Stocks Face Uncertainty in 2023

The U.S. stock market will face plenty of uncertainty in 2023, from China’s Covid surge to sticky inflation pressures and tighter central bank policies.  The S&P 500 Index ($SPX) (SPY) is set to fall more than -19% this year, and the Nasdaq 100 Index ($IUXX) (QQQ) will drop more than -32%, the largest yearly losses since the financial crisis in 2008.  Also, aggressive interest rate hikes by the Fed more than doubled 10-year Treasury yields this year from 1.510% to 3.873%. 

Soaring inflation in 2022 weighed on stocks and pushed bond yields up to 14-year highs.  Consumer prices surged this year from a combination of pandemic disruptions to supply chains and labor markets, commodity spikes after Russia invaded Ukraine, and government stimulus that boosted consumer spending.  Although most commodity prices fell back sharply from sharp rallies earlier this year, raw-material prices may accelerate again next year if the reopening of China’s economy sparks a surge in demand.

After raising interest rates this year at an aggressive pace to curb soaring inflation pressures, the markets will look to see if the Fed ends its tightening campaign.  At the FOMC’s last meeting of the year earlier this month, Fed Chair Powell said, “we are not at a sufficiently restrictive policy stance yet.  We will stay the course until the job is done.”  The resilience of the U.S. labor market will be tested next year if the economy stalls.  The U.S. unemployment rate was at 3.7% in November, just above the 43-year low of 3.5%, as the U.S. labor market remains tight. 

Corporate earnings are expected to fall next year, another factor that could weigh on stocks.  Morgan Stanley said current earnings estimates for next year are “too high.”  They predict earnings of $180 per share in 2023 for the S&P 500 versus analysts’ expectations of $231.  In addition, Morgan Stanley said the upcoming earnings recession next year might rival 2008, and markets have yet to price it in.

History shows that two consecutive down years are a rare event for equity markets.  The S&P 500 has fallen for two straight years on just four occasions since 1928.  However, if that does occur next year, drops in the second year tend to be deeper than in the first.  Crossbridge Capital is optimistic for U.S. stocks next year and believes the S&P 500 saw its bottom in June this year and said, “recession does not have to be doom for equities, and markets tend to bottom before a recession starts.”

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