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2023 Market Narrative

Unlike last year when nothing was certain and anything could happen, 2023 looks like markets are returning to reason. Fear won’t disappear in 2023 but the bottomless fear that accompanies world altering pandemics, societal lockdowns and helicopter money can finally step out of the spotlight. We can thankfully say 2022 is over and last years headwinds may turn into sailable cross winds of 2023.


But before I get into this year let’s look at a little history to find some common ground.


Since 2018 trade wars have expanded globally, a sweeping pandemic rocked global economies, supply chains went through complete overhauls, all while governments nearly made borrowing money cheaper than cash. Up until November 2021 stocks skyrocketed despite all the pandemic problems and uncertainty, but on the premise of one sentence from the world’s most powerful money manager, markets turned.


So what happened? And who is that?


If you guessed the Federal Reserve, you are correct. If we look back at FOMC statements from 2020, we find a consistent thread as they responded to economic data during the pandemic. In every statement they have reinforced their commitment to promote maximum employment and price stability. Of course, there are plenty who will debate if they successfully accomplished their goals, but I’m not here to complain. No I’m writing, to draw our attention to four key market moments captured by FOMC statements, because they just may help us plan for 2023.


As the country began returning to normal, Each FOMC statement from December 2020 to June 2021 contained the sentence:

“(the FOMC) will continue to increase its holdings…until substantial further progress has been made toward (their goals).”

This statement implied that there was still a ways to go, but after 15 months of propping up the markets through quantitative easing and asset purchases, the July of 2021 statement followed up with a new sentence:

“Since then, the economy has made progress toward these goals…”

You might say they were a little late to the game, but that’s not what I want to point out yet. At this point Markets started to get a little choppy, but the FOMC did not say how that changed things. Then in September 2021 the FOMC added one more sentence to follow the other two:

“If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted.”

Markets had a hard time digesting the possibility of a fed pivot, but in November we saw the Fed implement their beliefs when they began reducing purchases in treasury and MBS markets. From this point on the markets turned.


The Nasdaq index was the first to reflect the shift, as it was significantly more leveraged than other popular indexes. As the December meeting approached, everyone wondered if there would be a pattern in the coming months.


The Chart below sums it up.

When I look at this chart and read the FOMC statements, I have three thoughts worth carrying into 2023.

  1. Markets want consistency from the fed.

  2. Markets whipsaw when fear takes hold.

  3. Vague Monetary goals increase the monthly gap between market highs and lows.

So, what could change in 2023…


1.) We could see rate hikes cease:


If the Fed behaves like they have in the past, they will make a subtle policy statement that reflects a shift in their approach 2-3 months in advance. Has that happened yet? Yes. In November, they included a new sentence to their FOMC statement that had been lacking in all other statements:

“(they) will take into account… the lags with which monetary policy affects economic activity and inflation…”

December was the first meeting that revealed the seriousness of how they account for lagging indicators. The committee decided to slow rate hikes to 0.50%. Will the January meeting be the turn the markets are looking for? My guess is, no. As earnings reflect how expensive short-term financing has become in Q4 2022, fear will weigh heavily on markets until the Fed meeting in March/April. However, if they release a statement in January that describes a plan to end rate hikes, this would bring confidence and consistency back to lending markets.


2.) The whipsaw could steady out:


If the Fed comes out of this month with a plan, we should see equity markets begin to steady out (ie: not whipsaw back and forth). Businesses that rely on financing could come to lenders/investors with a plan showing how much money they will need and what growth over time will achieve their plans goals. Financers of these businesses could grow more confident when rising rate stop pushing the profitability goal line back every month. Under current monetary policy the fed makes it harder every month for companies to afford debt payments. Some of these businesses will have to find ways to cut costs or make more revenue in order to avoid a debt spiral. However, if rates steady out, business executives would be back to working with definable growth objectives rather than a continually more formidable borrowing situation.


3. Companies Would Know What They Need:


If the Fed actually takes into account lagging indicators, perhaps we will get a signal for rate hikes to end between March and May. However, even if the fed stops interest rate hikes, business plans made from 2020 to 2021 will still have to tackle the new cost of financing. These companies will no longer be in limbo if rate hikes end in 2023, and they will be able to find out what they can afford to keep on their balance sheets. Unfortunately, for businesses looking to cut costs, employment and non essential business services will be the first to go. Have we seen this happen yet? It is just beginning. The ISM services report came out below 50 indicating a pullback from previous months. Also more and more companies have started to announce employment cutbacks. The job market reports strong job openings, but hours worked is starting to show a decline.


Even if rates stabilize a half or a full point higher, leveraged companies are on borrowed time to break out of a debt cycle by reaching growth numbers or making cuts in the cost of doing business.


Summary:


Likely in the first half of 2023, rates will stabilize, which will be good news compared to continually climbing rates of last year. As first Quarter 2023 earnings rollout, companies will reflect the higher cost of debt. There will be some that sacrifice free cash flow for debt servicing and then others that capture new revenue. It will be, as many say, “a stock pickers market.” In the second half of 2023 we will find out how prepared companies had been to meet the rising costs of business. Right now many people wonder if there will be a market recession in 2023 or 2024 or a “soft landing.” I think a timelier question would be “how far through a recession are we?


During the great recession of 08-09, Nasdaq stocks peaked in October of 2007 and declined at a rate of 3.4% per month for 16 ½ months the recession wasn’t declared until month 14 on December 1, 2008. Currently the Nasdaq has declined for 13 months at a rate of 2.8% per month starting from its high in November of 2021 to its low in December of 2022.


If the Fed actually “accounts for economic lag caused by monetary policy,” it would seem that markets have already gone ¾ of the way through a market recession. As earnings come out, the most valuable question to ask is not “have earnings gone down,” but who has kept up their revenues, beaten the trends, and can manage their debt at least until falling rates sometime in 2024.


Securities offered through International Assets Advisory, LLC (“IAA”) – Member FINRA/SIPC. Advisory services offered through International Assets Investment Management, LLC (“IAIM”) –SEC RIA.


Blacor Investments is unaffiliated with IAA and IAIM. The information provided is based on carefully selected sources, believed to be reliable, but whose accuracy or completeness cannot be guaranteed. All information and expressions of opinions are subject to change without notice and are those of Blacor Investments.


Past performance may not be indicative of future results.

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