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This article looks at the possible direction of markets in 2023. It examines economic conditions, political developments, and industry trends that may impact market trends. It offers a detailed view of the market outlook for the coming year and is useful for individual investors and business owners to make informed financial decisions.
I. Introduction
The U.S. economy is expected to enter a recession in 2023, following rapid growth in 2021 but slowing momentum in 2022. Inflation is expected to remain above prepandemic levels for several years, and interest rates are not expected to fall until 2024 or later. The Federal Reserve is expected to continue raising rates into early 2023. Real GDP growth is expected to recover in 2024, but growth over the next decade is expected to be somewhat muted relative to prepandemic trends due to lasting effects from the pandemic on the drivers of growth and an aging demographic.
According to Bank of America, the global economy is expected to see recessions in the U.S., Euro Area, and UK in 2023, with China being the exception. The recession is likely to result in corporate earnings and economic growth coming under pressure in the first half of the year. Inflation is expected to come down in 2023, but it will take time for central banks to declare victory. Markets are expected to tolerate more risk later in the year, with the S&P 500 typically reaching its bottom six months ahead of the end of a recession. Bond markets are expected to be more attractive in the first half of the year, while the outlook for stocks should be better in the latter half.
2022 Explained
In 2022, financial markets faced challenges due to a combination of central bank policy and supply chain issues. The Federal Reserve and other central banks ended their 14-year era of quantitative easing, which involved money printing and record low interest rates, and implemented quantitative tightening, which involved selling assets from their balance sheets to reduce the amount of money in circulation and curb inflation. These policies, combined with interest rate hikes to address rising inflation, caused disruptions and uncertainty for investors and businesses and resulted in volatile market movements and a crash in prices for some assets. It remains to be seen how these events will continue to impact the market in the coming months and years.
II. Economic Factors Influencing Markets
Background
Key economic indicators, such as GDP growth, unemployment rates, and inflation, provide valuable insights into the overall health and performance of an economy.
GDP growth measures the expansion or contraction of an economy. A healthy economy is typically characterized by positive GDP growth.
Unemployment rates reflect the percentage of the labor force that is actively seeking employment. A low unemployment rate suggests a strong job market.
Inflation, measured by the Consumer Price Index (CPI), reflects the average change in the price of goods and services over time. Central banks typically aim to maintain a target inflation rate to ensure stability and predictability.
Together, these indicators provide a broad overview of the state of an economy and can help inform economic policy decisions and financial planning.
Global Economic Dynamics
GDP:
The global economy has experienced steady growth over the past few years, with GDP reaching $88 trillion in 2020, $94 trillion in 2021, and projected to reach nearly $104 trillion by the end of 2022, according to the IMF. However, the recovery from the pandemic has been strained by conflicts, supply chain bottlenecks, and inflation, leading to downward revisions in global economic projections. The annual GDP growth for 2022 was initially expected to be 4.4% in January, but this has since been adjusted to 3.6%.
Inflation:
Year-on-year inflation (CPI) in the OECD rose to 10.7% in October 2022, up from 10.5% in September. In 18 out of 38 OECD countries, double-digit inflation was recorded, similar to the previous month. Year-on-year inflation refers to the percentage change in the CPI from one year to the next. This means that the prices for goods and services in member countries of the organization have been increasing at a rate of 10.7% per year as of October 2022, compared to 10.5% in September. This information is important because it can give us a sense of how much the cost of living is increasing over time, and it can also influence economic policy decisions.
Employment
In 2022, the employment-to-population ratio worldwide was estimated to be approximately 55.8 percent, indicating that just over half of the global working age population were employed. Among the provided regions, Northern America had the highest employment-to-population ratio, at 58.8 percent, with Europe and Central Asia having the lowest at 53.9 percent. The recovery from the pandemic has been uneven, with advanced economies in the recovery stage while others face a prolonged crisis with high COVID-19 cases and deaths.
U.S. Economic Dynamics
GDP
The 2022 GDP numbers for the U.S. show a mixed picture of economic performance. In the first quarter, GDP contracted by 1.6%. This was followed by a smaller decline of 0.6% in the second quarter. However, there was a rebound in the third quarter, with GDP growing by 2.9%. The fourth quarter is estimated to show continued growth, with a projected increase of 0.7% in GDP.
The increase in real GDP was driven by increases in exports, consumer spending, nonresidential fixed investment, state and local government spending, and federal government spending.
Exports increased due to increases in both goods and services, with industrial supplies and materials, "other" goods, and nonautomotive capital goods being the leading contributors to the increase in goods exports. Services exports were led by travel and "other" business services.
Consumer spending increased due to an increase in services, led by health care and "other" services, which was partly offset by a decrease in goods, led by motor vehicles and parts as well as food and beverages.
Real GDP increased in the third quarter due to a smaller decrease in private inventory investment, an acceleration in nonresidential fixed investment, and upturns in federal and state and local government spending, which were partly offset by a larger decrease in residential fixed investment and a deceleration in consumer spending. Imports decreased.
Inflation
The Consumer Price Index in the U.S. increased by 7.1% over the last 12 months. This increase was driven mainly by the index for shelter, while the energy index decreased by 1.6% over the month. The food index increased by 10.6% over the last 12 months. The index for all items less food and energy rose by 6.0% over the last 12 months. This 12-month increase was the smallest since December 2021. All of this was well above the Federal Reserve's target of 2% for the annual inflation rate.
Employment
The unemployment rate in November 2022 was 3.7%, which is unchanged from the previous month and has been in a narrow range between 3.5% and 3.7% since March. This is one of the lowest unemployment rates seen in the U.S. since before the COVID-19 pandemic. During the pandemic, unemployment reached a peak of 14.7%, but has since recovered significantly. Overall, the unemployment rate has shown a trend of improvement in recent months, indicating a positive direction for the economy.
III. Trends to Watch 2023
Fed’s Hiking Cycle
The past year has been marked by unprecedented economic and financial market changes, and central banks around the world have responded with coordinated monetary policy adjustments at a faster pace than has been seen in decades. Central banks aim to prevent recessions. However, the current inflation dynamics leave policymakers with little option but to tighten financial conditions in an attempt to stabilize prices. In 2023, there is a potential for disinflation, but this will come at the cost of a global recession.
Consumer Spending
During the pandemic, many households saved more money and had more liquidity (available cash) than usual. However, in the past year, a significant portion of this extra savings and liquidity has been used up. This is because even though people have been earning more money and spending it, they have also been using their saved pandemic funds and increasing their credit card usage. It is estimated that there is currently between $1.2 trillion and $1.8 trillion in excess savings remaining, and this may be completely used up by the middle to end of 2023 depending on how much people continue to spend and how much prices go up.
Credit card balances (the amount of money owed on credit cards) have increased significantly in the last few months and are currently 15% higher than they were at the same time last year. This is the largest increase in over 20 years. However, delinquency rates (the percentage of people who are not paying their credit card bills on time) are still low and the overall amount of money owed on credit cards is similar to what it was at the end of 2019.
Labor
Employment is likely to take hit in 2023 as a result of the Fed's tightening cycle. As the U.S. economy slows down, the labor market is also expected to cool and potentially lose some jobs in 2023, leading to an unemployment rate of around 4.5%. There may be temporary relief from labor shortages in 2023 as demand for workers decreases, but recruitment and retention difficulties are expected to continue and the unemployment rate is still predicted to be relatively low compared to past downturns. When the economy starts growing again, severe labor shortages could return.
Strong Dollar
The value of the US dollar has increased significantly in the past year, reaching 20-year highs against a variety of major currencies. This trend is expected to continue in the coming year, although the gains are expected to be more significant against emerging market currencies. While a strong dollar can have positive effects, such as making imports cheaper and lowering prices for certain globally traded commodities, it can also have negative impacts on the US economy and businesses. It can make exports more expensive, and negatively affect the revenues and profits of US-based companies that operate in international markets. The appreciation of the dollar is also expected to have a negative impact on the country's GDP growth in the coming year, with estimates suggesting that net foreign trade will subtract about 1 percentage point from growth in 2023. Inflation set to fall quickly from peak, but remain above the Fed’s 2% target at end of 2023.
Housing
The Federal Reserve's plans to raise interest rates have had a negative impact on the housing market in the US. As a result of the increase in mortgage rates, measures of housing activity, including affordability, builder sentiment, housing starts, and turnover, have all decreased significantly. The decline in housing activity is expected to continue in the coming year, with estimates suggesting that home sales and construction activity could decline by 15-20% and 10-12%, respectively. While median home values have continued to rise due to low inventories and vacancy rates, there is a risk that house prices could decline by 10% in the coming year to return affordability to historical norms.
IV. Global Economic Events 2023
Russia/Ukraine War Escalation
The conflict in Ukraine has had a negative impact on the economy in Europe, including increased market volatility and rising prices. This, along with the increase in natural gas prices, has contributed to financial difficulties and a downturn in sentiment, leading to a likely recession in the fourth quarter. European countries have been able to adapt by finding alternative sources of energy, but gas demand is expected to decline in the coming winter. Inflation in Europe is expected to peak at a high level and remain above the target set by the European Central Bank. The ECB is expected to raise its deposit rate in response. High energy and food prices, as well as uncertainty about the war in Ukraine, are expected to continue affecting household incomes and consumer confidence.
China 2023
China's economy is expected to experience slower growth in 2022 due to the country's efforts to control the spread of COVID-19 and a downturn in the real estate sector. However, growth is expected to improve in 2023 as COVID-19 restrictions are eased and the real estate market stabilizes. The housing market is expected to face challenges in the coming years due to a variety of factors, including declining affordability and changes in policy. Additionally, China is facing competition from other countries as multinational companies seek to diversify their supply chains, which could impact the country's export dominance and ability to attract and retain top talent. In response, China is focusing on domestic growth through initiatives such as "indigenous innovation" and "internal circulation.
Japans Economic Dilemma
Japan's economy is expected to slow in 2023, but it will continue to grow at a faster rate than its potential. Consumption is likely to benefit from the reopening of the economy and capital expenditure is expected to remain strong due to various factors. External demand for goods is expected to weaken in the first half of the year, while demand for services is expected to improve throughout the year. Inflation is expected to decelerate after peaking at a high level, but it will remain above the target set by the Bank of Japan for most of the year. There is increased interest in wage growth for the fiscal year 2023 due to the Bank of Japan's position on the subject. The Bank of Japan is not expected to raise interest rates in the coming years due to concerns about global economic slowdown. Adjustments to forward guidance and the 10-year yield band are possible.
V. Institutional Insights
According to Bank of America, the global economy is expected to see recessions in the U.S., Euro Area, and UK in 2023, with China being the exception. The recession is likely to result in corporate earnings and economic growth coming under pressure in the first half of the year. Inflation is expected to come down in 2023, but it will take time for central banks to declare victory. Markets are expected to tolerate more risk later in the year, with the S&P 500 typically reaching its bottom six months ahead of the end of a recession. Bond markets are expected to be more attractive in the first half of the year, while the outlook for stocks should be better in the latter half.
According to Vanguard, about half of the upward pressures on global inflation are caused by supply chain disruptions and the war in Ukraine, while the other half is caused by demand. Restrictive monetary policy is intended to alleviate demand-driven inflation. However, support for policy tightening could decrease in 2023 if economies slow and corporate belt tightening leads to large-scale layoffs. The Fed needs to slow economic activity to solve the inflation issue, but the window for raising rates enough to cool inflation without inducing a recession is very narrow. As a result, central banks may have to tighten financial conditions to try to stabilize prices, even though this may lead to a global recession in 2023.
According to Goldman Sachs, The question of the year has been whether it is possible to reverse inflationary overheating without causing a recession. GS believes it is possible for an extended period of below-potential growth to gradually reduce labor market overheating and bring down wage growth and ultimately inflation, providing a challenging but feasible path to a soft landing. Initial steps along this path have been successful, but there is still more work to be done in 2023. The economy is expected to experience another year of below-potential growth and labor market rebalancing, which will address much but not all of the underlying inflation problem. The Federal Reserve is expected to slow the pace of interest rate hikes and focus on fine-tuning the funds rate to keep growth below potential, ultimately delivering slightly more than is currently priced. The risk of a recession is lower than expected due to the expected resilience of demand in the coming year.
VI. Biggest Losers 2023
U.S. Equities
Analysts expect Q4 2022 earnings estimates for S&P 500 companies to be lower than average, and that this trend is likely to continue in 2023. High inflation and rising interest rates are expected to reduce demand for discretionary goods and services, mortgages, and new vehicles. This decrease in demand is likely to lead to reduced revenue and earnings for companies, and potentially an increase in unemployment as companies lay off employees. These factors could potentially affect markets and stocks by leading to decreased performance and potentially lower valuations.
Housing
VII. Biggest Winners 2023
Bonds are Back
2023 is expected to be a good year for bond investments due to high starting yields, the end of the Federal Reserve's tightening cycle, and a likely decline in inflation. A portfolio of high-quality bonds can yield between 4% and 5%, and tax-adjusted yields in municipal bonds are attractive for investors in higher tax brackets. The Federal Reserve is expected to stop raising interest rates in the early to mid part of 2023, and yields may rebound early in the year. The yield curve is likely to remain inverted as monetary policy remains tight, and 10-year Treasury yields could fall as low as 3%. It is recommended to add duration to bond portfolios during periods of rising rates and to stay up in credit quality.
Oil Prices Rebound
Oil prices are expected to increase next year due to China easing Covid-related restrictions and ongoing concerns about supply risk caused by Russian aggression against Ukraine. China is the world's largest oil importer and its decision to move to a "living with Covid" policy, with reduced testing and quarantine requirements, is expected to increase demand as people start traveling again. Oil demand in China fell for the first time in two decades in 2022, but its return is expected to have a positive impact on prices in 2023.
VIII. FX Market Outlook
(Refer to the next article 'Total Forex Outlook 2023'.)
IX. Conclusion
In conclusion, the global economy is expected to enter a recession in 2023, with the U.S., Euro Area, and UK being among the countries affected. The recession is likely to result in corporate earnings and economic growth coming under pressure in the first half of the year. Inflation is expected to come down in 2023, but it will take time for central banks to declare victory. Markets are expected to tolerate more risk later in the year, with bond markets being more attractive in the first half of the year and the outlook for stocks being better in the latter half. It is important for investors to stay informed about key economic indicators and global economic trends in order to make informed decisions about their portfolios.
Roy Dunia
December 26, 2022
ChartAddicts LLC
Disclaimer: This article is the result of the analysis carried out by analysts associated with ChartAddicts. The article does not purport to represent the views or the official policy of ChartAddicts. This is not investment advice; please do your own research and consult a financial professional.
Sources:
“Prices & Inflation: U.S. Bureau of Economic Analysis (BEA).” Prices & Inflation | U.S. Bureau of Economic Analysis (BEA), https://www.bea.gov/data/prices-inflation.
“Gross Domestic Product.” FRED, 22 Dec. 2022, https://fred.stlouisfed.org/series/GDP.
“Vanguard Economic and Market Outlook 2023 .” Vanguard, https://investor.vanguard.com/investor-resources-education/news/4-key-topics-from-our-2023-economic-and-market-outlook.
CHAMBLESS, GINGER. “2023 Economic Outlook: Insights for What's Ahead.” 2023 Economic Outlook: Insights for What's Ahead, J.P. Morgan Chase, 7 June 2022, https://www.jpmorgan.com/commercial-banking/insights/economic-trends#:~:text=We%20expect%20the%20U.S.%20economy,annual%20growth%20rate%20of%201.8%25.
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