Harness Your Inner Philosopher to Create a Portfolio for 2023

The global financial crisis caused a major shift in the global economy, resulting in most asset classes increasing in value. However, last year, the opposite was true and investors were advised to sell everything. Now, in 2023, investors must make significant predictions about the world for the first time in fifteen years.

At the end of 2022, the S&P 500 index had dropped by 19%. However, it remained relatively stable during the second half of the year. Analysts generally agreed that inflation had likely reached its peak, but that a mild recession was likely to occur in wealthy countries during the first two quarters of 2023.

The outlook is not particularly optimistic, but it does provide a clear plan for investing. If a central bank is expected to take action in response to an economic downturn, then investing in bonds is a wise choice. Most major brokers anticipate that 10-year Treasury yields will be lower at the end of 2023 than their current 3.9% rate. As the economy begins to recover later in the year, stocks can be added to the portfolio.

It can be argued that savers should be more concerned about the next 12 years than the next 12 months. This is a difficult task, however, as predicting the future is more challenging than ever.

2022 was a year of drastic change, with prices fluctuating and central bankers taking a hard stance on monetary policy. This was a stark contrast to the period beginning in 2008, or even the 1990s, which saw steady growth and inflation, and extremely low interest rates. Was last year a momentary interruption, or the beginning of a new long-term trend that changes the way investments are made?

When it comes to Wall Street professionals, there is not a lot of consensus. This is evident in an analysis of more than 40 annual outlooks sent by brokers and asset managers to their clients by year-end. For example, when it comes to long-term inflation, the majority of professionals believe it will be difficult to return to prepandemic levels, but only by a slim margin of 56%.

BlackRock, the world's largest investment manager with over $10 trillion in assets under management, has declared that the world is in a new era. They have cautioned that inflation is likely to remain above the central bank's target of 2%, even if it does cool off.

Two major arguments back up this perspective.

The first, which is supported by renowned British economist Charles Goodhart, is that a growing elderly population reduces the size of the workforce, thus increasing the bargaining power of labor. The integration of Chinese workers into the global economy put a stop to this trend, but the one-child policy has now caused a demographic reversal in China.

The second argument is that globalization has a disciplining effect on labor demands and the prices of tradable goods and services. The world is now reverting back to economic and financial blocs, which could be hastened by the war in Ukraine.

If accurate, bonds are not as appealing for long-term investors. Furthermore, they may not be able to provide protection during stock market downturns, leading to the further decline of the popular "60/40 portfolio." Investors should consider inflation-linked bonds and commodities, and select stocks from inexpensive or "value" industries with predictable profits. An example of this would be Verizon Communications, a telecommunications company.

Predictions of a full return to pre-2020 trends are not as common, but there are still those who hold this view. This is likely more than what is suggested by sell-side recommendations. Market indicators of long-term inflation expectations have stayed within reasonable levels.

UBS, a Swiss bank, is suggesting that their clients invest in disinflation and the same stocks that have been successful in the past two decades, such as long-term bonds and the technology giant Netflix. UBS economists have determined that globalization has only decreased inflation by 0.16 percentage points annually and that, based on the current corporate announcements, reshoring of production will only occur on a small scale.

Contrary to popular belief, the data does not support the idea that aging is linked to higher inflation. In fact, many theorists believe that aging should actually lower inflation. A more plausible explanation is that the decreasing unionization rates in Western nations have weakened the bargaining power of workers, which has had a disinflationary effect. In the United States, only 12% of workers are unionized, compared to 21% in 1983. However, this is a complex issue, as pay increases are not always a reliable indicator of inflation. This is especially true in times of high inflation, such as the commodity shock experienced in 2022.

Investors now have the ability to decide their stance on the major philosophical issues that are impacting the markets. It is no longer possible to overlook these debates.