The Biggest Mistake Investors Will Make in 2023

...And How To Avoid It

The worst mistake investors will make this year won’t be getting caught with a stock on the heels of a disappointing earnings report. And with all due respect to economic prognosticators, it won’t be misjudging the Federal Reserve’s resolve fighting inflation—or the rising risk of a recession as the central bank pushes up interest rates at the fastest pace since the 1980s.

Odds of another big stock market slide are growing. As my partner Elliott Gue wrote this week for our CT Trader members, the S&P 500 and ETFs tracking its performance are highly concentrated among a few very expensive stocks. And that’s a proven formula for losses.

The 10 largest names in the S&P 500 by market capitalization, for example, are 26 percent of its total value. The top 50 names—the new Nifty 50 if you will—are more than 56 percent, close to the share they held a year ago when the stock market started dropping.

Worse, the S&P 500 is priced at more than 30 times normalized earnings, as calculated over the last decade. And estimates of next 12-months earnings have rarely been at greater risk of dramatic reduction.

Profit margins have been under pressure for more than a year due to inflation. They’d compress quite a bit further if the economy slips into recession. And many companies are at risk to steep increases in debt interest expense, especially if they rely on variable rate debt, face meaningful debt maturities and/or are accessing capital markets to fund investment.

Last year, the technology-heavy Nasdaq 100 proved particularly vulnerable to high valuations and margin risk, losing nearly one-third of its value as a result. This year, other sectors are likely to join tech in weakness, possibly as soon as Q4 earnings and guidance updates come out over the next month.

But the worst mistake investors will make in 2023 won’t be not being defensive enough. Rather, it will be not positioning for what comes next, when the Fed declares victory over inflation and eases up the pressure on interest rates and the economy.

That’s higher long-term inflation.

Raising interest rates to reduce demand is a time-tested way to bring down inflation near-term. But boosting borrowing costs also reduces investment. So when the Fed eases up, supply lags even further behind demand, driving prices higher still and worsening inflation.

For example, from July 1967 through August 1969, the Fed raised benchmark rates from 3.79 to 9.19 percent. From July 1971 to July 1974, it helped shove the economy into a deep recession by pushing rates from 4 to 13 percent. And from August 1977 through May 1981, the Volcker Fed boosted rates from 4.75 to 20 percent, nearly triggering a global depression.

Yet each time the Fed backed off, inflation returned with a vengeance. That includes the 1980s, when the post-Volcker US dollar crashed, the price of oil more than doubled over a 12-month period and gold briefly revisited its all-time high of over $800 an ounce in late 1987.

Only the combination of consistent pro-investment fiscal and monetary policy—as well as the emergence of China as a low cost manufacturer—eventually closed the supply/demand gap, and ended the inflation of the 1960s, 70s and 80s.

It’s a myth that many investors didn’t build real wealth in the 1970s and 80s. But being successful required taking control, and positioning in what does well in inflationary times. Simply buying the market averages didn’t cut it.

The popular investment media is now full of stories about investors who are postponing retirement because of losses sustained in 2022. And unfortunately, those banking on index ETFs to make them whole in 2023 will likely feel a lot more pain.

But last year was also full of opportunity for those who educated themselves about what to buy, and acted on that knowledge. At the start of 2022, for example, the oil and gas sector was near its lowest ever percentage of the S&P 500, and avoided by many institutions entirely. But it returned almost 65 percent to the index’ 18 percent loss. And most popular ETFs almost entirely missed that gain, due to concentration in big tech names.

Many investments that do well in inflationary times should be obvious. Energy, for example, is still in the early innings of a long-term upcycle, rooted in years of under-investment.

Developed world governments’ preferences notwithstanding, oil and gas will remain the world’s dominant fuel sources for years to come. And policies to discourage investment in new drilling—as well as necessary infrastructure like pipelines—will only worsen the long-term imbalance between constrained supplies and still growing demand.

In contrast, governments are underwriting spending on deployment of renewable energy. But margins for generating wind and solar will also rise along with higher oil and gas prices. And so will prices of the key natural resources needed to deploy renewables, from copper and iron ore to battery metals like nickel and lithium.

You might not have thought about real estate investment trusts as inflation beneficiaries. But inflation has been a reliable driver of both higher rents and land values.

REITs give investors the benefit of owning real property without the hassles of managing it. And the best in class will get a big lift in earnings, dividends and share prices in coming years, from in-shortage residential properties to industrial sites and even farmland REITs like Farmland Partners (NYSE: FPI).

Companies that can pass on higher costs to customers will also prosper in inflationary times. And their ranks include dominant players in a surprising range of industries, from food service to regulated utilities. Even some bonds will be big winners, provided buyers time purchases and stick to near-term maturities.

Bottom line: Whether your objective is income, wealth building or speculation, you’ve got to take control of your wealth. That’s not as easy as just buying an ETF. But by making the effort, you can build real wealth in the coming inflationary times, even as the typical investor watches their savings slip and slide away.

Thanks for reading! Check us out at Capitalist Times for more highly profitable investment insights like this, plus access to our exclusive investor community and stock research that’s enabled our readers to trounce the big Wall Street firms for more than 30 years.

Sincerely,

Roger S. Conrad