It has been a successful year for our accounts, and we would like to highlight a statement from our year-end letter in 2022:
“The Nasdaq will finish down over 30% this year. As we wrote in our last letter, we think a fair value for the S&P 500 is 3600. We are trading at 3800 now. That implies our risk from here is 5%, if everything goes according to plan, which, as we all know, never does. Could we go lower? Sure. Will it stay below that level? We don’t think so.”
Contrary to our projection, the S&P 500 did not trade down to 3600 in 2023. The actual low was right around 3800. As we write this letter, the S&P is trading at 4750. This is good news for us, as our accounts had a remarkable year. However, our views for the next year are less bullish than last year. Let’s discuss that.
In our third-quarter report, we highlighted that the U.S. Government will need to borrow around $1.6 trillion to fund our budget deficit in 2024. The Federal Reserve is also on track to shrink its balance sheet by over $1 trillion. The demand for money needs to come from somewhere, and we believe stocks will be one area that helps fund these cash needs. This need for money is likely to put a cap on stock prices in the near term. It’s not an exact science to say that investors, as a group, will sell $2.6 trillion of stocks to buy $2.6 trillion of bonds to fund the government due to various factors such as foreign buyers and sellers of debt, tax fluctuations, potential changes in spending, and the Federal Reserves policies. However, the money must come from somewhere, and in an election year, they aren’t going to raise taxes or cut spending. Where will that money come from? Our best guess is the stock market until the Fed decides to buy bonds again to fund the deficit.
Our view is that the markets are in a trading range until we get our fiscal house in order. We believe the top is around 5000 on the S&P 500, and the bottom is around 3800. We have identified a few areas that we believe won’t perform particularly well in this environment, and we plan to sell those positions and raise some cash in January. If we like a position, we will hold through the ups and downs the S&P gives us. If we think a stock can make 10% a year and bonds are at 4.5%, we will hold the stock and accept the volatility. If we are on the fence with a position or group, we will raise some cash.
Our current concerns are with the banks. We don’t believe the banking crisis has run its course yet. We anticipate more challenges ahead. In January, we will reduce some of our bank stocks that we think are most affected by our government needing to raise money. We will put that money in cash and wait for a better opportunity to buy other stocks. The last time we raised cash like this was in 2015, and we had to wait eight months before the market had a correction. We will see how it plays out this time.
Our biggest gainer for our accounts this year, in dollar terms, was BGC Group. The stock was up over 80%. BGC will benefit from all the bonds the government issues in 2024. The more debt they sell, the more bonds will trade, and the more money BGC will make. Some financial events (selling FMX) are coming that will give this stock a boost in 2024. We hope that news can push the stock to new highs.
Our worst performer in your accounts was Lumen. We believe the stock should be sold to another company, and we await an offer along those lines. We think there are numerous companies that would like to own this company and be willing to pay more than its traded for this year. That said, it hasn’t happened yet. This stock has been one frustrating ride, and we will wait to be taken out or they sell off more divisions to realize value.
We haven’t changed our view that we are in inflationary times. Free trade is being reversed, aging populations worldwide are less productive, and we see the potential for capital controls increasing worldwide. We don’t think these trends are easily reversible regardless of the party in power in Washington. One interesting note on the inflation front is one of the strongest stock markets in the world this year is Mexico’s, which is up 42%. We have been owners of Latin American stocks for five years, which we view as inflation proxies. Mexico is also a big beneficiary of the trade war with China as US companies outsource to either Mexico or the US.
As we said at the beginning, we think the markets will be more challenging this year than last, whichmakes sense. You don’t make 20% or more a year on a consistent basis. We do like the valuations on our oil and inflation stocks and plan to hold them this year as the market digests the gains of 2023. Oil stocks have been hurt as governments across the world released oil into the market from their version of the strategic petroleum reserve. In the US, we sold half our oil in the SPR that is set up in case there is a war. You can’t do that twice. We continue to think there will be pressure to the upside on oil, and that will hurt our inflation stats.
It was a great year, and we had a wonderful Holiday party. We look forward to seeing all of you in 2024.
Sincerely,
Mark Brueggemann IAR Kelly Smith IAR Brandon Robinson IAR