The Only Way to Trade the Markets in 2023

Around 12 months ago, I shared my prediction on how the markets would play out in 2022…

To me, the answer was crystal clear.

After a runaway bull market, Big Tech had rallied to dizzying heights. And I knew there would be pain ahead… Not just a little bit, but lots of it.

And that’s exactly how it played out.

You didn’t even need to be around the markets for decades to see it… price-to-earnings (P/E) ratios had shot into the stratosphere.

Stocks that had no earnings at all were trading at absolutely crazy prices… Analysts were coming up with new made-up ratios in an attempt to somehow backward-engineer their sky-high valuations.

All investors had to do was “buy the dip,” pin their ears back, and hang on for the ride.

An endless supply of cheap money had tricked investors into thinking the party could keep rolling into 2022 and beyond. Even the biggest investment houses like Goldman Sachs and JPMorgan thought the indices would keep rallying in 2022.

But I saw the perils of uncontrollable inflation firsthand many decades ago. And I warned my subscribers at the end of 2021 that the game was well and truly up…

Unruly Inflation

In 2021, inflation had gotten well out of hand… But the Fed was asleep at the wheel.

And as we’ve seen this year, it got stuck playing a massive game of catch-up – which it is still scrambling to do today.

That’s the thing about inflation…

Not only do rising prices steadily strangle consumers and the economy. But the double-whammy of rising interest rates to curb inflation puts an added hand-break on the economy.

Folks simply have less money to spend. And I think we’ve still yet to see that really flow into the markets.

The Fed is finding out that it takes a long while for those interest rates to bite. Because that’s the other thing about inflation…

Once it becomes entrenched – as it is now – it can take years to get it anywhere near back under control. Possibly many more years than people realize…

And as I look toward 2023, that’s exactly what I see… Inflation simply isn’t going away.

That means more rate rises than many first thought. Remember in September when the talking heads were predicting the Fed Funds rate would top out at around 4.6%?

But I see them going well above 5% in 2023… And finally, the market might be catching on.

After hitting 9.1% in June (a multi-decade high), the consumer price index (CPI) has been gradually declining these past months. However, here we are at the end of the year looking at the November release of 7.1%.

And that’s just the official number… Real inflation is way higher than that! A quick walk around your local grocery store will confirm all you need to know.

That’s why when that CPI data came out on December 13, the market’s reaction was telling…

After opening around 4% up, it spent the rest of the day receding. Perhaps the market is finally beginning to grasp that a CPI print with a “7” in it is not a positive story – even if it’s 2% lower than it was back in June.

And while it might have been a steady decline so far, I’m betting there will be some more surprises ahead. Another inflation jump in 2023 could well be in the cards, maybe just after the first quarter of next year.

Even if inflation does fall again after such a jump, I can’t see it falling below 5-6% anytime next year. It is too entrenched to be eradicated that quickly.

And that all flows into interest rates. Right now, some are still predicting rate cuts in the latter half of 2023.

But with inflation so sticky, even once the Fed rounds out its tightening cycle above 5%, rates aren’t coming down any time next year.

And that’s not my only prediction…

Supply Chains and Housing Disruptions

The other thing I suspect will continue is supply chain disruptions…

While COVID might have gone out of the news for now, there are still new strong waves of it sweeping the globe. And the world’s largest manufacturer of goods, China, is still navigating how it will deal with breakouts in the future.

These factors could continue to throw up disruptions well into 2023, harming the economy.

The good news for U.S. consumers is that the shortage of motor vehicles seems to have peaked for now. Paying above the sticker price for a new car will likely remain a thing of the past.

Already, we’ve seen that start to flow through into the price of second-hand vehicles.

And on the home front, steam is coming out of the housing market. But I don’t foresee it being as bad as some predict… Certainly not like we saw back in the financial sub-prime crisis of 2008.

Those who bought houses back then had to walk away after losing 20%, 30%, and often more of their purchase price. In this property boom, after several years of double-digit growth, homeowners are less vulnerable due to the build-up in their equity.

However, investors are going to have to tread particularly carefully in the equity markets. Because 2023 is going to be as challenging as any year I can remember.

The Best Strategy for 2023

Markets are going to remain extremely choppy in 2023…

Those still hoping for a return of the previous two years’ performance (2020–2021) will be greatly disappointed.

After a recent strong period through November and December, the S&P 500 is going to again come under pressure at the start of 2023. A slide back to around 3800 is a likely target in the first quarter of next year.

While it may recover somewhat into the second quarter and middle part of the year, I think it will again drift lower in the last quarter of 2023, back to around the 3800 level.

A start and finishing point around the same level might sound innocuous enough. But it’s the period in between that offers the greatest threat to unwary investors.

They’re going to be continually pulled into false breakouts in both directions. No sooner will they get into a trade than it will turn around and bite them. And that will rip up plenty of trading accounts in 2023,

It’s why in 2023, I’ll stick with my mean reversion strategy.

I’m going to look to get in on the other end of the trade when rallies and pullbacks run out of steam. And then I’ll aim to profit when they revert to the mean.

It’s the only viable (and profitable) way I see to trade the coming market.

Make no mistake, 2023 will be a trader’s market. That means being nimble, being vigilant, and ruthlessly sticking to your trading plan.

And, as always, taking your profits when you see them.

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

P.S. What are your thoughts about the coming year? Send them in to [email protected].

And if you’d like to join me in using mean reversion next year, you can find out how right here.