We believe the Fed is determined to cause a recession to control the demand side of inflationary pressures. By its own admission, the central bank can do nothing to solve the supply-side of the inflationary problem today. Allowing inflation to stay at persistently higher levels for longer remains the path of least resistance to deleverage the extreme debt-to-GDP overhang. In our view this macro scenario will likely create opportunities for investors to reposition portfolios in order to profit in this environment; we’ve outlined our key investment themes for 2023 here.
Value Over Growth
The current macro climate most closely resembles the ones that preceded both the 1973-74 stagflationary recession and the early 2000’s tech bust. Using these two periods as historical gauges, investors who bought traditional central bank reserve metals and sold short the most popular US equity benchmarks would have gained over 100% during the following two year period.
At the peak of the 2000 technology bubble, the top 10 US technology companies by market cap were valued at 30% of nominal GDP. By 2002, they bottomed at 6%. At the beginning of 2022, the largest 10 tech stocks reached 56% of nominal GDP. While these stocks have come down since then, collectively they are still valued higher than the comparable companies at the 2000 tech bubble top and likely have more downside risk left.
Historically, growth stocks underperform the markets when market sentiment turns bearish as investors focus on companies with stronger fundamentals, predictable cash flows, and robust balance sheets. Typically, the performance of stocks is tied to relative earnings growth. So, in a period of economic expansion, growth stocks are well poised to accelerate their bottom line due to multiple factors, including higher consumer spending and lower bond yields. But as the economy contracts, the market rewards companies that enjoy significant pricing power and stable cash flows.
Also, most value stocks pay investors a dividend, and the reinvestment of these payouts has been a major driver of the historical outperformance for value investors over the long term. Value stocks are ones considered undervalued according to measures such as price-to-earnings and price-to-sales multiples, while growth stocks are those expected to grow earnings and sales at a faster rate than the market average. Further, when interest rates stabilize again, this will further support value stocks.
Stock valuations today are still higher than that of the peak of the 2000 tech bubble amongst the popular mega-cap tech stocks. The 2022 year started with the highest fundamental valuations for US stocks in history and with the Fed in tightening mode now, there is still more downside risk for the most overvalued mega-cap tech stocks.
Traditional Reserve Metals
Global gold production has been falling since 2019 and is likely in the early stages of a new secular downtrend. Meanwhile, a collection of macro indicators continues to build up supporting a rising long-term demand environment for the metal. After decades of being massively under-allocated among large pension funds, hedge funds, and even central banks, gold is likely to emerge again as an alternative haven asset that protects against turmoil, but most importantly, against the political constraints that policy makers are facing, forcing inflation to run hotter for longer. We are at the onset of an inflationary decade and gold is likely to play a key role in portfolio positioning.
Since the end of the Bretton Woods system in 1971, there have been two major gold bull markets, a raging one in the 1970s and another substantial one in the early 2000s. Among the multiple idiosyncrasies causing the metal price to rise in each of them, one key macro driver precipitated the move higher in both, a multi-year decline in gold production worldwide. These contractions had a significant impact on fueling the strength and length of prior gold cycles. Today, we see the same macro development unfolding. At the same time, the scarce metal is starting to supplant US Treasuries as the preferred allocation among global central banks looking to improve the quality of their international reserves.
Metals of all varieties are critical to inflation protection, economic growth, and energy transition in the real world today. These are the factors that matter in the current macro environment. The companies that control the best new metals’ deposits offer deep value, strong growth, and appreciation. For investors to do well, they need to differentiate the best mining companies with the most prospective new discoveries.
Miners that have traditionally focused on precious metals have been redirecting their capital to battery metals and other mineral resources that comply with the green and ESG agenda. Many traditionally gold-focused miners have significantly shrunk their production while increasing investment in other metals. But even the major miners that remain steadfast in their commitment to gold have not significantly increased output. Newmont, for example, the largest global gold miner, is merely producing the same amount of gold it did 16 years ago while its reserves are down 24% from their peak in 2011. We expect gold will increase in 2023 and the price of gold may reach above $2,000 per ounce in 2023. Furthermore, the current fundamentals for precious metals mining companies provide them with pricing power and should outperform in 2023.
Although gold continues to significantly outperform other defensive assets, there are signs of bearish sentiment towards it, which tends to be bullish signals for precious metals investors over the short and medium term. Just recently, the Wall Street Journal had the following print on the front page of its business section stating: “Gold Loses Status as Haven”.
After breaking out to new highs, gold has been hovering around its 2011 high levels and looks to be ready for further appreciation as the Fed will sooner be forced to back away from its extreme hawkish stance. Inevitably, policy makers will be forced to reinstate financially repressive conditions allowing inflation to run hot for the sake of nominal GDP growth while suppressing interest rates. Monetary tightening works with a lag.
After a few strong years of performance preceding the 2020 recession and the inflationary wave seen since, silver has been consolidating before a larger move to re-test its prior highs at $50/oz. We look to accumulate assets with silver exposure and have a positive outlook as this metal is one of the few natural resources that remain incredibly constrained supply-wise while being a monetary asset that is historically undervalued and an important hedge against long-term inflationary pressures.
The overwhelming social pressure to adopt the green revolution, renewable energy technologies, and electrification has forced the gold mining industry to shift its capital and attention to so-called “critical” metals. Consequently, there has been a declining interest from major mining companies in deploying capital to gold-focused projects. This repositioning serves as a major tailwind for precious metals prices.
Mining & Commodities Cycle
As a significant part of what has been driving the initial phases of today’s inflationary era, we are likely at the early period of a major de-globalization trend. This is the opposite of the mid-1940s analog when World War II ended, marking the beginning of an increasingly globalized trade environment. The geopolitical climate between the authoritarian, centrally-planned, Eastern Bloc countries (China and Russia) and the advanced-economy Western democratic countries (the G7) has deteriorated rapidly. This will mean continued trade disintegration with authoritarian states. To accomplish this shift, it will require substantial new infrastructure spending in the years ahead that will strategically help Western countries to reduce their economic reliance on China and Russia and other autocratic states. This manufacturing revamp in the world’s largest, most advanced democratic economies will create strong secular demand for commodities.
Recall China’s infrastructure spending spree which drove up natural resource industries in the 2000s; but this time it may be on an even larger scale because it will be driven by the G7 countries and its allies. Note that manufacturing used to make up almost 30% of the US economy in the 1950s, but today makes up only 10% of the economy. We believe going forward manufacturing will go higher and should be one of the main investment cases for the long-term commodities bull market.
We look to take advantage of the low valuations and unsustainable compression in sectors such as energy and mining stocks sector which invest in large gold, silver, and copper deposits and exploration targets. While we have seen general fundamental improvements across the industry, many profitable mining companies are now trading at their lowest ever P/E ratios, currently matching those of the 2008 bottom.
Energy & Materials
Global economic growth remains tied to the availability of more energy, while the world’s consumption of primary sources of energy continues to grow which is primarily demand for fossil fuels. The developed world and Asia are short of fossil fuels such as oil and gas where countries compete with each other to ensure sufficient supply, while the green energy transition is moving very slowly. Long-term inflationary forces are driven by historic structural supply shortages for critical commodities in the energy and materials sectors ahead of a desired global energy transition as well as impending wage-price spirals reminiscent of the 1970s.
The Fed’s plan to halt inflation by raising interest rates and causing a recession is fundamentally bullish for commodities over the intermediate and long term. Demand for food, energy, and shelter is highly inelastic, so recessions do nothing to solve the fundamental supply problem. This is the same phenomenon that we saw play out in the 1970s. The secular downtrend of capital investment in oil and gas, as well as a variety of necessary metals, has already supports a future of rising long-term inflation. Fed tightening does nothing to stop the energy and materials structural supply problems to meet inelastic demand for food and energy, so there are deep-value and high-growth investing opportunities over the short and medium-term.
Bonds Becoming Attractive
After a terrible year for bonds in 2022, bonds are now relatively fairly priced and offer opportunities in 2023 to provide attractive yields at lower risk than we’ve seen for several years. Investors who are wary about the economy will likely gravitate toward Treasuries, which would push yields lower and prices higher, meaning it’s possible to enjoy relatively high coupon payments now and potentially sell at a premium later.
Summary
We’re now in an environment where fairly priced value stocks and tangible assets should well outperform those overvalued technology and growth stocks. We believe an active investing and macro-oriented approach will provide far superior returns going forward and outperform the index investing and buy and hold approach which worked well in the previous cycle.
Key Investment Themes:
Recession is likely to arrive in 2023. In order to prepare for the looming economic and corporate earnings recession, investors need to carefully evaluate and reposition their investment portfolios to protect and position their portfolios to take advantage of opportunities.
Inflation to stay at persistently higher levels for longer.
Value stocks to outperform growth stocks. Stock valuations today are still higher than that of the peak of the 2000 tech bubble amongst the popular mega-cap tech stocks. The 2022 year started with the highest fundamental valuations for US stocks in history and with the Fed in tightening mode now, there is still more downside risk for the most overvalued mega-cap tech stocks.
We’re at the beginning of a de-globalization trend leading to higher prices of commodities, gold, silver, mining, energy and materials stocks. The global manufacturing revamp amongst advanced democratic economies should create strong secular demand for commodities.
Prices of traditional reserve metals such as gold and silver gold are likely to rise in 2023.
Bonds are now relatively fairly priced and should offer opportunities in 2023 to provide attractive yields at lower risk than we’ve seen for several years.
Still have questions about your investment portfolio or retirement strategy? We’ve helped many investors plan for their future. Contact Paraiba Wealth Management at contact@paraibawealth.com or call (415) 742-8223 for a complimentary consultation.
Investment advisory and financial planning services are offered through Paraiba Wealth Management LLC, a Registered Investment Adviser. Intended for educational purposes only. Opinions expressed are not intended as individualized investment advice or a guarantee that you will achieve a desired result. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.
We believe the Fed is determined to cause a recession to control the demand side of inflationary pressures. By its own admission, the central bank can do nothing to solve the supply-side of the inflationary problem today. Allowing inflation to stay at persistently higher levels for longer remains the path of least resistance to deleverage the extreme debt-to-GDP overhang. In our view this macro scenario will likely create opportunities for investors to reposition portfolios in order to profit in this environment; we’ve outlined our key investment themes for 2023 here.
Value Over Growth
The current macro climate most closely resembles the ones that preceded both the 1973-74 stagflationary recession and the early 2000’s tech bust. Using these two periods as historical gauges, investors who bought traditional central bank reserve metals and sold short the most popular US equity benchmarks would have gained over 100% during the following two year period.
At the peak of the 2000 technology bubble, the top 10 US technology companies by market cap were valued at 30% of nominal GDP. By 2002, they bottomed at 6%. At the beginning of 2022, the largest 10 tech stocks reached 56% of nominal GDP. While these stocks have come down since then, collectively they are still valued higher than the comparable companies at the 2000 tech bubble top and likely have more downside risk left.
Historically, growth stocks underperform the markets when market sentiment turns bearish as investors focus on companies with stronger fundamentals, predictable cash flows, and robust balance sheets. Typically, the performance of stocks is tied to relative earnings growth. So, in a period of economic expansion, growth stocks are well poised to accelerate their bottom line due to multiple factors, including higher consumer spending and lower bond yields. But as the economy contracts, the market rewards companies that enjoy significant pricing power and stable cash flows.
Also, most value stocks pay investors a dividend, and the reinvestment of these payouts has been a major driver of the historical outperformance for value investors over the long term. Value stocks are ones considered undervalued according to measures such as price-to-earnings and price-to-sales multiples, while growth stocks are those expected to grow earnings and sales at a faster rate than the market average. Further, when interest rates stabilize again, this will further support value stocks.
Stock valuations today are still higher than that of the peak of the 2000 tech bubble amongst the popular mega-cap tech stocks. The 2022 year started with the highest fundamental valuations for US stocks in history and with the Fed in tightening mode now, there is still more downside risk for the most overvalued mega-cap tech stocks.
Traditional Reserve Metals
Global gold production has been falling since 2019 and is likely in the early stages of a new secular downtrend. Meanwhile, a collection of macro indicators continues to build up supporting a rising long-term demand environment for the metal. After decades of being massively under-allocated among large pension funds, hedge funds, and even central banks, gold is likely to emerge again as an alternative haven asset that protects against turmoil, but most importantly, against the political constraints that policy makers are facing, forcing inflation to run hotter for longer. We are at the onset of an inflationary decade and gold is likely to play a key role in portfolio positioning.
Since the end of the Bretton Woods system in 1971, there have been two major gold bull markets, a raging one in the 1970s and another substantial one in the early 2000s. Among the multiple idiosyncrasies causing the metal price to rise in each of them, one key macro driver precipitated the move higher in both, a multi-year decline in gold production worldwide. These contractions had a significant impact on fueling the strength and length of prior gold cycles. Today, we see the same macro development unfolding. At the same time, the scarce metal is starting to supplant US Treasuries as the preferred allocation among global central banks looking to improve the quality of their international reserves.
Metals of all varieties are critical to inflation protection, economic growth, and energy transition in the real world today. These are the factors that matter in the current macro environment. The companies that control the best new metals’ deposits offer deep value, strong growth, and appreciation. For investors to do well, they need to differentiate the best mining companies with the most prospective new discoveries.
Miners that have traditionally focused on precious metals have been redirecting their capital to battery metals and other mineral resources that comply with the green and ESG agenda. Many traditionally gold-focused miners have significantly shrunk their production while increasing investment in other metals. But even the major miners that remain steadfast in their commitment to gold have not significantly increased output. Newmont, for example, the largest global gold miner, is merely producing the same amount of gold it did 16 years ago while its reserves are down 24% from their peak in 2011. We expect gold will increase in 2023 and the price of gold may reach above $2,000 per ounce in 2023. Furthermore, the current fundamentals for precious metals mining companies provide them with pricing power and should outperform in 2023.
Although gold continues to significantly outperform other defensive assets, there are signs of bearish sentiment towards it, which tends to be bullish signals for precious metals investors over the short and medium term. Just recently, the Wall Street Journal had the following print on the front page of its business section stating: “Gold Loses Status as Haven”.
After breaking out to new highs, gold has been hovering around its 2011 high levels and looks to be ready for further appreciation as the Fed will sooner be forced to back away from its extreme hawkish stance. Inevitably, policy makers will be forced to reinstate financially repressive conditions allowing inflation to run hot for the sake of nominal GDP growth while suppressing interest rates. Monetary tightening works with a lag.
After a few strong years of performance preceding the 2020 recession and the inflationary wave seen since, silver has been consolidating before a larger move to re-test its prior highs at $50/oz. We look to accumulate assets with silver exposure and have a positive outlook as this metal is one of the few natural resources that remain incredibly constrained supply-wise while being a monetary asset that is historically undervalued and an important hedge against long-term inflationary pressures.
The overwhelming social pressure to adopt the green revolution, renewable energy technologies, and electrification has forced the gold mining industry to shift its capital and attention to so-called “critical” metals. Consequently, there has been a declining interest from major mining companies in deploying capital to gold-focused projects. This repositioning serves as a major tailwind for precious metals prices.
Mining & Commodities Cycle
As a significant part of what has been driving the initial phases of today’s inflationary era, we are likely at the early period of a major de-globalization trend. This is the opposite of the mid-1940s analog when World War II ended, marking the beginning of an increasingly globalized trade environment. The geopolitical climate between the authoritarian, centrally-planned, Eastern Bloc countries (China and Russia) and the advanced-economy Western democratic countries (the G7) has deteriorated rapidly. This will mean continued trade disintegration with authoritarian states. To accomplish this shift, it will require substantial new infrastructure spending in the years ahead that will strategically help Western countries to reduce their economic reliance on China and Russia and other autocratic states. This manufacturing revamp in the world’s largest, most advanced democratic economies will create strong secular demand for commodities.
Recall China’s infrastructure spending spree which drove up natural resource industries in the 2000s; but this time it may be on an even larger scale because it will be driven by the G7 countries and its allies. Note that manufacturing used to make up almost 30% of the US economy in the 1950s, but today makes up only 10% of the economy. We believe going forward manufacturing will go higher and should be one of the main investment cases for the long-term commodities bull market.
We look to take advantage of the low valuations and unsustainable compression in sectors such as energy and mining stocks sector which invest in large gold, silver, and copper deposits and exploration targets. While we have seen general fundamental improvements across the industry, many profitable mining companies are now trading at their lowest ever P/E ratios, currently matching those of the 2008 bottom.
Energy & Materials
Global economic growth remains tied to the availability of more energy, while the world’s consumption of primary sources of energy continues to grow which is primarily demand for fossil fuels. The developed world and Asia are short of fossil fuels such as oil and gas where countries compete with each other to ensure sufficient supply, while the green energy transition is moving very slowly. Long-term inflationary forces are driven by historic structural supply shortages for critical commodities in the energy and materials sectors ahead of a desired global energy transition as well as impending wage-price spirals reminiscent of the 1970s.
The Fed’s plan to halt inflation by raising interest rates and causing a recession is fundamentally bullish for commodities over the intermediate and long term. Demand for food, energy, and shelter is highly inelastic, so recessions do nothing to solve the fundamental supply problem. This is the same phenomenon that we saw play out in the 1970s. The secular downtrend of capital investment in oil and gas, as well as a variety of necessary metals, has already supports a future of rising long-term inflation. Fed tightening does nothing to stop the energy and materials structural supply problems to meet inelastic demand for food and energy, so there are deep-value and high-growth investing opportunities over the short and medium-term.
Bonds Becoming Attractive
After a terrible year for bonds in 2022, bonds are now relatively fairly priced and offer opportunities in 2023 to provide attractive yields at lower risk than we’ve seen for several years. Investors who are wary about the economy will likely gravitate toward Treasuries, which would push yields lower and prices higher, meaning it’s possible to enjoy relatively high coupon payments now and potentially sell at a premium later.
Summary
We’re now in an environment where fairly priced value stocks and tangible assets should well outperform those overvalued technology and growth stocks. We believe an active investing and macro-oriented approach will provide far superior returns going forward and outperform the index investing and buy and hold approach which worked well in the previous cycle.
Key Investment Themes:
Still have questions about your investment portfolio or retirement strategy? We’ve helped many investors plan for their future. Contact Paraiba Wealth Management at contact@paraibawealth.com or call (415) 742-8223 for a complimentary consultation.
Investment advisory and financial planning services are offered through Paraiba Wealth Management LLC, a Registered Investment Adviser. Intended for educational purposes only. Opinions expressed are not intended as individualized investment advice or a guarantee that you will achieve a desired result. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.
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