LPL Research’s Outlook 2023: Finding Balance is our guide to how the readjustments in the economy and markets may impact you in the coming year. The disruptions may not be fully resolved and there may be more challenges to come, but progress toward finding balance is well underway.
Through all the challenges, newfound opportunities, and highs and lows we’ve experienced during the last couple of years, it’s no surprise why we might be striving for more balance. Whether it’s about the markets and global economy or what’s happening in our local communities, the news we’re hearing on a daily basis has the potential to disrupt the balance of our lives. But with resilience, perspective, and the support of close connections, we can navigate through it all and regain our sense of equilibrium—even after another dizzying year, as 2022 proved to be.
After two years of disruption due to the COVID-19 pandemic, we’ve been searching for some kind of return to normalcy while still experiencing the aftereffects of the pandemic. Some of those aftereffects included imbalances created by the fiscal, monetary, and public health policies put in place to address the pandemic—and the process of addressing those imbalances has been disorienting at times. If 2022 was about recognizing imbalances built into the economy and starting to address them, we believe 2023 will be about setting ourselves up for what comes next as the economy and markets find their way back to steadier ground—even if the adjustment period continues.
The Federal Reserve (Fed) spent 2022 aggressively fighting inflation by raising interest rates. In 2023, we expect the Fed to find that point where it can stop raising rates as inflation starts to come under control. The Fed’s efforts to control inflation throughout 2022 pulled interest rates up from extremely low levels that were historically unprecedented. While that has been painful for bond investors, savers can now get an attractive yield for the first time in over a decade or since 2007 and 2023 will be more focused on how to potentially benefit from this significant shift. Stock market expectations may also see some realignment heading into 2023. The projections for certain market segments became too high in 2022 following a decade of low rates and a burst of extraordinary technology adoption. We expect 2023 will likely be more focused on the opportunities that may emerge from a market sell-off.
LPL Research’s Outlook 2023: Finding Balance is our guide to how the readjustments in the economy and markets may impact you in the coming year. The disruptions may not be fully resolved and there may be more challenges to come, but progress toward finding balance is well underway. And when those disruptions hit the market, it can be hard to find our footing and stay the course. Those are the times when sound financial advice is more valuable than ever, as it helps us find our center, remember our plan, and stay focused on our goals.
The global economy will likely slow from above 3% to somewhere in the mid-2% range in 2023. An important aspect for investors is that the U.S. appears to have fewer headwinds to growth compared with Europe and other developed economies. The divergence between domestic and international economies is most obvious in the inflation regime. For example, in late 2022 Germany was experiencing accelerating rates of inflation, while at the same time the U.S. appeared to be moving past the peak. The longer inflation is uncontained, the riskier the growth prospects. If the U.S. falls into a recession, it is more likely to occur during the first half of 2023 and would probably not be as deep as the 2008 recession, which was initiated by a fundamentally flawed financial market.
We will likely enter 2023 with a slightly different trajectory for inflation—particularly services inflation. In recent months, durable goods prices have clearly decelerated—and in some cases, outright declined—but services prices have been stubbornly accelerating as rent prices and health services have risen. We could potentially be entering a new regime as rents across the country are showing signs of abating.
During this transition period for services prices, the coming year could be the time when inflation is convincingly decelerating closer to the Fed’s long-run target of 2%.
If stocks are going to go higher in 2023, a prompt end to the Fed’s rate-hiking campaign will likely be a key component. The timing of the last rate hike of this cycle is uncertain and won’t be clear for a while, but our view is that the Fed will pause during the first quarter of 2023 amid an improving inflation outlook and loosening job market. Should that occur, stocks will likely move higher, consistent with history.
Stocks have tended to produce solid gains after hiking cycles end, including a 10% average gain one year later.
The path of interest rates will certainly be largely influenced by the Fed’s behavior, which will be guided by economic growth and inflation data. Equally important is the level of non-U.S. developed government bond yields, as foreign investors play an important role by purchasing U.S. Treasuries. Higher foreign market yields, all else equal, generally dissuade foreign investment into our markets. There are a range of scenarios we think could play out over the next year. However, given our view that the U.S. economy could eke out slightly positive economic growth next year, we think 10-year Treasury yields could end the year around 3.5%.
The 2022 midterm election was closer than many expected but, in the end, voters chose to rebalance the power dynamic in Washington. As expected, Republicans gained enough seats to win a narrow majority in the House, while Democrats held on to their slim majority in the Senate. Despite Republicans’ narrow House majority, their victory in the House significantly shifts the balance of power, since only legislation with broad bipartisan support will get passed once the new Congress is sworn in on January 3, 2023.
Uncertainty surrounding the course of the Ukraine-Russia conflict has thwarted diplomatic attempts to reach a negotiated settlement. The intense military campaign involves a significant contribution from NATO toward the Ukrainian war effort, specifically from the United States. Depending on how long the fighting continues, it is expected that many NATO countries, including the U.S., may debate the financial burden. Markets historically have navigated regional conflicts fairly well despite the human toll. The largest market vulnerability remains the war’s impact on inflation.
This year the global economy adjusted to a higher interest-rate campaign initiated by most central banks in order to tackle inflationary pressures. As such, expectations are rising that several regions may face a recession or a significant economic slowdown will unfold, which would weigh on demand. Unless there are severe shortages, commodity prices typically tend to ease until there are signs that central banks are nearing the end of the rate-hike cycle.
To say the U.S. dollar has vaulted higher during the Fed’s rate-hike cycle would be an understatement. Whether it is the result of the interest-rate differential (that is, that the Fed has been more aggressive than other central banks) or that U.S. markets have been attracting more investments from foreign investors, the result has been staggering. The strong dollar, while making imports less expensive, has put pressure on many of the large multinational companies with a global footprint.
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