Buh-bye, 2022. Let’s bid a not-too-fond farewell to a dismal year for the financial markets. This has been the worst year of the past half century for both stocks and bonds.

The federal holiday of New Year’s Day falls on Monday. The following day in Mind Over Markets, I’ll provide a detailed sector-by-sector update of the stock market’s performance in calendar year 2022. Keep the aspirin handy.

In the interim, you need to rebalance your portfolio for 2023, a new year that suggests better prospects for investors. History shows that the S&P 500 rarely declines two years in a row.

Rebalancing means adjusting the weightings of the different asset classes in your portfolio’s sleeves. Every year investment advisors, analysts and money managers review client portfolios to decide whether to change asset allocations to better reflect risk tolerances and objectives, always with an eye toward improving diversification.

But with the market’s expectation that the Federal Reserve will continue raising rates in 2023, regardless of inflation’s current cooling trend, many of the relationships among stocks, bonds, commodities and even international markets remain in flux.

As 2023 looms ahead, our flagship publication Personal Finance recommends that you maintain a diversified portfolio according to the following allocations (see pie chart). These percentages are intended to be generally applicable; you should tweak them according to your stage of life, investment goals, and risk tolerance.

About 5%-10% of your hedges sleeve should contain gold, the traditional inflation hedge. As of this writing, gold trades at about $1,820 per ounce. The consensus of analysts is that the yellow metal on the international market could reach 2,000/oz or higher in 2023.

Whether its during periods of inflation, deflation or stagflation, investors have long counted on international markets to diversify their portfolios away from market stress in the U.S. to preserve wealth. You should pursue this strategy in 2023.

Investors can be forgiven for being weary of the uneven pace of the global recovery, and the volatile regional markets that have accompanied these economic ups and downs.

The world’s economic leaders seem as if they’re in the business of revising their forecasts downward, and coming up with new reasons why a recovery is always just around the corner. The Russia-Ukraine war and COVID pandemic have thrown forecasting into a cocked hat.

However, many overseas equity markets are undervalued right now, especially in emerging nations, and they’re poised for a rebound. Focus on quality equity names overseas, rather than making wide bets on regions as a whole.

Which S&P 500 sectors are poised to outperform in the coming months? Let’s consult the Wall Street consensus. Overall, there are 10,835 ratings on stocks in the S&P 500. Among these ratings, 55.3% are Buy ratings, 38.8% are Hold ratings, and 5.9% are Sell ratings, according to research firm FactSet. Analysts are most optimistic about the energy (63%), communication services (61%), and information technology (61%) sectors.

Read This Story: Has Inflation Topped Out? (Does The Fed Even Care?)

You’ll notice that the above pie chart devotes a hefty 30% weighting toward bonds. This optimism about bond returns for 2023 is based on several factors: starting yields are the highest in years, in both nominal and real terms; most of the Fed’s tightening cycle is behind us; and inflation is falling.

The bond market currently offers yields that are appealing compared to other income investments. You should emphasize high-quality bonds, such as U.S. Treasuries and other government-backed bonds, and investment-grade corporate bonds. These assets can yield in the range of 4% to 5% without excessively high duration.

Santa goes on vacation…

The hoped-for Santa Claus rally? Didn’t happen. On Friday, the last trading day of the year, the main U.S. stock market indices closed lower as follows:

• DJIA: -0.22%
• S&P 500: -0.25%
• NASDAQ: -0.11%
• Russell 2000: -0.28%

For full-year 2022, the Dow performed the best among the major indices, down 9%. The S&P 500, NASDAQ, and Russell 2000 declined 20%, 34%, and 22%, respectively. Energy was the only S&P 500 sector higher Friday, and the only sector to finish 2022 in the green (+58%).

In the early months of 2023, monetary policy in the U.S. and overseas will continue to dominate the headlines. The balancing act among the Fed and its counterparts remains the same: curb inflation without clobbering economic health. There’s actually a chance that the Fed will fulfill its inflation fighting role without triggering a recession.

Regardless, Fed officials seem to view human hardship as a textbook abstraction. Fed Chair Jerome Powell (who faces no risk of losing his job) would rather err on the side of caution in fighting inflation, to preserve his reputation in history as a credible economic steward. When the next jobs market reports come out in January, we’re likely to see that rising rates are cutting into employment, which is exactly what the Fed wants.

The problem with the Fed’s hard-nosed hawkishess is that inflation is largely the result of the war in Eastern Europe and the global pandemic. Interest rate policy can do little to ameliorate those pain points.

It reminds me of something President Harry Truman once said: “It’s a recession when your neighbor loses his job; it’s a depression when you lose yours.”

That said, we could be approaching the point whereby central bankers around the world start to ease up. The Fed is expected to hike rates by at least another 0.50% (50 basis points) in 2023, but pause in the back half of the year.

Shake off 2022! Position your portfolio for 2023. And raise a glass to a happier New Year.

Stunning predictions for 2023…

Worried about 2023? For guidance in these uncertain times, our analysts have compiled a special report of seven macro predictions for the coming year.

The product of painstaking research, our report steers you toward quality, under-the-radar picks in a range of sectors. To download your free copy, click here.

John Persinos is the editorial director of Investing Daily.

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