How Will 2023 Unfold?

The year 2022 was an unpleasant one for investors. The Dow Jones Industrial Average (30 stocks) and the broader-based S&P 500 (500 stocks spread across major industries) peaked in first few days of the year (Yahoo Finance data).

The Fed’s response to stubbornly high inflation prompted the fastest series of rate hikes since 1980, according to data from the St. Louis Federal Reserve.  This has been the single largest factor in the downturn we saw in the equity and bond markets in 2022.

While we would never discount the severe humanitarian crisis that has unfolded for our friends in Europe, market woes were compounded by Russia’s invasion of its neighbor. The war on Ukraine exacerbated inflation by temporarily sending oil prices much higher and lifting commodities such as wheat. The allied response designed to punish Russia also trickled into financial markets.

The favorable economic fundamentals we were treated to in the 2010s—low interest rates, low inflation, and modest economic growth shifted dramatically last year.  The economy expanded, but the interest rate and inflation environment overwhelmed any tailwinds from economic and profit growth.

Notably, the S&P 500 Index declined by 19.4% in 2022 and the tech-heavy Nasdaq declined 33.1% and the Aggregate Bond Index declined 12.96%, according to Morningstar.  The DOW Jones declined 8.8% and benefited from its more defensive composition relative to the S & P 500.

Inflation is the root of the problem.

A year ago, the Fed belatedly recognized that 2021’s surging inflation wasn’t simply “transitory,” its word of choice at the time.  The annual CPI was running at 7.0% in December 2021; it peaked at 9.1% in June, and moderated to a still-high 7.1% by November, the last available reading according to the U.S. Bureau of Labor Statistics. The recent slowdown in inflation is welcome, but a couple of months of lower readings aren’t exactly a trend, at least in the Fed’s eyes.

How will 2023 Unfold? This is the question all investors are asking!

While the Fed appears set to slow the pace of rate increases in 2023, it has signaled that the eventual peak will last longer, as it attempts to bring the demand for goods, services, and labor into alignment with the supply of goods, services, and labor.

Of course, the Fed’s weapon of choice—higher interest rates—is a blunt instrument. It does not operate with the precision of a surgeon, and pain won’t be and hasn’t been spread evenly.

Despite chatter in some corners that we are in a recession, a 3.7% jobless rate, which is just above this year’s low of 3.5%, coupled with still-robust job growth, is sending a signal that the economy continues to expand.

However, this year is likely to bring new challenges, and attention has slowly been shifting away from inflation to economic performance.

1.  The Conference Board’s Leading Economic Index is far from a household name. But it is a closely watched index designed to foreshadow a recession. It’s not a good timing tool, nor should it be used to forecast the depth of a recession. But it has never failed to peak in front of a recession (data back to 1960).  Through November, it has fallen for nine-straight months, according to the Conference Board.
2. This is the relationship between short and long term interest rates where, normally, short term rates are lower than long term rates. However, the yield curve has been inverted, where short term rates are actually higher than long term rates, for the better part of the last half of 2022.  This has been a closely watched indicator of future recession.
3. Moreover, more than two-thirds of the economists at 23 large financial institutions expect the U.S. will slide into recession this year. (WSJ, January 2, 2023)

Nevertheless, a recession is not a foregone conclusion.

A resilient labor market and a sturdy consumer, with borrowing power and some pandemic cash still in the bank, could support economic growth this year.  Ultimately, we counsel that you must control what you can control. We can’t control the stock market or the economy. Events overseas are out of our control. But we can control the financial plan and our spending patterns.  It’s not set in concrete, and we encourage adjustments as life unfolds.

While we caution against making major changes simply based on market action, a critical question to be answered:  Has your tolerance for risk changed considering this year’s volatility? If so, let’s have a discussion.

The “silver lining” of the headwinds investors faced in 2022, is the increase in income one can achieve from the fixed income markets.  We have been active in taking advantage of higher interest rates.  If you have any questions relative to your personal situation, please call in to get on our calendar.  Ultimately, history has shown without fail, every bear market is followed by a bull market, so investors MUST remain focused and patient as this cycle plays out.

Wishing everyone a Happy and Prosperous New Year!!!

January 2023