"Such investor denial seems to characterize today's consensus. Many investors want the Fed to change course or 'pivot' simply because they want low interest rates to again spur speculation supporting the outperformance of investment themes like technology, innovation, disruption, venture capital, cryptocurrencies, SPACs, meme stocks and the like."
The Fed, however, "seems very hesitant to prematurely remove tighter monetary policies," RBA noted.
Stock market volatility always signals a change in leadership, with the landscape better suited to the new economic environment, according to RBA, which said the market this year isn't likely to resume the speculation seen in 2020 and 2021.
"Consensus is still focused on the leadership of the last five to 10 years," the firm said. "However, the global economy is changing and leadership within the financial markets is likely to reflect that changing economy.
"Investors missed the first 5-10 years of the bull market in U.S. equities, and they seem poised to miss the first 5-10 years of new opportunities in non-U.S. markets and real productive assets."
The firm suggested three investing themes for 2023:
1. Play defense for now.
Earnings and interest rates represent the two key inputs to stock valuation, but investors have been focusing more on the Federal Reserve and interest rates than on earnings, according to RBA.
"The U.S., and many other countries, are in the early stages of profits recessions, yet both equity and fixed-income markets have been very slow to anticipate the potential falloff in corporate profits," the firm said.
"An apparent limited fear of a potential profits recession suggests investors should start 2023 playing 'defense,'" the note added. "Defensive sectors tend to outperform during profits downturns, and our portfolios are overweight those sectors," the firm said, pointing to a chart showing areas such as health care, consumer staples and utilities.
2. Diversify geographically.
Investors probably should consider increasing geographic diversification, according to RBA. While consensus favors U.S. equities, profit fundamentals for the U.S. are among the worst for major regions in the global equity markets.
Negative earnings surprises contain significant information because they indicate companies are having trouble managing their businesses, the note said, adding that no company ever guides expectations to a negative surprise.
In 2017, the U.S. had the best profit fundamentals when using negative earnings surprises as a gauge, but today they are the worst, according to RBA.
The U.S. market is dominated by the most speculative sectors — technology, communications services and consumer discretionary — while some non-U.S. exposures are often considerably more defensive, "which might support outperformance as global profits cycles decelerate," the firm noted.
3. Accept that the world is changing.
Long-term investment themes appear to be changing with the world economy, according to the firm.
"Some growth investors rationalize ongoing investments in significantly underperforming sectors or themes by claiming they are long-term investments," RBA said. "However, the long-term structure of the U.S. and global economies appears to be changing, and such changes could foster a different set of long-term investment themes.
"Growth investors should not become mired in the old growth themes and should be on the lookout for new ones. After all, relatively few investors 10 years ago were looking at technology as a primary growth sector."
The energy sector is currently in second place for dividend yield in the U.S. and is first for long-term growth outlook, according to RBA. Energy's long-term projected earnings growth rate is roughly twice the technology sector's, the firm added.
Energy seems to stand out when comparing sectors' dividend yields to long-term earnings growth projections, while former leaders — technology, communications services and consumer discretionary — "don't seem to offer unique growth opportunities," RBA added.
Geopolitics appear increasingly unstable while globalization appears to be contracting, according to the firm. Long-term inflation might replace disinflation in the U.S. if globalization retreats, some critical production is limited to domestic factories and the supply of suppliers decreases, the note said.
"The U.S. has woefully under-invested in real, productive assets for decades," RBA said. "Energy infrastructure, manufacturing capacity, transportation infrastructure, electrical grid capacity and other critical public and private goods need significant re-building and modernization.
"As globalization contracts, investment in such real assets could prove critical to the ongoing stability and health of the U.S. economy," the firm said, adding that backing real productive assets could provide interesting long-term investment opportunities while improving the nation's competitiveness.
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