1. The terminal cash rate for this economic cycle will likely be around 4%. That means the Reserve Bank of Australia (RBA) will be largely done raising interest rates by around the middle of next year.
2. Elements of the equity markets will recover from their recent lows. In the US, I'd be looking at large-cap tech stocks like Microsoft Corp (NASDAQ: MSFT), Alphabet Inc (NASDAQ: GOOG) (NASDAQ: GOOGL), and Meta Platforms Inc (NASDAQ: META). Australia is a little trickier, given commodity stocks have been strong, bank stocks relatively stable, and some tech stocks, even after their shellacking this year, still look expensive.
3. Many stocks will never again reach their 2021 all-time highs. Many former market darlings and COVID-19 beneficiaries would have to 10x from here to get back to where they traded at their peak. It just isn't going to happen. I'm looking at you Zip Co Ltd (ASX: ZIP), Sezzle Inc (ASX: SZL), and Redbubble Ltd (ASX: RBL), and they've got plenty of mates.
4. That said, some fallen heroes will stage remarkable recoveries, rising 300% or more from these depressed levels. I own a few that have taken big tumbles for which I hold out hope of recovery, and in more recent times, I've taken bites in a few beaten-down ASX small and microcap stocks that are still growing quickly.
Recovery hopefuls: Pinnacle Investment Management Group Ltd (ASX: PNI), Aussie Broadband Ltd (ASX: ABB)
Newer bites: Field Solutions Holdings Ltd (ASX: FSG), Alloggio Group Ltd (ASX: ALO), Mighty Craft Ltd (ASX: MCL)
5. The economy will slow as interest rate rises start to bite. This will put pressure on corporate earnings, particularly in consumer discretionary retailers like Harvey Norman Holdings Limited (ASX: HVN), Kogan.com Ltd (ASX: KGN), and Temple & Webster Group Ltd (ASX: TPW). Profit warnings will likely outpace profit upgrades.
6. Even though some companies are likely going to experience falling profits in FY23, in some cases this has already been priced into their cheap stock prices. I'm certainly no energy and commodity stock expert, and I'm always very conscious of their cyclicality, but Woodside Energy Group Ltd (ASX: WDS) and BHP Group Ltd (ASX: BHP) trading on 8 to 10% trailing fully franked dividend yields and on trailing single digit multiples have significant future falls in the iron ore and oil price already reflected in their share prices.
7. On a trailing basis, some retailers look dirt cheap. At $2, the Dusk Group Ltd (ASX: DSK) share price trades at seven-times profit and on a fully franked dividend yield of 10%. The specialty retailer of home fragrance products didn't provide FY23 guidance given "ongoing uncertainty surrounding the macro-environment". Dusk is capitalised at $125 million, has $21 million cash, and no debt.
8. If you believe the economy will recover (it always has done so in the past) and corporate profits will be higher three to five years from now (as they have been in the past), and that will translate to a higher stock market in the future (as it has done so in the past), one of the simplest investing strategies and processes is to dollar-cost average into a low-cost exchange-traded fund (ETF).
My favoured option is the Vanguard MSCI Index International Shares ETF (ASX: VGS). Since its inception in 2014, it has returned 11.4% per annum, something that would have turned an initial $10,000 investment into almost $23,000. The ETF holds stakes in large US companies, including Apple, Microsoft, Amazon, Tesla, Johnson & Johnson, and Exxon Mobil.
If you want to throw in a local flavour, consider adding the Vanguard Australian Shares Index ETF (ASX: VAS). You'll get exposure to the big miners, the big banks, and the big supermarkets.
9. Interest rates will start turning lower around the third quarter of next year as the economy slows in response to standard variable mortgage rates of around 7.5 to 8%. Consumer confidence has already taken a big hit, dropping to its lowest level since April 2020 amid higher interest rates and surging inflation.
To the points above, discretionary spend – retail, food and beverage, even travel – is about to take a hit.
10. The forward-looking stock market has already priced much of what's coming into the prices of individual stocks. It knows not how far spending will fall, nor how much some corporate profits will shrink.
Just as the stock market is falling now, despite an economy with near-record-low unemployment, the forward-looking stock market will go higher in the face of a sharply weaker economy. Bad news is good news for the stock market.
In the meantime, volatility is likely to persist. There could even be another bear market from here, where the S&P/ASX 200 Index (ASX: XJO) falls a further 20%.
For stock pickers, use it to your advantage to add to your favourite existing stocks, and to throw a couple of new positions into your portfolio.
For ETF investors, continue making regular (fortnightly or monthly) contributions, come hell or high water. With annualised returns potentially around the 8% level, an investment made today would double in nine years.
It reminds me of the Bill Gates quote…
"Most people overestimate what they can do in one year and underestimate what they can do in ten years."
