Seriously, this isn’t where I think we’re going: 3,800 on the S&P 500 at the end of December 2022. Remember, at the end of last year, global economies were mostly open. coming back almost two years after a dislocation pandemic, and earnings appear to be on a corrective trajectory. The end of year 4,766 in 2021 is about 25% higher than where we are today. The Nasdaq Composite is even worse – staggered to the finish line heading into 2022 at 15,645, 50% above current levels. Those numbers are astounding – more like spectacular, in fact. Parts of the market are overvalued, including those high-flying turbochargers that sell for 20x sales with no immediate income. However, much of the public stock market feels reasonably priced, as the Federal Reserve feels confident that inflation is temporary and that a recession can be avoided. In early 2022, some pagans predicted that Russia would invade Ukraine, but most Wall Street strategists predict another year. Sorry. So what comes next? If you listen to the experts, almost all agree on a bad market in 2023. Even using target levels for the optimists in the crowd, such as Deutsche Bank is at 4,500, that 16% gain is still 6% lower than the S&P level on Jan. 4 of this year. The good news for anyone secretly speculating on the price, lurking somewhere in an underground bunker, is that the experts are often wrong. Some notable down years We decided to look at some data for the year after the market went down. The table below shows all the years since 1960 when the S&P 500 fell at least 10%. There are 10 cases except for 2022. Three out of 10 cases are illustrated, the market plummeted after a similar experience the previous year, the average drop was a terrible 16.5%. Two of those years, 2001 and 2002, were the aftermath of the dot-com bubble burst and then September 11th. The other year, 1974, occurred after the 1973 oil embargo and the onslaught of inflation in the US. +8% range for almost a decade. Many analysts have compared this historical period, and it is still a concern. Massive excess demand, fueled by low interest rates, pandemic stimulus financing, and reduced supply due to the effects of Covid, are the main inflationary factors during this time. The cause of the inflation in 1973 was the spike in oil prices and the government’s funding response. It is not surprising that the oil embargo was the driving force for the United States to become the number one oil producer in the world and the number one oil producer in the world. In six of the 10 years after the 10% drop, the S&P 500’s average gain was 17.5%. While it is somewhat comforting that there are twice as many strong markets after tough years as there are weak ones, there isn’t enough data to convince. Next, we look at 20-year data for what happened the next year, for the 20 worst performing stocks in the S&P 500 when the index was flat or down. Of course, since the market has grown tremendously since 2002, there are very few years to research. The table suggests that after a year of sideways to downward, the worst stocks in the index often have years of relative and absolute strength. If we use all years, there is no obvious trend in the underperformance of the worst performing stocks compared to the previous year. Back to the familiar enemies So, where are we? We go back to the enemies that are lurking: interest rates continue to rise and inflation is persistently high through 2023. Many factors make the Fed belligerent – housing prices, rents, and auto prices. used – reduced. The S&P 500 is down 20% on the year, the equally weighted S&P 500 is down about 13%, the multiples are compressed and sentiment is very negative – that’s bullish. On the other hand, there’s a problem with the unchanging labor market: Wages are tough, and we’re still working through the explosive aspects of Covid. Many companies have hired every candidate in their sights for fear of losing valuable people. Working styles and forms have changed dramatically since before the pandemic, making traditional measures of overall productivity less clearly relevant. Wages and the labor market are what Fed Chairman Jerome Powell cares about most, and honestly, I worry about. This leaves a gloomy picture. The overall market, at 16.5x the current consensus in 2023, is at the 30-year average. Valuations for many stocks are at multi-year lows, but investors are now unforgiving and risk-averse. Many companies, stressed by high interest rates, profit pressures and weakening demand, will lay off employees and their stock prices will suffer. Our advice: Maintain fair valuations, visible cash flow returns, and diversify your portfolio. Holding a mix of “defensive” winners that haven’t been priced to perfection, and higher-risk names, including some of 2022’s worst names that have been cornered into value territory, is a strategy we endorse. Lean too far in either direction for risk or the industry spectrum could turn sour. There will come a time in 2023 when the market is likely to go up, before earnings bottom out, before the Fed announces a turn around and before you know it, the bulls will be out of the vault. effective shelter. Karen Firestone is the president, chief executive officer and co-founder of Aureus Asset Management, an investment firm dedicated to providing state-of-the-art asset management services to families, individuals and institutions.