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Stocks busted by interest rate shocks in 2022. This is what will drive the market in 2023.


2022 is over. Take a breath.

Understandably, investors eagerly await the stock market’s worst year since 2008, with the S&P 500
SPX,
-0.25%

down 19.4%, the Dow Jones Industrial Average
DIA,
-0.22%

down 8.8% and Nasdaq Composite
CALCULATOR,
-0.11%

down 33.1%.

Adding to the pain, the bond market has also been a disaster, with some segments seeing the biggest annual losses in history while US Treasury prices tumbled, sending yields skyrocketing.

That provides a rare double shock for investors, who often see bond-backed portfolios as stocks take a hit.

So how about now? The calendar flip doesn’t take away the factors that caused market losses in 2022, but it does give investors a chance to think about how the economy and markets will evolve next year.

An interest rate shock as the Federal Reserve raises interest rates at an unprecedented rate in an attempt to contain inflation will make its mark in 2022. A return to higher interest rates — and what could be the end of the four-decade-long era of falling rates — is expected to resonate in 2023 and beyond.

A saying: End of 40-year era of falling interest rates is ‘major change’ for investors: Howard Marks

While inflation, still high, shows signs it has peaked, markets have been robbed of a seasonal rally ahead of the new year on fears the Fed’s continued efforts will spark for a recession that will wreak havoc on corporate earnings in 2023.

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

The interaction between Fed policy, inflation, economic growth and earnings will drive markets in 2023, analysts say.

Federal Reserve

“This is a Fed-led market that is predicted to be based on transient inflation,” said Quincy Krosby, chief global strategist at LPL Financial, in a phone interview. monetary policymakers initially believed.

The Fed dropped the “transitional statement” and launched an aggressive campaign to tackle inflation. “That leads to a market that is concerned about economic growth and whether we have to enter 2023 to face a severe recession,” Krosby said.

inflationary

Still, analysts say investors can find some optimism in signs that inflation has peaked.

“The days of CPI below 2% that we enjoyed from 2008 to 2020 may be over, possibly for a long time. But inflation could fall far enough (3%-4%) for the Fed to essentially think it’s done its job (though they won’t say it directly as the target is still 2%), but with all intents and purposes, we Tom Essaye, president of Sevens Report Research, said in a note Friday.

Skeptics doubt that slowing inflation will be enough to prevent the Fed from following through on signs that it intends to raise the federal funds rate above 5% and keep it there for a while.

Hedge fund giant David Tepper in a December interview with CNBC said he is “short slant” on the stock market “because I think an up/down trend doesn’t make any sense to me when I have so much…the central bank tells me what they’re going to do.”

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

Fear of recession

A resilient jobs market so far has led optimists — and Fed officials — to argue that the economy can avoid a so-called hard landing as monetary policy continues to tighten.

Also read: Stock investors face 3 recession scenarios in 2023

However, investors “are predicting a recession in early 2023, as evidenced by three-quarters of S&P 500 index earnings expected to decline and the room procedures continue to tilt forward,” Sam Stovall, chief investment strategist at CFRA, said in a note Wednesday. “The severity of the recession is still in question. We expect it to be light.”

The bear market for the S&P 500 has been around since January 3, 2022, when it closed at a record high before starting to slide. It ended with an annual loss of 19.4%.

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

“At about 12 months and 20%, the current bear market appears to be almost two-thirds of the way through the typical bear market decline. The current market appears to be following a trajectory similar to a historically average bear market to date,” they wrote. “Based on past trends, on average, bear markets don’t bottom until after the recession starts, but before the recession ends.”

Related: How long will the stock stay in a bear market? It depends if a recession hits, says the Wells Fargo Institute

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