The Markets of 2023

While 2022 continues for the remainder of this week, there are rumblings about what 2023 may bring.  With the traditional happy voices on Wall Street continuing to preach their eternal message about higher stock prices, some heavy hitters are discussing an alternative narrative.  It is always easy to find dissenting views, but when these views are shared in light of 60+ years of verifiable research, prudence requires that we at least take a look.  The implications for stock prices, the real estate market, the future for interest rates, and precious metals prices, are all in view.  Today we will take a look at these issues in turn, and discuss the forces at work that are molding an interesting 2023 to come.

When we look at various technical market analysis tools provided by the team at McClellan Financial Publications, we find that there is a major disconnect between the M2 money supply and GDP projections.  At the fastest rate in history, we are seeing M2 contract or get smaller, while the GDP expands or gets larger.  Normally when the GDP expands, policy makers want to increase the money supply to “lubricate” the gears of an expanding economy.  When there is an increased demand for currency, and an increased supply of currency to meet that demand, the financial system (and markets) function more smoothly and growth can occur. But when the demand for currency (in this case due to inflation) rises while the money supply decreases, this creates stress and volatility in the system.  If history rhymes with the future, we could see a severe lurch downward in stocks in 2023.

When we look at the relationship between GDP, M2, and the S&P 500 Stock Index, we see an evolving transition in terms of timing.  From 1960 until around 1978, the M2/GDP ratio moved nearly concurrently with the S&P 500.  That is when the ratio increased, stocks went up in tandem.  When the ratio decreased, stocks headed downwards; not moment by moment, but the trend was established and easy to identify.  Then in 1978, the high inflation dynamic began to change the relationship between M2/GDP and stocks.  Throughout the 80’s, there seemed to be a 6-month lag between trackable trends in M2/GDP and stocks.  That is, when M2/GDP began an upward trend, stocks tended to follow higher in about 6 months.  The reverse was also true in the downward direction, as stocks followed the ratio lower after a 6-month lag.

From the year 2000 until today, the relationship between the M2/GDP ratio and stocks is best modeled with a 1-yr time lag.  Instead of changes happening concurrently as in the 1960’s-70’s, or with a 6-month lag as in the 1980’s, changes have occurred about a year later so far in the 21st century.  With M2/GDP dropping at the fastest rate in history looking back a year, we could see stocks begin to mimic this movement over the next year.  Of course, since we have never seen the M2/GDP drop so quickly before, no one knows for sure how things will play out.  It is also possible that a new paradigm is being realized, that could shift the timing and correlation of M2/GDP and stocks once again, either back towards a 6-month lag, or towards a new 1 1/2 year lag.  Time will tell.

It is not only the professional chartists sounding the alarm bells about stocks.  And it is not only stocks that are coming under pressure in 2023.  Asset investment management firm BlackRock recently issued a warning that we could see a “recession unlike any other”, that will require a different approach to navigate successfully.  They too have recognized the extreme conditions in the relationship between M2, interest rates, and inflation, and predict a period of volatility and “heightened instability” as a result.  The article linked above also shares the express opinion that stock prices don’t yet reflect the realities of what is likely ahead, and projects a 20% reduction moving into 2023.  They also mention a slowdown in the housing market as a contributing factor.

Harvard economist Kenneth Rogoff also believes recession is a near certainty, along with further drops in stocks, real estate, and a declining labor market.  He cites the tightening of financial conditions (higher interest rates and lower M2) as major contributors, as policy makers try to slow down inflation.  He believes that as the loose money conditions of previous decades are reversed, the price of various assets previously inflated (stocks, bonds, real estate, art, cryptocurrency) will be under pressure to reverse downward as well.  A tight labor market and higher wage pressures are making inflation a difficult beast to slay, and he believes the Federal Reserve will not be able to decrease interest rates as quickly as Wall Street would like.

Thankfully for those of us who care about precious metals, there is a bright spot in this otherwise gloomy outlook for 2023.  Specifically, let’s talk about the prospects for gold.  Over the last 20 years, gold has outperformed US stocks, bonds, and commodities (see graph).  But the past is the past.  What about the future?  We have spent the bulk of today’s article outlining the challenges that many believe lie ahead for stocks.  This is important for gold investors, because history has shown that when stocks fall, general commodities often follow to a lesser degree.  But during those times, gold tends to buck the trend and rise.  We would expect to see this trend continue again in 2023, with gold being among the better performing asset classes for the year.

As we learned in 2022, sometimes the strength of gold is noticed the most when nearly everything else is having a tough time.  Those who previously claimed that cryptocurrency was the new “digital gold”, have seen gold remain solid as many crypto assets vanished throughout the year.  From what we can find from some of the sharpest minds on Wall Street, it appears likely for gold to continue to be a great place to park some capital for the months and years ahead.