I’m normally a boring “trust the market price, don’t overthink it, don’t try to get clever” kind of person. But in the spirit of entertainment, I’m going to throw out 2023 predictions for stocks, property, inflation, interest rates, and cryptos.
They’re predictions of where markets will be in a year, but as you’ll see, they’re often the market’s own predictions of where markets will be in a year. But still, feel free to throw them back in my face in a year’s time.
I’ll start with inflation because that’s the first step to forecasting the others. Inflation is the wildcard. If inflation is high, interest rates will be high. And everything else, in turn, is priced off interest rates.
On January 4, 2024, the eurozone’s HICP inflation rate will be… 3.0 per cent.
There are four useful indicators of future inflation rates, and they all roughly agree on that number. The indicators are the survey of monetary analysts (a survey of financial industry economists), the survey of professional forecasters (a slightly broader survey of financial industry economists and other forecasters), the market’s forecast of future inflation, and the ECB’s own projections.
The ECB’s projections are different from the others because the ECB is the one driving the bus. The ECB’s forecast tells us not what inflation will be, but what it intends inflation to be. The other forecasters, by contrast, guess whether the ECB will succeed at that.
Interest rate forecasts are easy too. There’s a hard way of forecasting interest rates, where you take the lending rate and then adjust it for current inflation, and then add back in expected future inflation. But there’s no need for any of that because the market already forecasts ECB base rates, month by month, over the coming year. As you can see from the following chart, the market is forecasting ECB base rates to peak at 3.04 per cent this September.
My market forecast only goes out as far as September, so I'm going to have to go out on a limb and predict the path of rates for the rest of the year.
On the one hand, inflation is expected to fall steadily through the year, so the ECB shouldn't really need to raise rates further. On the other hand, the ECB loves a rate hike, so maybe it'll find an excuse. My forecast is base rates of 3.3 per cent on January 4, 2024.
Last year, Kieran McQuinn of the ESRI talked me through his Irish house price model. It's based on housing economists' workhorse model for forecasting house prices.
McQuinn's model has four inputs: demand (the number of likely buyers), supply (the housing stock), affordability (disposable income and interest rates) and credit conditions (how easy it is to borrow). Based on interest rates from October, his model found Irish house prices were seven per cent overvalued. But if you plug in the forecasts for this year's interest rates, you get a further 6.7 per cent drop in fundamental values. That's 13.7 per cent in total.
McQuinn's model is the workhorse model used by housing economists, and its track record of forecasting Irish house prices is pretty good. But a 13.7 per cent drop in one year would be pretty savage. That's 2007-08 territory. I'll hedge my bets and say house prices will fall 5 per cent by January 4, 2024.
The big one for stocks will be whether inflation gets under control. I'm switching here from talking mainly about the eurozone and Ireland to talking mainly about the USA since that's where the action is in equity markets.
Over in the US, the inflation story is similar to the eurozone, but more so. They stimulated the economy harder in 2021 and got a bigger dose of (domestically generated) inflation. So they're having to slam on the brakes. It's embarrassing for Jay Powell and the Fed.
You can see the importance of interest rates on stock prices in the US by looking at the valuations of growth stocks. Growth stocks went on a huge tear in 2020 and 2021. This was the heyday of Cathie Wood's ARK disruptive technology ETFs. These ETFs are stuffed with money-losing companies that expect to make money in future. At their peak in February 2021, ARK ETFs had attracted $60 billion in funding.
By December 2022, ARK's assets had shrunk to just $11 billion, as the market for money-losing stocks collapsed. Money-losing companies are a terrible investment in a time of rising interest rates, because high interest rates increase the opportunity cost of waiting for future profits. The median stock in Cathie Wood's flagship ARKK ETF was down 83 per cent from its 2021 peak, as of mid-December 2022, according to the FT.
All of which is to say, the stock market hates inflation and it hates rising rates. If the Fed can achieve a soft landing — which looks doable based on the most recent data — the US market might be expected to get back to its recent P/E rating of about 23, from its current level of 19.
I hate forecasting market prices, but here I am. An earnings multiple of 23 gives a January 4, 2024 forecast for the S&P of 4,600. That would be a 20 per cent gain for the year. A great year.
Crypto is the hardest one. There is no workhorse model of crypto prices. The most you can say is that they seem to follow whatever trend they're on. And I suppose, over the very long run, the trend has been that they go up.
In November, I published the following chart of bitcoin prices in log form. It seems to imply bitcoin might have one last hurrah left in it.
But that doesn't look like a 2024 story. After its previous peaks, bitcoin didn't do much for a year or two. So my finger in the air forecast is bitcoin at $15,000 next January.
Needless to say none of this constitutes investment advice. Do not bet your pension on an S&P 500 rebound!