A gloomy winter
Three things to watch in 2023.
Inflation and the Federal Reserve’s response While inflation has probably peaked, it remains elevated and is unlikely to hit the Fed’s 2% target before the end of 2024. At its policy-setting meeting on Dec. 14, the Fed slowed the pace of rate hikes to a half-point increase (after four consecutive 75 basis-point hikes), which took the fed funds range up to a 15-year high of 4.25-4.50%. In their latest SEP, policymakers forecast they will raise the range to 5-5.25% by mid-2023 and hold rates there until 2024. They also project that in 2023 GDP growth will slow to 0.5% and the unemployment rate will increase to 4.6%.
Corporate earnings disappointments could push stocks lower Last June, FactSet expected fourth quarter S&P 500 earnings to grow 10% on a year-over-year (y/y) basis. But today, those estimates have shrunk to a y/y decline of 2.4% due to elevated inflation, rising interest rates and slimmer profit margins. When companies begin to report these results in mid-January, we expect cautious management guidance due to the risk of recession and rising labor, commodity, transportation and warehousing costs. So in November, we reduced our outlook for earnings in 2023 from $230 to $200 and from $250 to $220 in 2024. EPS in 2021 was $209, and our forecast for 2022 was $220. In early July, the consensus was for 2023 earnings to reach $250, but that projection has since declined to $234.
Keep the defense on the field 2022 was a difficult slog for equity investors, with the S&P plunging 27.5% from its beginning to Oct. 13. Stocks then staged a midterm election rally over the ensuing two months to Dec. 13, surging 17.5%. We do not believe this rally is sustainable. If earnings do decline because of slowing economic growth and slimmer profit margins and P/E’s contract due to elevated inflation and higher interest rates, stock prices could retest their mid-October low of 3,500—or perhaps lower. We continue to emphasize “stable demand” equity-market categories, such as energy, health care, consumer staples and utilities. These tend to have lower P/E ratios, less risky beta profiles and higher dividend-yield support.