Waiting for capitulation ignores “the C-Suite”… of positive macro factors
Here a bear, there a bear; everywhere where a bear.
Everyone’s a bear these days. Human nature is such that even experts, including in the world of economics and finance, tend to go with the flow. Stock market gurus, who rely on technical analysis defend their predictions with an impressive array of charts depicting bearish trends and patterns. Meanwhile fundamental analysts base their forecasts on several key financial parameters, both quantitative and qualitative. But then using an average Price/Earnings (PE) multiple that goes back 50+ years to estimate an S&P 500 target a year out just doesn’t make sense any longer. Per Investor Place, from 1965 through 2000, S&P 500 PE ratio was 15.6, but from 2001 through 2021 S&P 500 PE ratio was 25.7. Per the Wall Street Journal, as of December 30, 2022, S&P 500 trailing PE ratio stands at 18.59! Also, when a bull market is raging, the price drives the multiple; yet during a bear market, a historical multiple is used to estimate a target price about a year out because analysts are all over the map about when and by how much earnings need to “come in.”
The bull that suddenly vanished.
In any case, it shouldn’t come as a surprise that towards the end of 2021, most experts—from our nations’ leading financial institutions—supposedly utilizing technical and/or fundamental analyses foresaw a continuation of the bull market into 2022. In fact, a January 5, 2022, Reuters report, “Wall Street analysts’ 2022 outlook for S&P 500,” summed up some of these prominent predictions in a tabular form as follows:
It should be noted that the S&P 500 had closed at ~4766 on December 31, 2021. On December 30, 2022, the S&P 500 closed at ~3840, which would put the least bullish forecast by Morgan Stanley higher by 12.7% and the most bullish forecast by Wells Fargo higher by 27.5%! The current S&P 500 bear market was officially called on June 13, 2022, after the market had dropped 20% from the high it had reached on January 3, 2022—which is considered the start date for the current bear market.
From transitory to persistent.
The Federal Reserve (Fed) is accused—correctly— of being too late in recognizing that inflation was not transitory, as it kept saying from mid-2020 into late 2021. It’s now apparently seeing persistent inflation but that’s a mistake it will reconcile in the future—hopefully, not when it’s too late? But the sub header reference here applies to the selfsame analysts, who didn’t see the bear coming in late 2021 but now see the bear persisting into 2023.
Per human tendency to “go with the flow”—which has seen lower highs, lower lows all year—it is apparent that most of these analysts continue to be bearish for 2023. In fact, on December 24, 2022, Morningstar published an article, “Wall Street expects S&P 500 to finish 2023 at 4,000 after missing mark by the widest margin since 2008,” in which these major Wall Street forecasters’ S&P 500 target for year-end 2023 averages ~ 4031 as shown below:
Don’t fight the Fed or waiting for capitulation.
There are a few stray bulls out there and among them is Dr. Ed Yardeni of Yardeni Research, who in his December 26, 2022 article, “2023: Another Year of Living Dangerously?” boldly suggests:
“We think 2023 will be an up year. That’s because we are anticipating 60% odds of a soft landing… We think that the economy is much more resilient than it was in the past and much less prone to a credit crunch.”
Which is exactly the point. Real GDP in Q3 ’22 was 3.2% and real GDP in Q4 is expected to be 3.7%, which also happens to be the November ’22 unemployment rate. This is an economy that is in no hurry to go into a recession in 2023, as most Wall Street prognosticators expect, but instead continues to hold out hope for a soft landing.
Most analysts are focused primarily on inflation and what the Fed is doing to combat it. They universally believe in the mantra, “Don’t fight the Fed” and are consequently waiting for that infamous C-word action—capitulation—to occur in the financial markets. In this never-before-seen era that has seen:
- Fed funds rates largely under 2% since the start of the new millennium,
- an economy flooded with trillions of dollars through repeated quantitative easing (QE) programs by the Fed, and
- a crushing once-in-a-century pandemic that caused even more money being put into consumers’ pockets
to expect traditional market behavior is akin to “waiting for Godot.”
There are eight other Cs, besides capitulation, that are more relevant to how the markets will likely react in 2023. This “macro” C-suite of factors is listed below in alphabetical order and each component will be briefly discussed with regards to its likely impact on stock market performance in 2023:
After a losing battle with its draconian zero-Covid policy, the Chinese Communist Party suddenly capitulated on its almost three-year long effort to contain the Covid pandemic in China. Per a December 28, 2022, Foreign Policy report, “5 Predictions for China in 2023”:
“An internal briefing from China’s Center for Disease Control and Prevention (CDC) reportedly estimated that between Dec. 1 and Dec. 20, 250 million people were infected, further confirming that the government lifting its zero-COVID policy on Dec. 7 was a hasty reaction to the failure of the containment system. The China CDC estimate includes roughly 37 million people who were infected last Tuesday alone.”
Nonetheless, the good news is that China is finally re-opening and should contribute significantly to the global economy and more importantly to the stability of the global supply chain, in which China plays a major part. However, the bad news is that with China allowing global travel to resume, there is the danger of a Covid resurgence worldwide unless China undertakes massive inoculation measures within the mainland. With the Covid caveat in mind, China could turn out to be a net positive to global stock market performance in 2023.
Commodity prices have been declining rapidly in the second half of 2022. But in 2023 there could be a dichotomy between soft and hard commodity prices. According to the Economist Intelligence Unit’s December 27, 2022, report “What to watch in commodities in 2023,” prices for soft commodities will trend downwards but remain high in 2023, while prices for hard commodities will edge upwards in 2023 despite recent sell-offs. EIU calls China’s covid U-turn a wild card…
“from being a major downside risk to our demand and global price forecasts to an upside risk—much will depend on how quickly China opens up its economy in 2023.”
So, it’s fair to say that impact of commodities on global stock market performance remains unpredictable and more country specific. In the U.S., it’s impact should be more granular and impact specific stock market sectors, such as energy, based on how geopolitical events pan out.
It’s said that financial markets in the U.S. prefer divided government—when one political party controls the presidency and the other party controls at least one chamber in Congress—because it imposes a fiscal discipline on the federal government that has been impossible to maintain in the past couple decades. So, in 2023, with Republicans controlling the House of Representatives and the Democrats controlling the Senate, it will be difficult to dramatically impact the economy or further aggravate the national debt through fiscal policy, i.e., legislation that can be signed into law by the president. On the monetary side, the Fed will continue to squeeze money supply in 2023 through quantitative tightening (QT) and the markets have already anticipated that the federal funds rate will remain “higher for longer.” Any divergence from that path—an earlier than expected pause in rate hikes followed by a rate cut later in the year—will be a huge positive for U.S. stock markets, even if the economy were deemed to be in a recession. In any event, the most likely scenario—a fiscally mute Congress combined with a Fed near the end of its rate hiking phase—is a net positive for U.S. stock markets in 2023.
In its December 1, 2022, article, “The deflating of the great cash cushion,” the Financial Times noted:
“As stimulus programmes ended last year and the economy reopened — increasing opportunities to spend money — Americans’ cash war chest has been dwindling, and the spending extravaganza cannot last. Economists’ estimates for how much is left vary from about $1.2tn to $1.8tn.”
This is still a lot of cash in the hands of the American consumer and by most estimates US households will still have under $1tn in excess savings by the end of 2023. According to Mastercard SpendingPulse, American retail sales rose 7.6% year-over-year (YOY) this holiday season from Nov. 1 to Dec. 24. — SpendingPulse had anticipated just a 7.1% increase. The American consumer remains strong and will be a net plus for U.S. stock markets in 2023, as inflation continues to subside throughout the year and the consumer gets more bang for the buck.
A December 28, 2022 CNBC report’s headline, “U.S. records 100 million Covid cases, but more than 200 million Americans have probably had it” says it all. As we enter the fourth year of Covid, the variants are getting more transmissible but less deadly. The 2022 holiday season has so far not witnessed the kind of spike in cases and deaths that we had during the holiday seasons of 2020 and 2021. Irrespective of what the medical professionals and the media say, Covid is in the rear-view mirror for most Americans as we ring in 2023—this makes it a net positive for U.S. stock markets.
A December 14, 2022 TransUnion report, “More Pronounced Changes Expected in Consumer Credit Market in 2023 Even as More Than Half of Americans Remain Optimistic About Their Financial Future,” states:
“Despite a challenging macroeconomic environment, TransUnion’s new Consumer Pulse study found that more than half (52%) of Americans are optimistic about their financial future during the next 12 months. The youngest generations – Millennials (64%) and Gen Z (61%) – are most optimistic. The optimism levels are occurring against a backdrop wherein 82% of consumers believe the U.S. is currently in or will be in a recession before the end of 2023. The forecast found that there is room for optimism with auto loan and home equity originations expected to rise next year.”
So, even as delinquency rates are expected to rise in 2023, the overall consumer credit situation remains optimistic—consumption contributes ~70% to US GDP—and hence is a net plus for U.S. stock markets in 2023.
NBC News December 28, 2022, report, “After FTX’s spectacular collapse, where does crypto go from here?” stated the following:
“‘The issues we’ve been seeing in this space have been caused by individuals and institutions making mistakes or taking on too much risk, or worse,’ said Daniel Stabile, a partner at the Winston and Strawn law firm and co-chair of the firm’s digital assets and blockchain technology group.
Critically, experts say, nothing that’s transpired in the crypto market in 2022 undermines the inherent value of the blockchain. That’s the distributed, peer-to-peer network that processes bitcoin transactions and which technologists see as crypto’s core innovation.”
Which is similar to what I had tweeted on November 18, 2022, a week after FTX declared bankruptcy:
“Key takeaway of #FTX implosion is that old world corporate finance is not adequately equipped to deal with new world of crypto currencies—in a rush to regulate SEC must be careful not to ‘throw out the blockchain with the bad crypto actors!’”
The bottom line is crypto will rise again but it unlikely to reach the stratospheric heights it did in 2021—so, 2023 will be a year of consolidation and a rebuilding of investor confidence in crypto, which makes it a net positive for stock markets going forward.
JP Morgan’s December 23, 2022, report, “Currency Volatility: Will US Dollar Strength Last?” states:
“After a year of aggressive hiking and with another increase due in January 2023, the Fed will likely hold its policy rate and monitor the economy to see the full effect of its tightening so far. This pause should give the dollar’s rise a breather.
“Overall, while there are several possible pushbacks to USD strength from outside the U.S. — including negative growth surprises, the policy response to Europe’s energy crisis and currency interventions — the outlook for the dollar remains bullish into 2023. ‘We forecast a relatively modest 2% strengthening of the broad dollar index from current levels.’”
One can only conclude that a steadier greenback in 2023 won’t have much of a negative impact on the U.S. stock market like it did in 2022.
“A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.”
– Burton G. Malkiel, Author of “A Random Walk Down Wall Street.”
The forecast miss—by afore-mentioned experts—by double-digit margins of their 2022 year-end target for the S&P 500 is even more inexplicable because it should be seemingly easier to estimate the movement of an index than to pick a smaller basket of individual stocks. So, if these experts were to err by the same margin (ranging from 12.7% to 27.5%) in the afore-mentioned C-suite fueled upside expected in 2023—by which they have already erred with the larger downside we’ve experienced in 2022—the S&P 500 could end up anywhere between 4335 to 5072! Even if we split the difference, the S&P 500 could close YE 2023 at ~ 4704, which happens to be closer to Fundstrat’s Tom Lee’s target of 4750, as reported by Business Insider. However, while Tom Lee had nailed his YE 2021 forecast for the S&P 500 of ~4800, he was ~12.7% shy off his revised YE 2022 forecast of ~4400+. But then there is Professor Jeremy Siegel—from The Wharton School of the University of Pennsylvania—who told Scott Wapner, CNBC’s host of “Overtime,” in an interview on his year-end show, “My projection is a 15% increase [for the S&P 500 in 2023],” which would put it at 4415—just shy of the top 2023 forecast of 4500 by a Deutsche Bank analyst cited above. Professor Siegel also mentioned that expected job losses in 2023 would, in fact, make companies more productive, which is a good thing. In any case, two consecutive down years are a rarity in U.S. stock market history. As reported by Bloomberg in its December 21, 2022 article, “S&P 500 Facing a Historical Warning Sign After This Year’s Slump:”
“Since 1928, the S&P 500 Index has only fallen for two straight years on four occasions: The Great Depression, World War II, the 1970s oil crisis and the bursting of the dot-com bubble at the start of this century. In the benchmark’s almost 100-year history, such occasions are clear outliers.”
We have already been through a once-in-a-century pandemic and U.S. financial markets have already baked in most of the fallout resulting from it. The ensuing C-suite of positive factors highlighted in this commentary make it increasingly unlikely that 2023 will be a second straight down year for the S&P 500. 2023, like 1983, is more likely to witness the dawning of another “morning in America,” whether the technical chartists and the fundamental analysts foresee it or not. Not because their data/analyses are wrong, but both, macroeconomic and geopolitical circumstances have been defying logic during the pandemic era and there is no reason to believe we will be fully back to normal market behavior in 2023. Happy New Year to all!
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