The S&P 500 finished 2022 down 19% on the year, which was the broad index's first negative year since 2008, a time when the Great Recession was rattling markets and the economy. Last year's return was a major reversal of fortunes, given that the S&P 500 averaged an annual return of 14.3% in the 10 years that ended in 2021.
As they set their sights on the rest of 2023, investors have a lot to think about. The Federal Reserve is still planning to raise interest rates, albeit at a slower pace. That's because inflation is still running hot. And corporations continue to lay workers off, preparing for difficult times ahead. All of these factors can impact how you position your portfolio.
So, what's in store for 2023? Here's what the smartest investors are worried about this year.
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How confident are you?
Gallup polls Americans monthly about their assessment of the economy. A reading of zero, which indicates indifference and equal levels of positive and negative outlooks, has been the average measure over the past 20 years. In November, this figure was negative 39. This was higher than June 2022, but still lower than June 2021 when inflation was still believed to be temporary.
Only 15% of Americans polled said economic conditions were either good or excellent. And a whopping 40% rated economic conditions as poor. Higher food and energy prices, the war in Ukraine, and the ongoing coronavirus pandemic are still top of mind. Clearly, Americans remain incredibly pessimistic about the economy.
Why does the average American's confidence in the U.S. economy matter so much? I view it as a self-fulfilling prophecy. If people believe that hard times are coming, then they will start to cut back on spending as much as possible in order to stretch their budgets. And this has cascading effects.
Less consumer spending leads to lower revenue for businesses, small and large alike. And then these companies will start to institute cost-cutting measures, lower their financial forecasts, and try to conserve cash to strengthen balance sheets in case things do worsen. Capital expenditures are put on hold, and employees are laid off. These developments further pressure Americans' confidence in the economy.
Simply thinking that the economy is going to get worse can turn the fear into reality. This is why analysts closely watch consumer confidence.
Still a tight grip
With central bank officials signaling that they could push the federal funds rate above 5% sometime in 2023, it makes sense that consumers are worried. The U.S. economy hasn't had to deal with a federal funds rate this high since December 2007. It's a situation that dampens liquidity, pushes up borrowing costs for businesses and individuals, and discourages spending in favor of saving. It's essentially like pressing the brakes on the economy.
What's more, with the Consumer Price Index rising 6.5% in December on an annualized basis, inflation is still well above the Federal Reserve's 2% target. So, even though central bankers plan to slow down the pace of rate hikes this year, they will likely be forced to keep them elevated for some time in order to get high prices under control.
In this type of environment, one characterized by a gloomy economic outlook, how can investors best position their portfolios to weather the storm? To be clear, I don't think investors should completely abandon their strategies strictly based on macro factors, especially because the focus should remain on the next 5 to 10 years.
However, when uncertainty and worries are high like they are now, ensuring that you own competitively advantaged, profitable, and growing businesses is always a good course of action. That will no doubt give you peace of mind in times like these.
