Where's The US Stock Market Going In 2023? How Should We Trade That?

Before we decide how we're going to trade we clearly need to grasp what is likely to happen. Only if we know which way prices are going can we hope to be correctly positioned for those price changes. Therefore, if we're interested in the US stock market, we need to understand what influences move the prices in that market.

Within the US markets, we have different indices – S&P 500, Dow Jones Average, Wilshire 5000, and so on. Each of them covers different segments of the overall US stock market. Where it all becomes interesting is that different outside influences will change each of those – and also sectors like FAANG, industrials, FMCG, and so on – differently. So it's possible for us to trade both index levels and also changes in relative prices between the different indices and sectors. It's entirely possible, for example, that the same influences that lower the FAANG stocks raise up the DJIA. Or perhaps only relatively, while both indices either rise or fall.

Price moves in general stock market indices, or sectors within them, can be complicated, which is what makes them interesting of course.

A list of things that affects the prices of US stock markets includes, but is not limited to:

• General macroeconomic factors like economic growth, the foreign exchange rate, unemployment, and so on.
  

• Economy-wide prices like interest rates, inflation, and so on.
  

• Technological change, differences in new tech coming to market will affect different sectors, therefore different indices, in different ways

• Political changes in taxation, legal liability, and so on. Never underestimate the ability of politics to change prices.

• At the level of the whole market individual corporate performance is very muted.

Which way US stock markets will go will depend, of course, upon which way those influences themselves go.

S&P500 over 5 years from Mitrade.com

Macroeconomic factors

Growth in the economy is normally a boost for stocks. Obviously, there's more economic activity to be making money out of. Be careful here though. Stock prices generally fall before a recession and start rising again before it ends. Rising unemployment is equally a value destroyer for stocks. But unemployment can be high and yet stocks will rise again if it just starts to fall. The stock markets are looking ahead to the future after all.

Inflation, interest rates – economy-wide prices

Generally speaking, a rise in interest rates, or inflation downgrades the value of growth stocks relative to value stocks. So, the FAANGs, Tesla, other EV adventures, battery makers and so on – the growth stocks of the current technological revolution – will decline relative to the more generally boring stocks like utilities and supermarkets. This just on the basis that with positive real interest rates and higher inflation more money now is worth more than promises of more further into the future.

Political changes

This is something we don't really have to worry about this year. Yes, there might be a hiccup as the debt limit is raised but other than that the recent elections led to a split Congress. Therefore no one really has the power to change things very much. There aren't going to be any major changes in the law about the economy simply because no one party holds all the power.

Individual companies

Given that we are here interested in the indices, the overall stock market performances, we don't need to worry about specific corporate performances. They get blurred out in the averaging process.

Technological change

This isn't so much of a decider on stock prices in any one year. The technological wave works on a longer cycle than just 12 months. We're just coming down off one now, EV and batteries and rare earths and all that. Nio, Rivian, Tesla and many other EV makers, there're a handful of battery companies, lots of froth in mining for weird metals and so on. Quite what the next wave will be no one is quite sure yet but we'll obviously find out.

The most obvious prediction for any economic number for this year is that it will be very like last year's number. This is just because economies are very large things and it takes time for things to change. Inflation will be between 0 and 10%, GDP will change by a couple of percent, maybe. Interest rates are going to be between 3 and 5%. All of those are – except in the most extraordinary of circumstances – going to be true.

Now, we'd probably like to know whether inflation will be 3% or 3.4%, whether interest rates will be 4 or 4.25% and so on. Predictions after the decimal point in economic numbers shouldn't be taken all that seriously though.

With that in mind we have a few predictions for where the S&P 500 is going to be at the end of the year. UBS thinks it'll be at 3900, and KKR at 4150. CFRA thinks it will rise 2.9%, to be a touch over 3900. But note that those are, well, they're really saying that the S&P 500 will end the year within a few percent of where it starts it. Which is obeying our first rule above about economic numbers but not being much more helpful than that.

S&P500 at 1-minute intervals from Mitrade.com. Note that daily movements are very much larger than the spread.

It was a British politician who said that the real problem was “Events dear boy, events.” Or to go American on it, it's the curveballs thrown by the reality that makes the difference. Things we just can't see coming. This makes sense too, as the efficient markets hypothesis insists. Things that are already known are already in market prices. It's the new facts, the things we don't currently know, which change prices as those new things are incorporated into the prices.

So, what are the new things which might change our views? Clearly, we could have an honest-to-goodness recession. Or inflation could have become embedded and thus need much higher interest rates to kill off – which would induce a recession in itself. Or we could see the Russian/Ukrainian fighting spread and thus leading to another bout of destabilization of global trade. Or China could go into a recession which would grossly affect everyone else given the size of that economy.

Events – they're what change prices because they are the new information that needs to be included into prices.

Assuming that we're still interested in the general stock market level then the obvious – and best – way to trade those general levels is through the indices. There are several of them all offering different levels of exposure to different sectors and influences. Below this very general level, there's also an entire universe of more specific instruments but they are to trade sectors, and industries, rather than that general stock market.

So, other than to note that we can trade semiconductors, or FAANG, utilities, or consumer goods, as sectors we're not going to go into more detail on that here. We are concerned with the general market, not sectors of it.

The oldest such stock market index for the US is the Dow Jones Industrial Average. This is actually very restrictive in what it covers. It's the old industrial giants with very little new economic influence. As such it has its uses but much more to trade against one of the other indices than as something on its own. The change in relative values to the S&P 500 for example, rather than as something for its own sake.

The most liquid stock market contract in the world is the S&P 500. This is the top 500 US-listed companies by market valuation. It includes NYSE and NASDAQ stocks and so is heavily influenced by those new economy stocks in a way that the DJIA is not. The liquidity means that the S&P 500 is also very cheap to trade – the bid/ask spread is small. This makes it the best candidate for trading in and out, we leave less money with the markets the smaller that spread is.

The Wilshire 5000 is actually fewer than 5000 stocks these days as there are fewer than that traded on the major markets. But that's what it tries to be all the same – all stocks listed on the major exchanges. The Wilshire is the best instrument for the US economy specifically, as most of the smaller stocks are not part of the global economy – many of the S&P 500 ones are.

Again, assuming that we wish to be at this high level of generalisation. We have different indices. But what are the best instruments to trade them?

Futures and options

One option is futures and or options upon whichever index directly. The problem here is that the time value of either declines quickly. That value of either a future or option is a combination of the time to exercise and the distance from the current price. Day by day, as we hold a position, that time value declines.

US Stock ETFs

Another is an Exchange Traded Fund (ETF) based upon one of those indices – say the S&P 500. ETFs are generally easy to trade, some have very low spreads. It's also possible to use them to take a long term position. If we wanted to take a view for many months – just an example – then we might well use an ETF rather than a future or option. S&P 500 ETFs are some of the largest ETFs in existence, so popular is this method.

US Stock CFDs

The third way is to use Contracts for Difference, CFDs. These have their risks – it is possible to be blown out of your position. But they also offer much greater gearing (one reason why you can be blown out) and therefore much greater profits on the right position. Gearing means they are best suited to short-term positions rather than those months long as well.

The S&P 500, to take just one example, is covered by a multitude of instruments. We can trade futures or options. But even within that we can look at the S&P 500 or there are the S&P 500 minis (CME: ESOO). Or we can look at exchange-traded funds and there are many, many, of those. With gearing to exaggerate the bull performance, or the bear. Or just the straight index itself.

Even within just straight S&P 500 ETFs, there are differences. The SPDR S&P 500 ETF (NYSEARCA: SPY) is in many senses much like the iShares Core (NYSEARCA: IVV) and the Vanguard (NYSEARCA: VOO). They're holding the whole index, there's no gearing, and they're pretty plain vanilla in fact. But there are still differences. VOO and IVV charge 3 basis points or so, within the fund, and SPY 9.5 basis points. That means that if we're following a buy-and-hold strategy then we'd prefer the two lower costs over the single higher.

However, SPY has a hugely greater volume in it, with its own associated constellation of options and other instruments. That means that the bid/ask spread is lower. So, we should probably prefer that if we're using a short-term trading strategy. We'll leave less on the table for the markets by trading the higher basis points for the lower spread.

Note that this is just an example. There are so many different possible instruments to use to trade the various different stock market indices that a thorough examination of them is a good idea. For different ones will be best suited to different strategies.

If we are to use Contracts for Difference, CFDs, then those sorts of problems rather go away. For we would be trading the CFD on the index, not the instrument. So, here, on the S&P 500 that would be US500 or SPX500. This just underlines the above points about the details of specific instruments.

Clearly, there are millions of ways to trade us stock markets because there are millions of traders each following their own path. But the major divergence is between those who trade specific companies and situations and those who trade the markets as a whole.

Trading the markets as a whole is more about macroeconomics than it is microeconomics. It's about the general conditions in the economy as a whole, not about whether one specific company is about to do better than the competition. Or not, in the case of going short.

It's important to understand that trading the market as a whole is not, in fact, trading the economy. Rather, it's trading the profits to be made from the economy which is a subtly different thing. But given that constraint, yes, trading at this higher level, of the indices, the levels of the markets, can be a profitable strategy.

The trick is just to be on the right side of price movements.

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