Market review 23.12.31
Hello everyone,
It’s the final day of 2023, and many market participants have been sharing their outlook for next year. I thought I would indulge in how the future could play out.
This post is for a big-picture perspective but also entertainment. As traders, we should listen to what price tells us each week rather than being rigidly tied to long-term forecasts. With that caveat, let’s begin.
US Equities
Exactly ten years ago to this month, an anonymous blogger going by the pseudonym ‘Jesse Livermore’ showed that the single greatest predictor of future 10-year total returns for the S&P 500 (SPX) is how much the average household is currently allocated to stocks:
Jesse is a physicist by profession but is deeply immersed in financial markets as a side obsession. The original blog post from Jesse is worth reading in full (link). It’s lengthy but thoughtfully explains why household equity exposure impacts future returns and is a much better predictor of returns than valuations or economic data.
Household equity allocations may have structurally increased over the decades, impairing the above relationship. For example, many employers transferred the responsibility of retirement investing to their employees by switching from defined-benefit plans to defined-contribution plans. Individuals now hold equities that used to be beneficially owned by their employers.
But even if the grey line on the above chart doesn’t fully catch up with the blue line, we’re still looking at single-digit annual return for the SPX over the next ten years. This is a stark contrast to the outsized returns seen in the 2010s.
The above relationship can be used to calculate the path that SPX might take over the next ten years:
A “lost decade” is consistent with what legendary investors like Howard Marks and Stan Druckenmiller have been saying.
Howard Marks wrote a thought-provoking memo a year ago titled “Sea Change.” He followed up with a second piece, “Further thoughts on sea change,” two months ago.
Howard argues that in the 2010s, we saw phenomenal price appreciation of assets (stocks, bonds, and real estate) thanks mainly to falling interest rates. But he cautions that we won’t have such a significant tailwind in the future. Interest rates can remain elevated, and this will hinder businesses' ability to grow. Thus, investors should focus on yields more than price appreciation for returns.
Stan Druckemiller echoes a similar message. To paraphrase what he said in a presentation from over a year ago:
“There’s a high probability that the market will be flat for ten years, like the 1966-1982 period. That said, some stocks and sectors still did very well over that time – such as coal, oil, and chemical companies.”
This also happened during the 2000s: SPX was flat, but emerging markets and commodities did phenomenally well. More recently, as interest rates climbed rapidly in 2022, SPX and QQQ were down 18% and 33%, respectively. However, various LatAm and Materials ETFs (eg. EWZ, ECH, ARGT, SLX, XME) were up 12-25%!
This leads me beautifully into the next section.
Latin America & Materials
I have dedicated two blog posts to this space in recent months (see here and here).
LatAm equities are one part of the market I feel I can passively hold for years and with a sizeable allocation without closely monitoring Intermarket swings as I do for more sensitive areas (eg. US small-cap growth).
Countries like Mexico, Brazil, and Argentina are now coming out of multi-decade bases. Below is a monthly chart for ILF (Latin America 40 ETF). It finished 2023 with a fresh 10-year breakout:
ILF has outperformed SPY over the past 6-, 12-, and 24-month time frames. And the ILF:SPY ratio continues to carve out a beautiful 4-year base:
Few global regions look this constructive relative to the US. In fact, VEU:SPY recently retested all-time lows while EEM:SPY made lower-lows thanks to the weakness in China.
Add to its technical setup the fact that LatAm valuations are among the lowest in the world, and we can see how this region can produce strong returns while SPX struggles to make single-digit annual returns.
Other segments with good long-term prospects are steel, infrastructure, and energy.
Like ILF, the steel ETF (SLX) also finished the year with a major breakout.
Individual steel names like ZEUS have been stair-stepping higher this decade despite all the wild economic gyrations. Many copper names, such as SCCO, FCX, TECK, and IVN, also look fantastic.
Let’s turn our attention to oil/energy, as it’s been a critical sector in Intermarket Analysis over the past two years.