“When the facts change, I change my mind - what do you do, sir?”
John Maynard Keynes
As we entered 2022, we said on our CNBC interview on 12/29/21 that the S&P “down 20% is very likely at some point during the year if not more” despite the S&P hitting new all-time record highs. This view combined with flexible thinking allowed us to make money in 2022, while many funds struggled.
When thinking about my top picks for 2023, the first thought that came to mind was how volatile this upcoming year could be. There are many potential variables, both positive (eg. potential peace in Ukraine, China exiting zero Covid, Japan exiting yield curve control) and negative (eg. higher than expected wage inflation, real-estate implosion, tech demand slowdown) that are changing at a rapid pace. The speed and impact of these constant changes on the market brings to mind the investing environment of the Global Financial Crisis and the Tech Bubble.
Whether it is inflation numbers, growth data, or large market moves, each new piece of information requires me to evaluate my current position and adapt. To paraphrase Charles Darwin in the Origin of Species, “It is not the most intellectual or strongest of the species that survives, but the species that is best able to adapt and adjust to the changing environment in which it finds itself.” This focus on flexibility on a DAILY basis has helped us to generate positive returns in 2022 for my Satori hedge fund while others of my species died.
In summary, my two overarching investment themes from 2022 remain for 2023:
The reasoning behind these two investment themes is the persistent issue of inflation staying higher than expected, which is the #1 enemy for the Fed and consequently your investment portfolio. 55% of core PCE inflation (the Fed’s preferred measure) is services excluding housing, which is driven by wages increases (AHE +5.1% y/y). These wage increases are being driven by the 1.7x more job openings (10M+) than unemployed (6M+). While we are hearing a lot of headlines from big tech names laying off employees, it is important to remember that over 75% of jobs in the US are not from public companies. As a result, you will probably need a hard recession to kill 4M "excess" jobs to drive down wage inflation.
What does a recession mean for the stock market?
A bear market performance for the S&P without a recession typically averages just under a 30% loss. The S&P declined 25% from its peak on January 3rd to its closing low on October 12th.
If in 2023, we do not get a recession or it is mild, we may have seen the lows already for this downturn. However, we do think we will get a recession and it is likely to be closer to severe given there are 4M “excess” job opening that will need to be destroyed to get wage gains under control.
A bear market that is accompanied by a recession typically results in an S&P decline of over 40%, indicating that we have not seen the lows for this downturn yet. 3000 is our single point estimate on the S&P in this scenario with 2400 being our downside case.
Our Top 5 Picks for 2023 are:
Given our expectations of the S&P hitting 3000, these are hedged with shorts in:
We expect initial guidance to be horrible for 2023 when companies report poor Q4 results, especially in the technology sector. For example, we think it is likely that high profile stocks like $AAPL will pre-announce negatively in the first week of January. In a similar vein, we expect $TSLA to miss Q4 delivery expectations. How the market and these two stocks react to these events will determine how we position for Q1 results. Do we get another bear- market rally to start the year or do we head back to the lows in October driven by poor Q4 results?
We actually bought $TSLA on the long side for the first time since 2019 in December. We made money on both our short and long position in 2022 though we do not own it currently.
We believe demand will take another step lower between now and the end of 2023 given
There are also negative tail risks from
There are only two drivers that determine the price level of the S&P, earnings and the multiple applied to those earnings. Multiples began to contract early in 2022, with earnings estimates peaking in June and then starting to decline for the first time in two years. Looking at the behaviors of these drivers both historically and presently has been a major factor in our thought process when evaluating how early 2023 will look.
Multiple contraction due to rising interest rates has primarily driven the drop in the S&P up until now. The S&P trailing PE peaked at 32.3x in March of 2022 and it is now 18x.
But, during high inflation environments, the trailing PE for the S&P is much lower than average:
Based on this data, we believe that reductions in S&P earnings estimates and further multiple compression will drive the next market move lower. Earnings estimate reductions started for the first time in two years with the Q2 earnings season results and Q3 guidance. The EPS in 2021 for the S&P was $193. The estimate for CY22 is for EPS to expand to $219, which is down from the prior estimate of $229 before the Q2 earnings season. Similarly, the estimate for CY23 is for EPS to expand to $234 in 2023, which is down from the estimate of $252 at its peak in June before Q2 earnings.
We think the estimate for CY23 will eventually be closer to $200 from its peak of $252 when looking at earnings reductions during prior recessions. In 2022 these estimate cuts led to drops in the stock market and we believe the same will hold for 2023.
Our single point price target for the market bottom on the S&P is 3000 derived from 2023 S&P EPS of $200 with a 15x multiple. At the low end we can see the S&P reach 2400 based on a 12x multiple which is not unreasonable at inflation levels above 5% historically.
However, it is important to note the decline downwards is rarely a straight line, as rapid and significant rallies in the S&P often occur during bear markets. While the S&P went down 49% during the tech bubble and 57% during the Global Financial Crisis, there were five rallies between 18-21%. Each time, people were quick to call the bottom despite the fundamentals still getting worse. To put this in perspective, the compound annual price return for the S&P over the past 70 years is under 8%.
Even during 2022, we saw the S&P rally seven times with an average gain of 9% while it finished down 19% for the year on a price basis.
With so much complexity and volatility in today’s investing environment, how should investors be positioned to start the year?
TOP 5 PICKS FOR 2023
#1) CASH IN 3 MONTH TBILLS
#1) Cash - This remains our favorite investment in 2023 just like it was in 2022. While the singular focus of my fund is to maximize reward while minimizing risk by trading the market daily, not everybody can trade daily. Particularly for those of you who cannot trade this market daily, cash is king. Sitting on cash allows us the flexibility to reinvest if the S&P goes lower in 2023. Rather than guessing whether stock prices have gone down enough, cash allows us to wait for the fundamentals to bottom and make calculated investments that maximize reward while minimizing risk. Moreover, that cash can also be invested in 3-month treasury bills earning about 4.3% per annum to start 2023 versus just 0.03% to start 2022. You are essentially being paid for your patience to wait until the risk to reward is in your favor.
#2) $XLV - No one wants to die and many of us (including myself) have put off going to the doctor since Covid. The healthcare sector typically outperforms during recessions. When the S&P dropped 37% in 2008, the healthcare sector dropped 23% while the riskier S&P biotech subsector dropped 8%. Over calendar 2000 & 2001, the S&P dropped 19% over this 2-year span, while the healthcare sector gained 22% and the biotech sector gained 19%. In 2022, the S&P dropped 19% while the XLV dropped only -4% while the XBI was down a hefty 26%.
On a single stock basis, we are interested in companies focused on obesity, Alzheimer’s, and cancer. However, many of these names have already performed relatively well in 2022. Therefore, we believe the diversity provided by the healthcare ETF $XLV helps minimize this potential downside risk for the average investor. For those comfortable with a higher risk strategy, $XBI is our preferred biotech ETF given its greater than market drop in 2022.
#3) $URA - Commodities should continue to do well as a result of underinvestment in capacity expansion over the past decade. In particular, we like uranium, oil, and copper.
Since the disaster at Fukushima in 2011, nuclear as a source of energy production was significantly curtailed over the next decade. However, with Russia invading Ukraine, the world is looking again to nuclear for clean energy and as a means of gaining further energy independence from Russia. We expect Uranium related names like to perform well and the $URA ETF is a great way to get diversified exposure to the space.
We like $USO for oil as The Strategic Petroleum Reserve is down to the lowest level since 1984. Beyond that, the Biden administration has initially talked about refilling reserves at around $70 although recently this changed to $80. This was a top 5 pick of ours to start 2022 and finished up 29%.
Lastly, we like $FCX to get exposure to “Dr. Copper” as it should benefit from the ramp in EV sales as the world moves to clean energy.
We like commodities in general as China, the world’s largest buyer of most commodities, now exits their zero Covid policy, but we think these spaces should benefit the most and $URA is our top pick.
However, picking the right entry price point for a commodity is essential for successfully investing. Unlike stock prices that can go up infinitely, commodity prices operate more cyclically. High commodity prices destroy demand, which then lowers that commodity’s price, which in turn helps increase demand.
#4) $MUFG - Japanese banks should be significantly more profitable as their treasury yields go higher. On paper, shorting Japanese government bonds (JGBs) over the past two decades made sense as government debt exploded higher. However, the Bank of Japan (BOJ) continued to cut rates to below zero as deflation was their main enemy while at the same time buying JGBs. These two behaviors in tandem were the primary drivers that allowed JGBs to soar higher despite fundamentals suggesting otherwise. As a result, shorting JGBs was commonly referred to as “the widow maker trade.”
As of late December, we think that trend changed. The BOJ finally seemed to acknowledge rising inflation by loosening their yield curve control. At the same time, they raised their inflation forecast to 2.9%, the highest annual rate since 1989. As a result of these changes, we believe rates will eventually rise, especially with the appointment of the next head of the BOJ in April.
With this looming change in mind, we believe that buying Japanese bank stocks presents a potential opportunity for equity investors. For two decades, Japanese banks have had to contend with JGB 10- year yields consistently below 2% and occasionally straying into negative yields. Since listing in Japan on April 2nd of 2001, 8306.JT (Mitsubishi UFJ Financial Group) is down 27% while the Nikkei is up 102% & the S&P is up 235%. However, this December saw JGB 2Y yields turn positive for first time since 2015. Therefore, Japanese Banks should now be finally able to make decent money lending. To position our own fund for this opportunity, we own a basket of names including Mitsubishi UFJ Financial Group ($MUFG) which is the ADR of Japan’s largest bank.
#5) $META - Meta looks to be a solid long as we believe the stock is undervalued relative to what it should be. We think the biggest contributor to Meta’s undervalued stock price is how much money they are spending, which has negatively impacted the company’s valuation, as it trades at an 11x CY22 PE vs the S&P at 18x and the largest internet advertising-based company, $GOOGL, which trades at 17x.
We would also note that META has suffered arguably more than any other company from:
However, Meta’s Instagram Reels product (which competes with TikTok) went from an annual run rate of $1B in revs in their June quarter to $3B in revs in the September quarter of 2022, with user growth and engagement remaining surprisingly solid.
Moreover, the spending that offsets META’s earnings, particularly spending on the Metaverse, is fully within their control to regulate. Their recent actions including cutting spending plans just two weeks after giving guidance indicate that future spending will have more scrutiny going forward.
While we are wary of tech stocks in general, particularly those related to advertising spending (which declined over 20% during the 2008/09 recession), META is worth owning on the long side. The stock is down nearly 70% from its highs and Meta may be one of the few companies that sees its multiple expand while multiples for the market decline in 2023. But both $DIS and $NFLX starting an ad supported streaming tier in Q4 will take away online ad revenue dollars from existing players including $META. As a result, we are hedging our risk by pairing a long position on Meta with short position in online & offline advertising related companies with higher valuations.
My General Investment Strategy & Outlook for 2023
To decide whether my investment advice is suitable for you, I believe it is important that you understand my investment style. My goal is to produce good RISK ADJUSTED returns while minimizing downside risk during periods of severe stock market declines. In keeping with this principle, our net exposure (% of fund invested in long positions minus % of fund invested in short positions) has averaged just ~25% over the lifetime of the fund but produced over 80% of the return of the S&P.
Our end goal is to be greedy long term. It is easy to take on enormous amounts of leverage/risk and speculate on meme stocks, crypto, concept/innovation stocks and other volatile sources to make enormous short-term returns in a bull market. However, the risk of losing multiple years’ worth of returns when the market turns is extremely high. At the Satori Fund, we emphasize disciplined risk adjusted investing to ensure that investors not only are protected, but can even profit in both bull and bear markets.
For example, on a total return basis including dividends:
The math behind our philosophy is simple: if you lose 50%, you must be up 100% to get to even. Therefore, risk management is crucial to ensure long-term success. Having come off a 13-year-old bull market fueled by unprecedented fiscal and monetary stimulus; risk management is going to become ever more important as we move forward.
Our commitment to our principles of risk management and disciplined investing has allowed us to consistently succeed against the Hedge Fund Return Index while many other hedge funds have come and gone. As of now, we have almost doubled its return since our inception over 18 years ago.
When I can, I try to update major changes to my thinking that I can disclose on Twitter under @DanielTNiles with more expansive thoughts on my website danniles.com.
For those of you who want all the information available including fund performance, we can only disclose this if you meet the government criteria for being a “qualified or accredited investor.” Please go to https://invest.thesatorifund.com/register to see if you qualify or use the following button below.
All the best for you and your investments in 2023,
Dan & the Satori Team
Performance Disclosure Notes
Performance data quoted represents past performance and is not indicative of future results. Current performance may be lower or higher than performance data quoted. Performance data shown (a) is calculated net of all fees and expenses, including an incentive fee accrual, (b) assumes the reinvestment of any dividends and distributions and that investors are eligible to participate in the profits and losses from New Issue securities pursuant to FINRA Rules 5130 and 5131 since inception of the Fund, and (c) is not audited, although the financial data upon which it is based is subject to an annual audit. Actual performance for an investor may be materially different as fees and performance may vary depending on factors such as timing of investment and eligibility to participate in New Issues. Performance results may reflect expense subsidies and waivers in effect during periods shown. Absent these waivers, results would have been less favorable for certain periods.
Index performance quoted is shown for illustrative purposes only, does not represent actual Fund performance and is not meant to forecast, imply or guarantee future Fund performance. An index is unmanaged and cannot be invested in directly. Performance data for the indices is gross and does not reflect any deduction for fees, transaction costs or other expenses that an investor would pay if invested in the Fund directly.
Other Important Facts
The Fund is part of a master-feeder structure whereby Satori Fund I L.P. (a Delaware limited partnership) and Satori Fund, Ltd. invest as a “feeder” in Satori Master Fund Ltd. (the “Master Fund”), a Cayman Islands exempted company.
Pursuant to an Advisory Agreement (the “Advisory Agreement”), the General Partner has retained STP Investment Partners, LLC (“STPIP” or the “Investment Manager), an affiliate of the General Partner and SEC filed Exempt Reporting Adviser to serve as investment manager of the Fund. STPIP is a Pennsylvania limited liability corporation. For more information including organizational chart for STPIP please visit https://adviserinfo.sec.gov/firm/summary/306086
This document includes information relating to hedge funds that are exempt from registration under provisions of the Investment Company Act of 1940, as amended and other securities laws, including the Securities Act of 1933. As such, any shares or interests offered by such funds may only be sold through non-public “private placements” to qualified investors who meet certain net worth requirements and standards of investment sophistication.
Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Readers should not assume that any investments in securities, companies, sectors or markets identified and described were or will be profitable. Investing entails risks, including possible loss of principal.
The investment products mentioned in this document may not be eligible for sale in some states or countries, or suitable for all types of investors. Specific securities identified and described do not represent all of the securities purchased, sold or recommended for advisory clients. A list containing all recommendations made by the manager within the last twelve (12) months is available upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities.
THIS DOCUMENT IS FOR INFORMATIONAL PURPOSES ONLY AND IS NOT AN OFFER OR SOLICITATION WITH RESPECT TO THE PURCHASE OR SALE OF ANY SECURITY. THIS DOCUMENT IS INTENDED ONLY FOR THE PERSON TO WHOM IT HAS BEEN DISTRIBUTED, IS STRICTLY CONFIDENTIAL AND MAY NOT BE REPRODUCED OR REDISTRIBUTED IN WHOLE OR IN PART NOR MAY ITS CONTENTS BE DISCLOSED TO ANY OTHER PERSON UNDER ANY CIRCUMSTANCES. THIS DOCUMENT IS NOT INTENDED TO CONSTITUTE LEGAL, TAX, OR ACCOUNTING ADVICE OR INVESTMENT RECOMMENDATIONS. PROSPECTIVE INVESTORS SHOULD CONSULT THEIR OWN ADVISORS ABOUT SUCH MATTERS. ANY INVESTMENT DECISION WITH RESPECT TO AN INVESTMENT IN A HEDGE FUND SHOULD BE MADE BASED UPON THE INFORMATION CONTAINED IN THE CONFIDENTIAL MEMORANDUM OF THAT FUND. THE INFORMATION CONTAINED HEREIN THEREFORE IS NOT INTENDED TO BE COMPLETE OR FINAL AND IS QUALIFIED IN ITS ENTIRETY BY THE OFFERING MEMORANDUM AND GOVERNING DOCUMENT FOR EACH FUND.
Dan Niles is founder and portfolio manager for the Satori Fund, a tech-focused hedge fund.