Markets are closed today as investors await the first session of 2023. Following a rough year – the worst to date for the S&P since 2008 – bulls are hoping for a January rebound.
If a rally does emerge, however, any gains made this month are unlikely to stick without at least some dovishness from the Fed.
“We’ve had everything from Covid problems in China to the invasion of Ukraine. They’ve all been very serious. But for investors, it is what the Fed is doing,” explained UBS director Art Cashin.
Cashin’s right; everything else over the last two years has really been a distraction. Even Covid was unable to knock stocks off their highs for long. It took a little over 6 months for the S&P to set a new high on the heels of quantitative easing (QE) and rate cuts.
The threat of runaway inflation and (eventually) stagflation did little to dent sentiment from 2020-2021 as equities went into speculative overdrive. Many Wall Street banks expected even better returns last year.
They were all wrong, of course, as inflation galloped higher (like we warned it would), completely obliterating the Fed’s estimates.
Treasury Secretary Janet Yellen and Fed Chair Jerome Powell famously said in December 2021 that inflation was merely “transitory” despite a November year-over-year CPI reading of +6.8%. Shortly thereafter, Allianz chief economic advisor Mohamed El-Erian raked both Yellen and Powell over the coals in a brutal CBS interview.
“The characterization of inflation as transitory is probably the worst inflation call in the history of the Federal Reserve, and it results in a high probability of a policy mistake,” El-Erian said.
“So, the Fed must quickly, starting this week, regain control of the inflation narrative and regain its own credibility. Otherwise, it will become a driver of higher inflation expectations that feed onto themselves.”
He continued, adding that if the Fed waited too long to raise rates, it would risk a recession. Virtually all of El-Erian’s predictions came true. Nearly every credible economist sees a major recession on the horizon.
The coming earnings season is likely to be critical in determining the market’s trend for the rest of the year. So too will be the December jobs report, which comes out on January 6th before the market opens. December 2021’s jobs data saw a huge miss (+199k payrolls reported vs. 450k expected), starting off what turned out to be a terrible year for bulls on a bearish note.
Since then, little has changed. Investors are still worried about the Fed raising rates into a recession. Now, though, a recession is almost here, and the Fed just increased the 2023 median rate (+5.1%) again at its last meeting.
Hopes of a dovish shift in response to slowed growth have diminished significantly. As a result, 2023 is already shaping up to be “2022-like” in many ways. Don’t be surprised if the indexes finish lower this year because of that, even though we’ll probably also see several wicked bear market rallies on the way down, just like we did in the year prior.