As we wind down 2022 and reflect on a turbulent year in the stock market, we wonder what will come next year.
The 2022 market was undoubtedly filled with more losses than wins, as the macro storyline of inflation and the Fed gripped markets and pushed valuations lower.
So what should you expect next year?
Well, more of the same seems to be the forecast as those and other major macroeconomic storylines seem unlikely to have been resolved by midnight on December 31, though there should be some new considerations as the story unfolds.
Inflation and the Fed
This ever-evolving storyline is here to stay and will likely be the major talking point for a second-year running.
The Fed had been raising rates at a breakneck pace of 75 basis points, up until December when it dropped to a 50 basis point hike.
Before the hike, investors had been all about the initial pivot. Perceiving that the sooner hikes were cooled, the lower the terminal rate would be, and the sooner rates would come back down.
However, like all great stories, the plot thickened with a twist, which came courtesy of Fed Chair Jerome Powell, who separated the pace of rate hikes from the terminal rate and length of tightening.
Powell stated that “the timing of that moderation is far less significant than the questions of how much further we will need to raise rates to control inflation, and the length of time it will be necessary to hold policy at a restrictive level.”
Looking ahead to next year, we will continue monitoring inflation readings for clues on whether we should expect the terminal rate to be higher or lower than current projections which were set at over 5% in the latest December dot plot projections. Further, we will watch subsequent dot plots for renewed projections from 2023 onward to know when to expect a pivot from hikes to reductions.
Nearer-term
Given that spending and the labor market has been resilient so far to the Fed trying to slow the economy, there are a lot of cracks that could yet arise in economic and earnings reports.
According to Dubravko Lakos-Bujas, global head of equity macro research at JPMorgan, the “proverbial snowball should continue to gain momentum next year as consumers and corporates more meaningfully cut discretionary spending and capital investments.”
As of now, the labor market remains red hot and consumer spending remains resilient. However, if cracks start to form there, companies will take a hit and so will their stocks. Expect rocky roads ahead.
Farther-term
While the nearer outlook for 2023 is grimmer, markets are forward-looking. We anticipate future outcomes and price them for that today. Then we reprice when we find out we over or under-reacted.
The Fed is aiming for slow economic growth, so we will price lower as economic data and company earnings reflect further slowdown.
However, all the while, investors will be anticipating a Fed switch to rate reductions after likely holding rates steady for a time. The most recent dot-plot projections have rate drops set to start in 2024 at the latest.
As next year progresses, we will start to get a better idea of how long we are likely to stay at the terminal rate. This will in turn indicate when we will finally see reductions start and begin the conversation of the pace of rate reductions. Investors will be pricing higher as rate reductions get projected nearer.
While the nearer term has conditions that favor defensive stocks that fare well in a down economy, the farther term could see a renaissance in growth stocks as investors try to time the bottom.
