The Fed’s monetary tightening in an effort to curb soaring inflation and the resultant recession risk have not been friendly to the stock market in 2022. The US500 has undergone its worst year in more than a decade, with the first double-digit percentage annual loss (-38.4%) since the Great Recession in 2008.
According to the Conference Board, the US real GDP growth for the coming 2023 is predicted to be 0% (vs 1.5% in 2022). This is seen as a pessimistic outlook as the figure is much lower than the predicted figure for the World (2.1%), the Mature Economies (0.4%), and Emerging Markets and Developing Economies (3.5%). Despite disposable personal income being expected to remain flat in the near future, consumer spending is projected to grow at a slow but steady pace, above $14K billion. Total fixed investments are expected to remain flat as well, at average +0.8%. On the other hand, a split US government may complicate the pathway for Democrats to push through several large fiscal packages. While this may help in lowering the debt ceiling, it could also mean the government’s ability to provide economic relief will be hobbled should there be an economic downturn. In terms of trades, OECD projected US trade deficits (in both goods and services) to gradually deepen, from -$937.1B to -$1T. It is also important to note the dwindling communication opportunities between the two major economies US and China, despite the recent Biden-Xi meeting which involved discussion about avoiding potential conflicts between the two countries. In addition, ongoing conflicts between the West and Russia may also extend beyond 2023, leading to many complications especially in the global economies.
A recent study has showed that there was 9.5% in excess inflation, which was mainly contributed by the autos (2.5%), other core goods affected by issues similar to those faced by vehicles (1.0%) and energy prices (2.1%). However, based on the OECD prediction tool, the US CPI is expected to hit 5.6% (y/y) in Q1 2023, then continue down to 3.8% (y/y) in Q2 2023, and finally remain unchanged at 3.1% (y/y) in the latter half of the year. The projection for gradual cooling of inflation is based on an assumption that various price spikes shall unwind gradually as supply constraints are resolved (the NY Fed’s Global Supply Chain Pressure Index has dropped to around 1.00, compared to the peak seen in Dec 2021 at 4.30), normalization of consumer spending mix, better adjustment to disruption of affected industries from the Russia-Ukraine conflict, expectation for lower oil prices, and falling housing prices following a sharp deterioration in housing affordability, coupled with the effect of the Fed’s monetary tightening.
Based on econometric models by Trading Economics, Non Farm Payrolls are projected to be on average around 170K in 2023. This may imply that the overheating of the US labor market might be continuously and gradually reversed throughout 2023, followed by below-average wages growth which is projected to be around 4% next year (the average figure for wages growth from 1960-2022 was 6.20%). The OECD projected the US unemployment rate to rise slightly throughout 2023, with Q1 at 3.87%, Q2 at 4.11%, Q3 at 4.32% and Q4 at 4.49%. CME Fedwatch indicates the Fed is likely to continue its rate hike throughout Q1 2023 until the 4.75%-5.00% range, then remain unchanged before the central bank lowers its benchmark rate in Q4 2023, to the 4.50%-4.75% range.
The Goldman Sachs forecasts the US500 to drift to 3600 by March 2023, before the index starts sliding higher to eventually reach 4000 by Dec 2023 – this projection is based on the scenario that interest rates will remain high, albeit with the US narrowly missing a recession (Soft landing). There is still downside risk: according to trading economics’ forecast model, the 2-year and 10-year US bond yield are projected to hit 5.12% and 4.03% respectively in 12 months’ time. If case of recession or as GS stated it hard landing, the US500 could bottom 3150 in 1st half of the year, before the index starts sliding higher to eventually reach 3750 by Dec 2023.
There is an interesting fact that the US500 index has historically posted double-digit gains on average following inflation hitting its peak. According to a research study by Strategas Research Partners, the average 6-month, 12-month, and 24-month return for the US500 following peaked inflation (data taken since 1947, excluding 2008) were 11.7%, 17.4% and 20.2%.
All in all, it remains to be observed whether a ‘soft landing’ could be achieved without triggering a recession. A ‘stickier’ inflation could prompt the Fed to raise its fund rate to a higher level, which could aggravate recession risk; otherwise the magnitude of rate cuts would depend upon the state of the economy.
US Stock Market and US500 Review
- A split US government may dampen its authority in fiscal policies.
- A generally cold US-China relationship and Western-Russian geopolitical tension likely to persist in 2023.
- The Fed policy may appear passive given the uncertainties and its need to react based on economic data.
- General expectation for US economic growth remains neutral to negative.