Even among the cheeriest of market outlooks for 2023, the one predicting that the Dow will hit 38,000 to 40,000 in the next 12 to 18 months is certainly an attention-grabber.

But that’s where Neil Hennessy, the founder of Novato, Calif.-based Hennessy Funds and the company’s chief market strategist, is putting his money, so to speak.

Hennessy was not present at his company’s 15^th annual press luncheon in New York City Wednesday because he was undergoing back surgery, but the firm's chief investment officer, Ryan Kelley, explained that Hennessy’s prediction is based on strong economic fundamentals that have been overshadowed by “noise.”

For instance, consumption is still strong, he said. “Employment has no cracks yet, and that continues to be a good part of the overall economic fundamental outlook,” Kelley said. “And most importantly, there’s cash. There’s cash everywhere. We see $7 trillion in cash on the balance sheets of S&P 500 companies. We see $10 trillion sitting in money market and fixed-income funds. We see $18 trillion with consumers as money in the bank. Two years ago, that earned nothing. Now that cash is productive even if you leave it in the bank.”

Meanwhile, Kelley continued, U.S. equities look very good from a risk/reward standpoint, as companies continue to increase dividends and buy back stock. Earnings growth is still positive, though it has slowed, and at less than 17 times earnings, the Dow and the S&P seem to be more reasonably priced than they were over the last few years.

“So Neil’s call of 12 to 18 months, 38,000 to 40,000, which is about a 12% to 16% increase from where we are right now” is totally doable, Kelley said.

The big question is: How does the market get there? 

Certainly, Kelley said, geopolitical issues, supply-chain issues and a potential railroad strike all are possible inflationary events. “We think that’s going to continue to worry the markets, continue to drive the markets throughout next year,” he said.

But there have been some real bright spots. For instance, the energy sector has risen 69% this year, even though tech is down 25%, Kelley said.

“In 2022, we’ve seen a large disparity of returns. There are some sectors that are completely outperforming and then there are others that are completely underperforming,” he said. “If you look at the three major indices, the Dow is down only 5% for the year, Nasdaq is down almost 30% for the year, and the S&P is about halfway between, down 16%.”

That performance, he said, gives investors a clue about where success will be found next year. No longer are Microsoft, Tesla, Facebook, Amazon, Apple, Nvidia and Google the backbone of performance. The leaderboard is changing, and investors need to change with it.

If 2020 was all about large-cap tech and working-from-home stocks, 2021 was all about financials and energy, and 2022 has been all about energy, with its positive returns, and the defensive stocks (like consumer staples and utilities), he said. “While just about flat for the year, [defensive stocks are] doing much better than the rest of the market,” he said.

Value investing is continuing to have its moment, and Kelley said he believed that would remain the case for much of 2023.

“It’s important to stay invested, important to stay diversified,” he said. “But given what we think about the market right now and the volatility that we see out there, we think sticking with value is still a good place to be.”

As far as sectors that Hennessy Funds likes in the near future, Kelley said they include financial stocks (which are attractively priced at about half of the overall market), utilities (which are a slow and steady play) and energy.

Hennessy Funds, which runs 16 funds with $3.2 billion in assets under management, has had a particularly good year, Kelley said.

“The reason that’s important is we do often lag on the upside. We’re not going to be among some of the high-flying names, and we’re not going to participate fully sometimes on the upside,” he said. “But we’ve always told our investors that it’s important to protect on the downside. And that’s what we’ve done this year.”

Out of the 14 domestic funds in the Hennessy stable, 11 are outperforming the S&P 500, seven have positive total returns, nine are beating their own primary benchmarks, and eight are in the top quartile rankings of their category at Morningstar, Kelley said.

“It’s nice to see the numbers and know that at least what we’ve been saying all these years is actually coming true.”