A rate shock destroyed stocks in 2022. What the pros say will drive the market in 2023.

2022 is over. Breathe.

Investors were understandably eager to ring the bell for the worst stock market year since 2008, with the S&P 500 SPX,
-0.25%
fall of 19.4%, the Dow Jones Industrial Average DJIA,
-0.22%
down 8.8% and the Nasdaq Composite COMP,
-0.11%
lose 33.1%.

Adding to the pain, the bond market was also a disaster, with some segments posting their biggest annual losses in history as US Treasury prices crashed, pushing yields higher.

This offered a rare double whammy to investors, who typically see portfolios depreciated by bonds when stocks are hurting.

And now? The calendar reversal doesn’t make the factors that drove the market’s losses in 2022 go away, but it does provide investors with an opportunity to reflect on where the economy and markets are going in the year ahead.

A rate shock as the Federal Reserve raised interest rates at a historically rapid pace in its effort to contain inflation set the tone for 2022. A return to higher rates – and what could be the end of a four-decade period of falling interest rates – is expected to reverberate into 2023 and beyond.

The Tell: End of 40-year period of falling interest rates is crucial ‘radical change’ for investors: Howard Marks

As inflation, still high, shows signs that it has peaked, the market has been deprived of a seasonal rally heading into the new year by fears that the Fed’s continued efforts could trigger a recession that will devastate corporate profits in 2023.

Read: How a Santa Claus rally, or lack thereof, sets the stage for the stock market in the first quarter

The interplay between Fed policy, inflation, economic growth and earnings will drive the market in 2023, analysts say.

The Fed

“This is a Fed-led market built on inflation that was not transitory,” as monetary policymakers initially believed, said Quincy Krosby, chief global strategist at LPL. Financial, in a telephone interview.

The Fed abandoned “transitional rhetoric” and launched an aggressive campaign to fight inflation. “This has led to a market concerned about economic growth and if we enter 2023 facing a significant economic downturn,” Krosby said.

Inflation

Investors, however, could find some optimism in signs that inflation has peaked, analysts said.

“The days of CPI below 2% that we enjoyed from ’08 to ’20 are probably over, possibly for a long time. But inflation could fall enough (3%-4%) for the Fed to essentially think that she has accomplished her mission (although she doesn’t say it directly because the target is still 2%), but for all intents and purposes we could get out of 2023 without a significant inflation problem,” said Tom Essaye, president of Sevens Report Research, in a Friday note.

Skeptics doubt that a slowdown in inflation will be enough to prevent the Fed from acting on its indications that it intends to raise the fed funds rate above 5% and hold it there for some time.

Hedge fund titan David Tepper, in an interview with CNBC in December, said he was “leaning short” on the stock market “because I think the up/down just doesn’t make sense. for me when I have so many…central banks telling me what they’re going to do.

See: Fed officials reinforce stern message of slowing inflation with higher interest rates

Recession fears

So far, a resilient labor market has optimists — and Fed officials — saying the economy could avoid a so-called hard landing as monetary policy continues to tighten.

Read also : Stock market investors face 3 recession scenarios in 2023

Investors, however, “expect an economic recession to materialize in early 2023, as evidenced by three-quarters of the expected decline in S&P 500 earnings and continued defensive trends in the sector,” Sam said. Stovall, chief investment strategist at CFRA, in a Wednesday note. . “The severity of the recession remains uncertain. We expect it to be soft.

The S&P 500 bear market is backdated to January 3, 2022, when it closed at an all-time high before beginning its fall. It resulted in an annual loss of 19.4%.

“The average bear market since World War II lasted 14 months and resulted in a 35.7% decline from the previous peak,” Glenmede analysts wrote in a December note.

“At around 12 months and 20%, the current bear market appears to be close to 2/3 of the typical bear market decline. The current market appears to be on a similar trajectory to an average historical bear market so far,” they wrote, “Based on past trends, on average, bear markets don’t peak until after a recession begins, but before a recession ends.”

Related: How long will stocks stay in a bear market? It depends on whether a recession hits, according to the Wells Fargo Institute.

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