We’re on the home stretch of a year in which “unprecedented” doesn’t even begin to capture it. Nothing went according to plan, for anyone, from Russia’s invasion of Ukraine to the Fed’s domestic attempts to combat inflation. Along the way, we saw spiking gas prices, tanking equity and bond markets, a continued red-hot labor market, a head-scratcher of a mid-term election, and a broad and deep meltdown of crypto. While stubborn resistance has succeeded beyond all hopes for the Ukrainians, intransigent inflation has resulted in a series of interest rate increases that we will only know the impact of sometime in 2023. Any one event had implications for everything else, and the intertwinement was perhaps exemplified by a year in which equities and bonds had a highly correlated pricing action.
As the new year approaches, market trends seem to be in their later stages and may reverse themselves in 2023. The recent uptrend in stocks and bonds may be reflecting this sentiment as they are forward leading indicators. We have most likely already seen the peak in inflation rate, the current drop may continue and the FED rate increase may end as soon as Q1 2023.
But that does not get us out of the woods, not so fast. Rate increases have a 6-12 month lead time, and most economic indicators, both domestic and global, point out to a recession sometime in 2023.
In short, another volatile year is upon us. There are two main scenarios we may see happen.
(1) A strong first quarter, a recession, and a pull back as a result in Q2 and Q3, again a strong recovery in Q4. We see there is a 75% chance for this to happen, albeit not a deep but rather mild one.
(2) There is a 25% chance to avoid a recession (a soft landing). Without a recession, 2023 has the potential to be a strong year, more prone to seasonal cycles.
Here are the headlines we’re watching:
We expect to see a flat economy for the whole year, a 12-month growth of close to zero. Inflation (Consumer Price Index) should ease down to 3.5% range. Let’s expand on this a bit. Inflation is the result of an imbalance between the money available in an economy that is demanding goods and services, and the amount of goods and services available to be sold. The first part of this equation has been inflated by Covid related government help. The second part of this equation has been deflated by Covid related supply chain issues and the commodity crunch caused by the Russian attack on Ukraine. Both factors will likely normalize in 2023. Add the pressure created by the base effect, a full point drop in CPI each quarter is not inconceivable. (Inflation is calculated in comparison to the prices a year ago. Once you are comparing to already high prices, your rate of increase starts to slow down, known as the base effect). Also, the sharp increase in shelter and auto prices in 2022 will likely reverse in 2023 as they are rate sensitive, which is a trend that has already started to happen (Not surprisingly as this was FED’s goal).
We expect a positive year in stocks, high single digit returns, but with volatility and under significant pressure during the first half as a result of a potentially recessionary pull.
A non-recessionary scenario could mean a good year for stocks in 2023. If a recession occurs, a U-shaped action could be in the cards, with a strong second half. The depth of the recession will also determine the depth of the pull back in stocks. We see a potential for a mild recession, not a deep and long one. US Bonds With the inflation down trend, bond yields will likely go down as well. 2023 may be the year of a bond rally as a result, taking the 10-year treasury down to 3% range. A 2023 shallow to mild recession scenario is a positive as bonds typically do better in these types of periods.
The rate differential caused dollar uptrend will likely reverse next year and global stocks and bonds may become more attractive on a dollar-based return.
It is likely we have seen the peak in mortgage rates. as next year, albeit slowly, we may see 30-year fixed mortgage rates coming down to 4% range as they are strongly tied to 10-year treasury rates.
Rate increases will likely end in Q1 and we may see rate cuts towards the end of the year. This depends on the trajectory of the economy. If the recession scenario plays out, a rate cut would not be surprising, as part of the reason for rate increases is to create that option. If the economy remains resilient and a soft landing occurs, rates can stay higher for longer. According to NDR, the probability of an economic contraction in 2023 is 75%, which is down from 90%.
Most Frequently Asked Question
Will 2023 be the year of a tech rebound? Based on our research by NDR, not so quickly. Typically, when the tech underperforms the SP500 in a year, this rout spreads over to the following year.
Thanks for reading our 2023 outlook, we hope that you found it useful and informative. For questions and comments, please reach out to your advisor. Have a great 2023!