Cramer's investment strategy for 2023 is a Fed-driven tale of two halves

Published Thu, Dec 15 20222:04 PM ESTUpdated Thu, Dec 15 20222:12 PM EST

Coming into 2022, we told Club members that with inflation running hot and the Federal Reserve on the warpath to beat it back down, the time for playing so-called story stocks was over. You know the kind we're talking about, shares of companies that don't make money and instead tell grand stories of future profits thanks to supposedly monstrous addressable markets. One year ago, Jim Cramer said investors must focus on companies that make things and do stuff for a profit, which they can then return to shareholders via buybacks and dividends. As time went on and it became clear that we were looking at Fed policy interest rates that would be higher for longer, we added to that view, commenting that the one thing we didn't place enough emphasis on was valuation, being cheap compared to peers and historical levels. So, we added that to our guiding principles for 2022. The Fed's actions shrunk the multiples of stocks that grew sales and earnings but were simply too expensive in a world with positive real interest rates. The more shares we sold of these kinds of stocks the more money we saved. As we close the book on 2022 and turn our attention to 2023, we want to once again update members on our thinking for the year ahead — our world view so to speak — which will determine how we think about our universe of potential investments. We see rates at 5.5% next year For starters, we think the Fed could take rates to 5.5% as the progress policymakers are making in the battle against inflation will come to a halt at some point before hitting the central bank's 2% inflation target should unemployment levels remain low and wage inflation stays up as a result. The Fed on Wednesday stated that officials see the end-point rate when hikes are finished at 5.1%. As we discussed during our December "Monthly meeting" on Thursday, the issue is hope, there is still too much hope out there and not enough concern over affordability. Put another way, consumers are still too willing to accept and pay higher prices. Until that's no longer the case, prices will continue to rise and the Fed will therefore have no choice but to continue to raise rates. Fed needs to tackle wage inflation Commodity inflation aside from copper, and consumer inflation aside from food and new cars already appear to be in the rearview with the latter benefiting from loosening supply chain dynamics. However, unless we get to the point where people are rethinking the cost of their current lifestyles, we are going to hit a floor on inflation somewhere above that 2% rate and the Fed is going to be forced to tighten further. Under this scenario, we're looking at a bifurcated market in which those who don't need credit to survive — or those wealthy enough that they can get cheap credit — do OK. Maybe they even come out of this inflationary period stronger thanks to excess money to invest at these depressed price levels for assets. And those reliant on credit do poorly — or worse should they need to sell beaten-down assets to fund more pressing needs. That goes for consumers as well as companies that depend on debt as the latter will need to pay more for that debt. That, of course, will eat into profit margins. It will force companies to forgo growth initiatives in order to focus on required maintenance investments. 2023 is the year the Fed wins Fortunately, we think this less optimistic view plays out in the first half of 2023 as we believe next year to be the year the Fed wins the day on inflation. It's also why we are holding on to some stocks that won't do well in 5.5% rate world. That's because we need some stocks that can survive the pressure and take off once we start to see inflationary readings come back down to Earth. What we want to see is consecutive inflationary readings trend back toward 2019 levels – not below expectations, but actually plateauing or better yet going down. Jim said he wants to see these trends back-to-back in the consumer price index (CPI), producer price index (PPI) and wage component of the government's employment report. We see that, and we'll be glad we held onto the tech names that have been crushed this year. We will also begin to rethink those names in our portfolio that benefit from higher levels of inflation. Bottom line So, ultimately our base case for 2023 as it stands now is a tale of two halves: the first, a brutal one characterized by a Fed that will say and do anything to get inflation tracking back toward its 2% target – including raising rates until unemployment exceeds 4% in order to stop wage inflation; and the second characterized by improved investor sentiment and a more supportive economic backdrop as the Fed declares victory and signals an end to rate hikes. The first half will be good for those names that benefit from inflation such as consumer staples, health care and energy stocks. As data comes in that signals a rollover in inflation, we will rethink these names in the second half and look for ways to put cash to work in those beaten names that stand to come back with a vengeance. To be clear, our focus remains on companies that make things and do stuff for a profit; have an attractive valuation; and return cash to shareholders via dividends and buybacks. Furthermore, even when the shift happens, the thinking is that the rise in rates will stop but that doesn't mean they are coming right back down right away. While we will look to reallocate funds for the second half of the year to those names that are most pressured by inflationary dynamics, we won't be looking to the story stocks that thrived during the Covid pandemic. The focus will remain on profits, cash flow and reasonable earnings-based valuations as positive real interest rates demand real profits at grounded valuations. (See here for a full list of the stocks in Jim Cramer's Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

Jim Cramer on Squawk on the Street, June 30, 2022.

Virginia Sherwood | CNBC