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Stocks were destroyed by interest rate shocks in 2022. Here’s what will drive the market in 2023.




2022 is over. Take a breath.

Investors were understandably eager to ring in the stock market’s worst year since 2008, with the S&P 500 SPX,
-0.25%
down 19.4%, the Dow Jones Industrial Average DJIA,
-0.22%
fall 8.8% and Nasdaq Composite COMP,
-0.1[ads1]1%
reduction 33.1%.

To add to the pain, the bond market was also a disaster, with some segments experiencing their biggest annual losses in history while US Treasuries fell, sending interest rates higher.

It offered a rare double whammy for investors, who typically see portfolios dampened by bonds when stocks suffer.

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

An interest rate shock as the Federal Reserve raised interest rates at a historically rapid pace in its bid to curb inflation set the tone for 2022. A return to higher interest rates – and what could be the end of a four-decade era of falling interest rates – is expected to resonate in 2023 and beyond.

Tell: The end of the 40-year era of falling interest rates is decisive “sea change” for investors: Howard Marks

While inflation, still high, shows signs of peaking, the market was robbed of a seasonal upturn heading into the new year by fears that the Fed’s continued efforts will trigger a recession that will destroy corporate earnings in 2023.

Read: How a Santa Claus rally, or lack thereof, sets the stage for the stock market in the first quarter

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

Fed

“This has been a Fed-led market that has been based on inflation that was not transitory,” as monetary policymakers had initially believed, Quincy Krosby, global chief strategist at LPL Financial, said in a telephone interview.

The Fed dropped the “perishable rhetoric” and launched an aggressive campaign to tackle inflation. “That has led to a market that is concerned about economic growth and whether we’re going into 2023 with a significant economic slowdown,” Krosby said.

Inflation

However, investors may find some optimism in signs that inflation has peaked, analysts said.

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

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

Hedge fund titan David Tepper said in an interview with CNBC in December that 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.”

See: Fed officials are reinforcing the tough message to curb inflation at higher interest rates

Fear of recession

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

Also read: Equity investors face 3 recession scenarios in 2023

However, investors “anticipate an economic recession to materialize in early 2023, as evidenced by the three quarters of projected S&P 500 index earnings and continued bias toward the defensive sector,” CFRA investment strategist Sam Stovall said in a Wednesday note. . “The severity of the recession is still in doubt. We expect it to be mild.”

The bear market for the S&P 500 dates back to January 3, 2022, when it closed at a record high before beginning to slide. It ended with an annual 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 peak,” analysts at Glenmede wrote in a December note.

“At roughly 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 to an average historical bear market so far,” they wrote. “Based on past trends, bear markets, on average, bottom out not until after a recession begins, but before a recession ends.”

Related: How Long Will Stocks Remain in a Bear Market? It depends on whether a recession occurs, says the Wells Fargo Institute



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