_{“It says in the brochure,” said Arthur, pulling it out of his pocket and looking at it again, “that I can have a special prayer, individually tailored to me and my special needs.”
– “Oh, all right,” said the old man. “Here’s a prayer for you. Got a pencil?”
– “Yes,” said Arthur.
– “It goes like this. Let’s see now: “Protect me from knowing what I don’t need to know. Protect me from even knowing that there are things to know that I don’t know. Protect me from knowing that I decided not to know about the things that I decided not to know about. Amen.” That’s it. It’s what you pray silently inside yourself anyway, so you may as well have it out in the open.”
– “Hmmm,” said Arthur. “Well, thank you”
– “There’s another prayer that goes with it that’s very Important,” continued the old man, “so you’d better jot this down, too, just in case. You can never be too sure. “Lord, lord, lord. Protect me from the consequences of the above prayer. Amen.” And that’s it. Most of the trouble people get into in life comes from missing out that last part.”}

~ Douglas Adams, The Hitchhikers Guide to the Galaxy

It’s the time of the year when next year investment outlooks are released. If you are a newbie in this business, it is very important to devour as many as possible of those so that you can make as many as possible mistakes early on in your career when it is not only less painful to do so, but also when your ego is more flexible, hopefully, to allow you to learn from those mistakes.

If you are more experienced, you may be able to sift through the myriad of new investment outlooks and find that rare and original gem which may help you make money in the future. Either way, at best reading new year investment outlooks will make you look smart in the short-run when you attend those non-finance-related-but-people-want-to-know-about-investment Xmas drinks. At worst though, they will cloud your judgement as a professional investor and make you lose money in the long run.

This year has been brutal for investors, and it is very tempting to conclude that next year will be much better, which is essentially what most investment outlooks are saying. Note, 2023 is not necessarily projected to be a stellar year but still a year of small double digits returns (so slightly above the average).  It would be interesting to read therefore those people who forecast returns in the two tail distributions, especially the one on the left (another brutal year). I would say there would a be a lot of informational value if an experienced name has such a view for next year.

Looking at some of the major trends this year though, all of them have recently been at least partially unwound. Going from less to more: higher US yields have unwound about 1/4 of their move, weak US equities about 1/3, strong USD about half, strong commodities about 2/3, and last but not least, strong crude has unwound all of its move this year! We have another two weeks of trading until year end and those unwinds may be reversed (i.e., confirming the trends of the year), but that already tells us something about what to expect going forward.

These major trends will not explain everything but a good chunk of everything that is happening in the investment world. Many other trades are just a derivative of those major trends. For example, receiving Emerging Markets (EM) rates is almost a consensus trade for next year but it is heavily dependent on what happens to US rates. Long EM and European stocks are favourites for next year, but these cannot be considered in isolation to what happens in US equities. And people who trade FX for a living do not need a reminder that there are always two sides to the ‘coin’ (and one side is almost always the USD).

Commodities are slightly trickier, though. This year the correlation between individual commodities was higher than normal, but that is not always the case. Basically, the role of the USD in FX, USD rates in Fixed Income and US equities in Equities, is played by the price of oil in Commodities as energy takes such an outsized role in the cost structure of any commodity. But sanctions, tariffs, the weather etc., can also affect the way some commodities trade in markets.

This year commodities were the only asset class as a whole (looking at the five major ones, Rates, Credit, FX, Equities and Commodities) which posted positive returns. And this comes after a decade of pretty poor returns otherwise. Does it mean that is it for commodities?

There are also the odd idiosyncratic trades which offer enormous value to those who can discover them. This year some of those idiosyncratic trades were Brazil (rates, equities, FX), Turkey (both rates and equities), FTSE, India (equities), almost all Latam FX, etc. (obviously there were a lot of idiosyncratic trades in individual equities and credit). Can China provide double digit idiosyncratic equity returns next year, after two absolutely horrible years and almost a decade of flat returns? Can Japanese rates experience the opposite?

Then there are the relative value trades and those ‘technical’ trades (mostly in Fixed Income) which could provide an extra source of gains almost regardless of the direction of the major trends in the market. For example, after more than a decade of rates stuck at zero, a sufficient number of interest rates have gone up to provide now a decent cushion even if rates continue to trend upwards next year.

The table below provides the total return for each of the selected asset classes during the last major interest rate hiking cycle in the late 1970-early 1980s. Rates peaked in this cycle in 1981. It is interesting to note that 1) neither of these asset classes did that bad; 2) interest rates (especially T-Bills) did pretty good considering.

It is even more interesting to observe that USTs did not have that many more negative annual total returns when the yield on the 10yr moved from about 2.5% in 1951 after the Treasury – Federal Reserve Accord to more than 15% in 1981 than in the ensuing bull market thereafter. Moreover, during the bull market there were also significantly more years when the negative total annual return was higher than the worst negative return in the three decades after 1951. The point is that it is quite reasonable and, in fact, mathematically logical, to expect a positive return in 2023 for many fixed income markets.