beaten-down stock portfolios as they head into the new year. ‘There doesn’t seem to be a lot of people, despite the drawdowns, who are saying, Hey, the pain has been awful, Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, told DealBook. ‘And the reason is, because all things considered, they’re still up 50 percent since the start of the pandemic.'” [That last statement is inaccurate. See below.]

Note: That “up 50 percent” significantly overstates investors’ returns. Using the 3-year period from pre-Covid January 1, 2020, the S&P 500 rose a total of 25% (including dividend income). Bonds (using the Vanguard Bond Index Fund) fell a total of 8% (including interest income). For a 60/40 portfolio with international equities and bonds included (using the Vanguard LifeStrategy Moderate Growth Fund), the total return was only about 11%. Moreover, CPI (all items) inflation, now a key investment concern, rose a total of over 15%, reducing that portfolio gain to a “real” (inflation-adjusted) loss.

This is an important point, because investors are not sitting back, relaxed with fat gains. Some (many? most?) are anxious. For retirees taking out distributions, the picture has become worrisome. Therefore, the past three years of investment, economy, financial and personal turmoil has approached a point of decision making. And yet, there is an apparent reluctance to make investment changes. Why? Likely, it is caused by the lack of clear future direction as discussed further in the article:

“… Wall Street as a whole hasn’t been so divided about the prospects for the next year since the global financial crisis, reflecting deep uncertainty over U.S. monetary policy, corporate profits and a wider debate about whether the world’s biggest economy will fall into recession. The average forecast expects the S&P 500 to end 2023 at 4,009, according to Bloomberg, the most bearish outlook since 1999. But the predictions range from a low of 3,400 to as high as 4,500, representing ‘the widest dispersion since 2009,’ Ms. Shalett pointed out.

“’There’s always uncertainty in forecasts. But you know, many times you have a good gauge of where you are with [Fed] policy, where you are in the profit cycle, where you are in terms of valuation,’ she said. ‘As we head into 2023, it’s been our opinion that all of those things are in flux.’”

When investors freeze in the face of risks and uncertainties, raise cash

A build-cash strategy in this market reduces the risk of things going awry and being caught a mad investor dash for the exit. The probability of such a 2023 event is abnormally high because of the investor freeze and the overly large number of risks and uncertainties that now exist.

Remember this truism: It is easier to frighten investors than to reassure them. This reality is why bear markets plummet from fear (panic selling), and bull markets struggle up a “wall of worry.” Worse, with investors already concerned, that fall could be outsized. It’s simply too big a risk to rely on the hope that all will turn out okay without an interim panic along the way.

About that panic…

The stock market’s internal weaknesses could make a selloff dangerous

About 30 years ago, the SEC began to make controversial changes to the stock market’s and stock exchanges’ rules and operations.

It started with a terrible change. Using a flawed study as support, the SEC removed the major requirement that short sellers could only sell on an “uptick” in a stock’s price. The uptick rule was created in the 1930s to counter the previous destructive profiteering actions taken by Wall Streeters. They would short stock on the way down, eventually causing panic selling by investors at lower prices. The short sellers then bought, covering their short positions, thereby earning a nice profit.

Then came the removal of NYSE specialists who were required to ensure an “orderly” market in the stocks they handled. That requirement meant they would step into out-of-balance selling or buying periods, buying or selling to prevent an abnormally large price change. Labeled as money-making monopolists, they were booted, with the SEC mistakenly presuming that electronic trading could provide better market-making.

Then came the approval for multiple exchanges trading the same stocks, with the SEC touting competition to make for better pricing and trading. Instead, it created pay-for-order-flow side deals, then middlemen handling the action while earning billions. (The new SEC head is now dealing with that latter issue, even as the middlemen say they are benefitting investors.)

Then came electronic game playing in which some traders benefitted by getting SEC-approved order flow information sooner than others. Even the old specialist book of limit and stop orders (which was necessarily kept private from everyone else) was made accessible, meaning those orders could be gamed as well.

Then came the fallout: “Flash crashes” – When exchanges’ electronic trading systems stop making reasonable bids in a downturn, so market-sell orders receive abnormally low prices. They are the antithesis of orderly markets. When the melees first occurred, the need to fix the flawed trading systems became obvious. However, the SEC, not wanting to admit defeat and bring back the humans that prevented such trading problems in the past, created an electronic fix: “Circuit breakers” that stopped trading for a quick time-out. They do not solve the problem. Mini-trading stops do not incentivize electronic trading systems to jump aboard a sinking stock – nor can they prevent destructive short selling.

Going through all these issues is a reminder that the stock market remains susceptible to short-driven price drops, flash crashes and panic selling when the conditions are right – like now.

The bottom line: When risk and uncertainty are this high, don’t commit

Will a selloff happen? Will it be a panic selloff? Who knows? The point is the probability is unacceptably high that it could happen in this environment.

But what if a selloff doesn’t happen and stocks rise? If the driving force is a reduction in the risks and uncertainties, then we can then confidently look for buying opportunities. However, if the risks and uncertainties remain, the higher prices simply increase the risk of stock ownership.

So, raise cash. It’s the only sure way to avoid getting caught.

For more discussion of current conditions, see my Dec. 28 article, below…

MORE FROM FORBESThe Stock Market Fads Are Crumbling – Beware The Spreading ShockwavesBy John S. Tobey