A rate shock wrecked stocks in 2022. What pros say will drive the market in 2023

My Comments: Here we are at the beginning of 2023 and I for one am trying to figure out what to do with my modest investment portfolio. I’ve been 40% in cash for much of 2022 and watched much of the rest of it shrink. At some point I want to push the cash back to work.

What follows is not a definitive road map but might give you some meaningful insights going forward.

by William Watts 31 DEC 22 https://tinyurl.com/3yy2d8ta

2022 is over. Take a breath.

Investors were understandably eager to ring the bell on the stock market’s worst year since 2008, with the S&P 500 SPX, -0.25% falling 19.4%, the Dow Jones Industrial Average DJIA, -0.22% dropping 8.8% and the Nasdaq Composite COMP, -0.11% shedding 33.1%.

Adding to the pain, the bond market was also a disaster, with some segments seeing their biggest annual losses in history while U.S. Treasury prices slumped, sending yields soaring.

That offered a rare double whammy for investors, who usually see portfolios cushioned by bonds when equities suffer.

So now what? The flip of the calendar doesn’t make the factors that drove market losses in 2022 go away, but it offers investors an opportunity to think about how the economy and the markets will evolve in the year ahead.

A rate shock as the Federal Reserve ratcheted up interest rates at a historically rapid pace in its effort to rein in inflation set the tone in 2022. A return to higher rates — and what may be the end of a four-decade era of falling interest rates — is expected to reverberate in 2023 and beyond.

While inflation, still elevated, shows signs it has peaked, the market was robbed of a seasonal rally heading into the new year by fears the Fed’s continued efforts will spark a recession that will devastate corporate earnings in 2023.

The interplay between Fed policy, inflation, economic growth and earnings will drive the market in 2023, analysts say. 

The Fed

“This has been a Fed-led market that’s been predicated on inflation that was not transitory,” as monetary policy makers had initially believed, said Quincy Krosby, chief global strategist at LPL Financial, in a phone interview.

The Fed dropped the “transitory rhetoric” and launched an aggressive campaign to tackle inflation. “That’s led to a market that’s concerned about economic growth and whether we enter 2023 facing a significant economic downturn,” Krosby said.

Inflation

Investors, however, might find some optimism in signs inflation has peaked, analysts said.

“The days of sub-2% CPI that we enjoyed from ’08-’20 are likely gone, possibly for a long time. But inflation could fall far enough (3%-4%) for the Fed to essentially think it has accomplished its mission (although it won’t say it directly as the target is still 2%), but for all intents and purposes, we could exit 2023 without a material inflation problem,” said Tom Essaye, president of Sevens Report Research, in a Friday note.

Skeptics doubt that a slowdown in inflation will be sufficient to keep the Fed from following through on its indications it intends to raise the fed-funds rate above 5% and keep it there for some time.

Hedge-fund titan David Tepper in a December interview with CNBC said he was “leaning short” on the stock market “because I think the upside/downside just doesn’t make sense to me when I have so many…central banks telling me what they’re going to do.”

Recession fears

A resilient job market so far has optimists — and Fed officials — arguing that the economy could avoid a so-called hard landing as monetary policy continues to tighten.

Investors, however, “are anticipating an economic recession to materialize early in 2023, as evidenced by the three quarters of projected S&P 500 index earnings declines and continued defensive sector leanings,” said Sam Stovall, chief investment strategist at CFRA, in a Wednesday note. “The severity of the recession remains in question. We expect it to be mild.”

The bear market for the S&P 500 is backdated to Jan. 3, 2022, when it closed at a record high before beginning its slide. It ended with a yearly loss of 19.4%.

“The average bear market since World War II has lasted 14 months and resulted in a decline of 35.7% from the previous high,” wrote analysts at Glenmede in a December note.

“At approximately 12 months and 20%, the current bear market appears to be close to 2/3 of the way through the typical bear-market decline. The current market appears to be following a similar trajectory of an average historical bear market so far,” they wrote. “Based on past trends, on average, bear markets do not bottom until after a recession begins, but before a recession ends.”

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