Stocks crashed as interest rates surged in 2022. Here’s what will drive the market in 2023.

2022 is over. Take a breath.

Investors understandably looked forward to the worst year for the stock market since 2008 with the release of the S&P 500 SPX.
-0.25%
19.4% drop, DJIA Dow Jones Industrial Average,
-0.22%
drop by 8.8% and Nasdaq Composite COMP,
-0.11%
fallout 33.1%.

On top of that, the bond market has also been a disaster, with some segments experiencing the biggest annual losses in history, while US Treasury bond prices plummeted, driving yields up sharply.

This dealt a rare double whammy for investors, who typically see portfolios amortized by bonds when stocks suffer.

So now what? The reversal of the calendar does not eliminate the factors that led to market losses in 2022, but gives investors an opportunity to think about how the economy and markets will develop in the coming year.

An interest rate shock, when the Federal Reserve raised interest rates at a historic pace in an attempt to curb inflation, set the tone in 2022. A return to higher rates—and what could be the end of a four-decade era of falling interest rates. rates – expected to be reflected in 2023 and beyond.

Tell: The end of a 40-year era of falling interest rates is a decisive ‘sea change’ for investors: Howard Marks

While inflation, still high, shows signs of having peaked, the market has lost its seasonal rally ahead of the new year on fears that the Fed’s continued efforts will spark a recession that will devastate corporate earnings in 2023.

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

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

Fed

“This was a Fed-driven market that was based on inflation that was not transient,” as monetary policy makers initially believed, Quincy Crosby, chief global strategist at LPL Financial, said in a telephone interview.

The Fed abandoned the “passing rhetoric” and began an aggressive campaign to combat inflation. “This has left the market worried about economic growth and whether we will enter 2023 facing a significant economic downturn,” Crosby said.

Inflation

Analysts say, however, that investors may find some optimism in signs that inflation has peaked.

“The days of CPI below 2% that we enjoyed from 2008 to 2020 are likely over, perhaps for a long time. But inflation could fall far enough (3%-4%) for the Fed to essentially decide it has accomplished its mission (although it won’t say so directly, as the target is still 2%). could get out of 2023 without a significant inflation problem,” said Tom Essay, president of Sevens Report Research, in a Friday note.

Skeptics doubt that slowing inflation will be enough to deter the Fed from carrying out its instructions to raise the federal funds rate above 5% and keep it at that level for some time.

Hedge fund titan David Tepper, in a December interview with CNBC, said he was “leaning toward shorting” the stock market “because I think the pros/cons just don’t make sense to me when I have so many… central banks.” telling me what they’re going to do.”

See: Fed officials back up strong inflation slowdown message with higher interest rates

Recession Fears

There are still optimists in the resilient labor market – and Fed officials – who say the economy can avoid a so-called hard landing as monetary policy continues to tighten.

Also read: Stock market investors face three recession scenarios in 2023

Investors, however, “anticipate an economic recession that will materialize in early 2023, as evidenced by a three-quarters forecast decline in S&P 500 earnings and a continued defensive bias,” Sam Stovall, CFRA’s chief investment strategist, said in a note on Wednesday. . “The severity of the recession remains in question. We expect it to be soft.”

The bear market for the S&P 500 dates back to January 3, 2022, when it closed at an all-time high before starting to decline. It ended with a yearly loss of 19.4%.

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

“After about 12 months and 20%, the current bear market seems to be close to 2/3 of the way of a typical bear market decline. The current market appears to be following an average historical bear market trajectory so far,” they wrote. “Based on past trends, on average, bear markets bottom only after a recession starts but before it ends.”

Connected: How long will stocks stay in a bear market? It depends on whether a recession hits, says the Wells Fargo Institute.

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