Stock Market Trends for 2023 | To invest

The S&P 500 is down 19.2% through December 16 in 2022 and is on track for its worst calendar year performance since the global financial crisis in 2008. Unfortunately, the themes that dragged stock prices down in 2022 aren’t going away any time soon.

Inflation has been the talk of the year on Wall Street and is the No. 1 topic on the minds of investors and central bankers heading into 2023. Concerns about the negative impact of inflation and the Federal Reserve’s monetary tightening triggered a sell-off in risky assets in 2022. Growth stocks, technology stocks and cryptocurrencies were particularly hard hit.

While the Fed has made some progress on inflation in the second half of 2022, prices, wages and interest rates continue to rise. The US economy has remained largely resilient throughout the year, but a sharp downturn in the housing market and weakening consumer confidence are just two signs that cracks are starting to appear. Economists and analysts see a strong chance of a recession in the US in the coming year.

What key themes should investors monitor and how can they position their portfolios to mitigate risk and take advantage of these circumstances? Here are four themes investors should keep in mind as we head into 2023:

Inflation has been the main concern for both the Fed and investors in 2022. The Consumer Price Index, or CPI, reached a 40-year high of 9.1% in June 2022. The Fed has been aggressively raising interest rates since March in an effort to bring inflation closer to its long-term target of 2%. Those rate hikes included four consecutive increases of 0.75 percentage points from June to November.

As a result, the Fed Funds target rate has risen from near zero in early 2022 to between 4.25% and 4.5% heading into 2023. The CPI fell to 7.1% for November, indicating that the Fed is making progress in its fight against inflation.

Unfortunately, the Fed’s preferred inflation measure, the core personal consumption expenditure index, or PCE, has a long way to go to reach its target range. Core PCE, excluding volatile food and energy prices, was up 5% from October. Core PCE inflation has fallen from a peak of 6.8% in June, but is still more than double the Fed’s target of 2%.

To make matters worse, a tight labor market is contributing to rising wages and price pressures. Wages rose 5.1% in November and many companies are simply choosing to pass on higher labor costs to customers by raising the prices of goods and services, further contributing to inflation.

Inflation is likely to remain high for some time to come and will be a major concern for investors in 2023.

Increased inflation is a sign of an overheated economy, and the Fed’s main ammunition against an overheated economy is tighter monetary policy. In addition to allowing $95 billion in assets to roll off the balance sheet each month, the Fed has been raising interest rates to cool inflation.

Higher interest rates increase borrowing costs for both businesses and consumers, slow economic growth and weigh on corporate profits. Looking ahead to 2023, the Fed will likely continue to raise interest rates until inflation is significantly lower.

In December, the Federal Open Market Committee, or FOMC, released its updated long-term economic forecasts. The FOMC forecast core PCE inflation for 2023 at 3.5% and a terminal fed fund interest rate for 2023 at 5.1%.

According to the CME Group, the bond market is currently pricing in a 52.7% chance that the Fed will raise rates by another 0.5 percentage point by March 2023.

Any additional rate hike will make life harder for investors in 2023, and the timing of the Fed’s eventual swing from rate hikes to rate cuts in late 2023 or early 2024 could be a major catalyst for the stock market.

So far, the economy has remained relatively resilient to Fed tightening, but it looks like a US recession is on the way in the first half of 2023. Consumer confidence is falling. Rising mortgage rates have caused home sales to fall. Existing home sales have fallen for nine consecutive months, falling 24% year-on-year in October.

Wall Street analysts are taking note of the weakening economy. A growing number of economists and investment banks expect a recession in the first half of 2023, along with a sharp fall in stock prices.

Quincy Krosby, chief global strategist for LPL Financial, says economic indicators clearly indicate that the US economy is slowing. Krosby says Fed Chairman Jerome Powell’s comments after December’s FOMC meeting indicate that the central bank is prioritizing inflation over economic stability.

“While persistent claims are rising, Chairman Powell’s focus has been on the strong labor market and the need to balance it, even if it means significantly higher unemployment levels,” says Krosby. “The market response is similarly focused, but on the possibility of a recession. As the (FOMC) and…Powell’s press conference remarks (suggest)…the Fed will continue to raise rates in early 2023 and not start lowering rates until 2024.”

Unfortunately, Krosby says the Fed’s aggressive mindset probably means a “soft landing” for the economy is unlikely.

Analysts now predict that S&P 500 companies will report a 2.8% earnings decline for the fourth quarter of 2022. Were it not for the booming energy sector, the S&P 500 would be on track for a 1.8% earnings decline in 2022 .

Stock selection may become even more important than usual in a weakening economic environment.

Bank of America analyst Savita Subramanian says rising interest rates have completely shifted the risk dynamics in the stock market.

“Things have changed: energy is now in low beta, along with financials and industrials, after having higher betas than any other sector over the past decade. Tech, discretionary and (technology, media and telecom) have moved from in-line or low beta to the three riskiest sectors,” says Subramanian.

Bank of America predicts the S&P 500 will drop to new multi-year lows of about 3,000 in the first half of 2023, before bouncing back to just 4,000 by the end of the year.

Nicholas Juhle, chief investment officer of Greenleaf Trust, says investors should be cautious about the energy sector after a big year in 2022.

“The energy sector tends to go through boom-and-bust cycles, and if restrictive monetary policy is effective in reducing aggregate demand while the supply chain recovers, energy could be in for a downturn,” says Juhle. “On the other hand, I would be more constructive on the hardest-hit sectors such as information technology and communications services, where valuations have taken a beating, in part due to higher discount rates.”

Despite the potential for major volatility, Wall Street analysts still see overall stock price increases in 2023. The S&P 500 analyst’s 12-month average price target is about 4,496, according to FactSet, suggesting an increase of about 16, 7% relative to the value of the index at the end. December 16.