Welcome to my interview with Jim Pearce, chief investment strategist of Personal Finance, Mayhem Trader, and Personal Finance Pro. Jim [pictured] was trained as a stock broker, and he’s been following Wall Street for more than 40 years.

As we face a new year fraught with uncertainties, now’s a good time to tap Jim’s uncanny prescience as a market forecaster. My questions are in bold.

Let’s get down to it. What do you think will be the dominant investment theme in 2023?

A return to normalization will be the dominant theme, which will seem anything but normal after three years of aggressive monetary action by the Federal Reserve in response to the coronavirus pandemic and then rapidly rising inflation as a result.

Shortly after the outbreak of COVID-19 in early 2020, the Fed flooded the credit markets with cash to avoid an economic collapse. That strategy worked extremely well, but the tradeoff was a big spike in inflation commencing during the second half of 2021.

In less than a year, we went from a zero interest rate policy (ZIRP) to the fastest increase ever in the fed funds rate. Consider this: in the summer of 2020, the yield on the 10-year Treasury note fell to nearly 0.5%. By the fall of 2021, it had risen above 4%. That has enormous implications not only for the bond market but for all other financial assets, too.

One of those consequences was a major stock market correction that saw the S&P 500 Index lose 25% of its value before bottoming out in October. Do you think it may fall even further in 2023?

No, I believe the worst is behind us as far as that goes. That does not necessarily mean that a roaring bull market is on the way, but the risk of a stock market crash is considerably less now than it was six months ago.

It’s no accident that the stock market bottomed out and started rallying at precisely the same time inflation started coming down. Despite the big rise in interest rates, consumers kept spending and the jobs market remained surprisingly strong. That’s the key to corporate profitability, since it is difficult to grow bottom-line profits while top-line revenue is shrinking.

One sector that performed quite well in 2022 despite the stock market correction were energy stocks, which as a group were up 65% in late November while all other S&P 500 industry groups were showing a loss. Will energy stocks continue to lead the market in 2023?

I don’t think so. Keep in mind, 2022 was an aberration for two reasons: the war in Ukraine disrupted global energy supply chains thereby pushing gasoline prices to a record high that summer, and demand for energy rebounded much quicker than anyone expected in the wake of the pandemic.

Read This Story: Can The Energy Sector Sustain its Mojo in 2023?

The net result was surging demand for oil and natural gas at the same time one of the world’s largest energy producers, Russia, was prohibited from supplying those products to most of its primary markets due to economic sanctions. A lot of investment capital went into energy stocks since that was about the only sector of the economy that was growing in 2022, but some of that money will flow back into other sectors now that the risk of a crash has subsided.

In addition to oil and natural gas, most other commodity prices rose in 2022 while inflation was surging. In particular, food prices jumped more than 10% due to the soaring cost of wheat, corn, and other basic agricultural products. Do you think that will continue to be a problem in 2023?

Food prices should level off in 2023. The fact of the matter is that the wholesale prices of wheat, corn, and many other agricultural products peaked during the first half of 2022 and are already considerably lower now than they were then. For example, the price of wheat nearly doubled in March, but by August was back to where it was at the start of the year.

However, those lower input costs are not immediately realized at the supermarket. Higher food prices are sticky, so it will take several months for consumers to see lower retail prices at the grocery store. By the middle of 2023, I expect the rate of inflation for food prices to drop in half from its peak above 10% in 2022.

Perhaps one of the most surprising developments during the past year was a massive decline in the price of Bitcoin and most other cryptocurrencies. After peaking above $65,000 in November 2021, Bitcoin fell below $16,000 one year later. Where does Bitcoin go from here?

Prior to the past year, proponents of Bitcoin touted it as a hedge against inflation and an alternative investment class that is not highly correlated to the stock market. However, just the opposite turned out to be the case. While inflation was soaring and the stock market was tanking, Bitcoin lost more than three-quarter of its value.

That begs the question, what purpose does Bitcoin and other cryptocurrencies serve in a diversified portfolio? Quite frankly, I cannot provide a reasonable argument for owning cryptocurrencies as a portfolio diversifier. That said, clearly there is a lot of interest in cryptocurrencies, so that market won’t disappear but at this point Bitcoin appears to be little more than a form of legalized gambling as far as I am concerned.

The FTX fiasco made clear just how vulnerable the cryptocurrency market is to corruption, so my biggest expectation for Bitcoin in 2023 is for government regulators all over the world to tighten up trading and custody requirements for it.

Do you think a crackdown on crypto might have an impact on more traditional alternative asset classes such as precious metals?

Yes, and I think we are already seeing that. At the same time Bitcoin fell 20% in the wake of the FTX scandal in November, the price of gold jumped by about half that amount. The price of silver also rose to a similar degree.

Prior to that, Bitcoin was often referred to by its adherents as “digital gold,” but that may no longer be the case. Unlike Bitcoin and other cryptocurrencies, gold is a tangible asset that has a long history of use as both a commodity and a currency. And now that the inherent security weakness of cryptocurrencies has been exposed, it appears that some investors are reverting to traditional precious metals such as gold and silver as alternatives to stocks and bonds.

Speaking of bonds, you haven’t discussed them much over the past couple of years. Will that change now that rising interest rates have pushed bond yields considerably higher?

While the Fed was pursuing its ZIRP, I could not justify advocating for owning fixed-rate bonds since their prices are inversely proportional to yields. In other words, I knew bond yields would eventually go up, driving down the prices of existing bonds and I didn’t want our readers to be exposed to that risk. But now that bond yields are approaching their historical levels, I believe owning bonds in income accounts makes sense.

That said, buying bonds is not nearly as cheap and easy as buying stocks. Bonds are normally sold in large blocks, in some cases with a minimum investment of $250,000. As a result, the spread between bid and ask prices for “odd lots” can be quite wide. That makes them costly to own and limits the ability to diversify a bond portfolio. For that reason, I still believe that owning bonds via a bond fund is preferable for most self-directed investors.

If you were to make one long-shot prediction for the financial markets in 2023, what would it be?

My long-shot prediction is for small-cap stocks to outperform large-cap stocks. Over the past five years, small-caps stocks have grossly underperformed large-caps. During that span (through November 2022), the small-cap Russell 2000 Index gained just 20% while the S&P 500 Index was up 50%.

That makes sense, given the degree to which very accommodative monetary policy tends to favor big businesses. But now that those days are over, I expect small-cap stocks to enjoy a resurgence of popularity on Wall Street. If I’m right about that, there are some great bargains to be found in that space.

Editor’s Note: My colleague Jim Pearce has created a tool that lets him pinpoint lightning quick profit opportunities. It’s also a tool that won’t be available to anyone else. Not even existing Personal Finance subscribers.

As this proprietary tool finds new money-making trades, Jim will only share them inside his new advisory, Personal Finance PRO. Click here for details.

John Persinos is the editorial director of Investing Daily. Send your questions or comments to: mailbag@investingdaily.com.

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