While it seems extremely doubtful markets will end the year in positive territory, holiday miracles do happen. And we are not just talking about a certain football team pulling out an improbable win after trailing by 33 points late in the game. Many children may be wondering if Santa will be making a visit to their house this year and similarly, investors might be wondering if we will see a “Santa Claus” rally to end this difficult year on a high note.
The past week was another series of ups and downs with the stock market rallying to begin the week as the monthly Consumer Price Index (CPI) report came in better than expected and showed inflation is cooling. However, inflation remains elevated well above the comfort zone of the Federal Reserve and certainly most consumers. The Fed did shift down its pace of interest rate hikes last week when they raised rates by 50 basis points, or one-half of one percent; the first step down after four consecutive 75 basis point (three-quarters of a percent) rate hikes this year. Markets reacted negatively to the comments made by Fed Chair Jerome Powell after the meeting in which he stated that the Fed now anticipates that interest rates will need to remain higher for longer. Powell’s comments also indicated the Fed has more work to do (i.e. will continue to raise rates) and would like to see further evidence that inflation is on a sustained downward path.
The Fed also released their quarterly “Dot Plot” showing estimates by policymakers on where they forecast interest rates will be over the next several years. It should be cautioned these forecasts are frequently updated as economic conditions change and these dot plots are rarely accurate over longer periods of time. The latest release shows the Fed expects short-term interest rates to continue moving higher over the next year and remain there, hence the “higher for longer” message given by Powell post-meeting. With the stock market being so dependent upon Fed action at this time, this was the catalyst, along with a disappointing retail sales report, that sent markets sharply lower in the second half of the week. The S&P 500 ended the week about 2% lower, following similar losses the previous week.
Will Santa Come to Town?
A Santa Claus rally generally occurs within the last five trading days of the year and spills over into the first two trading days of the new year. Often it is the result of institutional buying to position portfolios prior to year-end for a favorable set-up going into the new year. In years where there is a down market, optimism for prospects in the new year lead to buying. Given the market action of this past year, conventional wisdom might say this would be the case now but unfortunately we do not share that same enthusiasm given the current headwinds in the markets and economy. We certainly would not complain about a nice rally to end the year, but these types of rallies tend to be short-lived and we again want to emphasis that investors should look past what happens over the next couple of weeks and maintain a longer-term approach to the markets.
It is time to consider what we think might happen in the upcoming new year. Inflationary risks appear to be subsiding, but there is a risk they could return, similar to what happened during the 1970s. We do expect the Fed to continue to raise interest rates, albeit at a slower pace than they did this past year and to a much smaller extent. They will eventually need to pause to assess the impact of their monetary policy. Interest rates are likely to remain elevated relative to where they have been the past several years. Wage growth is most likely the largest ongoing inflationary pressure given the current state of the labor market; something the Fed is monitoring closely. The markets are likely to shift their primary attention from inflation to earnings. Companies are expected to continue to unload their glut of inventory at discounted prices, which will help alleviate inflationary pressures but will also lead to lower earnings. Expect the markets to react negatively to disappointing earnings and downward estimates during the first half of the year. We are of the belief there will be a recession in 2023, but it will be mild. The stock market will likely drift lower, but not too significantly from where it is now. The second half of next year brings more optimism. We will provide further detail on our thoughts for the upcoming year in weeks to come.
Following the CPI report and the Fed meeting last week, the rest of the year should feel rather anti-climactic. Retail sales reports last week were disappointing so retail sales from the holiday season will maintain a higher than usual emphasis, but we will not have a clear assessment of those until after the first of the year. With so many economists and business leaders expecting a recession, the markets seem to already be factoring one in. But the question will be to what extent. If the Fed is able to engineer a soft landing and avoid a recession or if the recession is mild, the stock market could react quite positively. So while remaining cautious, we continue to urge investors to remain mostly invested and perhaps keeping a little bit of cash available. We still believe we are much closer to the bottom of the market than the top and the greatest risk in 2023 might be missing out on a recovery. But we are also cautioning that decent returns over the next several years are likely to be much more difficult to come by than they were during the past decade.
The markets of today are very different than markets of the past. Fortunately there are also various strategies available to help people who have saved a lifetime to protect their wealth while not missing out on earning interest or participating in the market. When it comes to retirement planning, do not leave your hopes on a miracle; have a plan in place where you can feel confident. If Santa does come to visit, we hope you receive something special in your stocking and not a lump of coal.
From all of us at Secured Retirement, we would like to wish you and yours the very Merriest of Christmases and a happy holiday season!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
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