Monthly Outlook 202212 - Timing the Recession and the Fed‘s Pivot： Bullish and Bearish Views on the 2023 US Stock Market

MonthlyOutlook202212 EquityResearch·StrategyResearch·MonthlyOutlook TimingtheRecessionandtheFed'sPivot:BullishandBearishViewsonthe2023USStockMarket ReportThesis: AlthoughtheFedhasindicatedthatithasnointentiontocutratesin2023,themarketisstillclingingtothehopethatpolicyrateswillpeakinMay2023theearliestandthenstarttodecline.Investors’outlooksforoverseasmarketin2023aredivided,andwearemoresympathetictothebearishviews. ReportAbstract: AnOverviewoftheBullishViews: Thetrendisbecomingmorepronouncedthatinflationispeakingorreachingapeakingsoon.InadditiontothemoderatingPCE,consumers'inflationexpectationsfortheyearaheadfellsharplyinDecember2022.However,wearewaitingforthistrendtobecomemorevisible. AveragehouseholdequityallocationintheUShasfallensharply.Historically,thisindicatorisnegativelycorrelatedwithstock-marketreturns.Inthecurrentbearmarketinwhichbondshaveperformedjustaspoorly,thedecreaseintheproportionofstockallocationmoreclearlyshowsthatinvestorshavebeenactivelysellingofftheirequityassets.BullishinvestorsexpecttheUSstockmarkettobottomoutinthefirstquarterof2023. Since1946,mostyearsinwhichUSstockshavefallenhavebeenfollowedbybullishreturnsinthefollowingyear.A19%dropintheS&P500thisyearcouldmeanareboundin2023.However,weconsiderthistypeofinductivereasoningtoberisky,aseventhoughitisimprobablethatthemarketwillbebearishfortwoyearsinarow,everyinstancethatthemarketfellfortwoconsecutiveyears,itfellhard. AnOverviewoftheBearishViews: Evenifinflationfalls,itisstillfarfromtheFed's2%inflationtarget,andhopesofaratecutin2023arelikelytobedashed.However,wedobelievethatthekeyelementforthe2023stockmarketwillbethetimingoftheFed'spolicyshift,whichwillcreatestructuralopportunitiessimilartothoseseeninNovember2022,althoughasustainedbullmarketislesslikelytooccur. Thereisgoingtobeaheadwindforinvestorsineitherdirectionofearningsorvaluation.TherisktoearningsisthattheFed’spossiblepivottoanendofitsratehikesin2023wouldbebasedonthefactthattheeconomywillenterrecessionbythefirsthalfof2023,meaningthatdownwardpressureonstockearningswillhitthemarket.TherisktovaluationisthatiftheUSeconomydoesnotfallintorecessionin2023,theexpectationsofratecutswillhavetobeadjusted. Marketsentimentisgloomyandoutflowsfromriskassetsarelikelytocontinue.GlobalfundshavetakentherecentrallyasanopportunitytosellandfledtheUSstockmarketoverChristmas.Inaddition,mostinstitutionsviewbondsasarelativelybetterbetin2023amidarecession.Webelievethatasinflationislikelytobesticky,investorsshouldremainconservativeonthespaceforlong-termbondyieldstofall. Risks:TheFedcouldremainhawkishanddoesnotcutratesin2023evenifinflationcoolsdown;Marketsentimentispessimisticandoutflowsfromriskassetscontinue. 12January2023 ResearchAnalystShiruiOuyang(852)38923120 ouyangshirui@dwzq.com.hk Relatedreports 1.EmbracingRisksandOpportunities 2022-04-11 2.TheUSStockMarketHasNotFullyPricedinInflationDataandInterestRateHikes 2022-06-29 3.FadingInflationandGrowth:WhatAretheSignalsDeliveredbyUSEconomicIndicators? 2022-07-20 4.NegativeInterestRateEraisOver,andWhereisEurope Headed? 2022-08-09 5.BePreparedforFurtherAggressiveFedRateHikes 2022-09-16 6.ReduceriskexposuretoEuropeanmarketsandbewareofliquidityshortageintheUS 2022-10-17 7.ReduceriskexposuretoEuropeanmarketsandbewareofliquidityshortageintheUS 2022-11-28 Wewouldliketoacknowledgethecontributionandsupportprovided byHanruoFeng(冯涵若). TableofContents 1.AnOverviewoftheBullishViews5 2.AnOverviewoftheBearishViews8 3.RisksHighlight9 TableofFigures Figure1:TheFed’sdotplotinDecember2022showsthatofficialexpectationsforthepeakinterestratein2023isupfromthepriorroundofprojection4 Figure2:MarketimpliedFedpolicyratepeakrosetoabove5%fromtheexpectationof4.9%amonthago(asofDecember262022)4 Figure3:MarketimpliedFedpolicyrateasofNovember20224 Figure4:Consumers'inflationexpectationsfortheyearaheadfellsharplyinDecember5 Figure5:NewordersfordurablegoodsdeclinedinNovember20225 Figure6:Newordersfornon-defensecapitalgoodsexcludingaircraftstillshowedamonth-on-monthincreaseinNovember5 Figure7:AverageUShouseholdequityallocation(asofDecember2022)6 Figure8:GlobalfundsoutflowfromtheUSanddevelopedmarkets6 Figure9:GlobalfundsoutflowfromUSequity6 Figure10:S&P500returnsafterbearishyearssince19467 Figure11:USequitymarketperformanceduringthelastfivetradingdaysofthecalendaryearandthefirsttwoofthenewyear(asof2021)9 Whilecentralbanksaroundtheworldarestartingtoslowtheirpacesofinterestratehikes,theirwordsregardingfuturepolicymovesremainhawkish.AccordingtotheFederalReserve'slatestdotplotasofDecember142022,officialexpectationsforthepeakinterestratein2023isupfromthepriorroundofprojection.MarketimpliedpolicyratepeakasofDecember262022rosetoabove5%fromtheexpectationof4.9%amonthago.AlthoughtheFedhasindicatedthatithasnointentiontocutratesin2023,themarketisstillclingingtothehopethatpolicyrateswillpeakinMay2023theearliestandthenstarttodecline.Italsomeansthatthesecondhalfof2023couldbemorebullishforUSstocksafteritssteepdeclinein2022. Figure1:TheFed’sdotplotinDecember2022showsthatofficialexpectationsforthe