With a dismal year ending for both stock and bond markets, investors around the world can attribute most of their troubles in 2022 to record high and persistent inflation. At its peak, inflation, as measured by the Consumer Price Index (CPI), reached 9.1% this past June. Overseas in Europe, primarily because of uncertainty brought on by the war in Ukraine, inflation registered as high as 11%, likely pushing the Eurozone into recession in the fourth quarter. Energy shortages have been a major story in Europe, while broader service price inflation has infiltrated the U.S. economy. In large part due to these runaway prices, this year has been one of the most fluid and rapidly evolving economic landscapes in history, with the coordinated tight monetary policy by central banks in Europe, Asia, and North America being unprecedented in scope.
Incredibly, despite all the handwringing and dour forecasts, the U.S. economy has weathered these high prices and grown by 2.6% in the third quarter, supported by a strong employment market and job creation. In a recent jobs report for the month of November, 263,000 jobs were added, anchoring the unemployment rate at a low of 3.7%. However, cracks have been appearing in the foundation of the U.S. economy, including the biggest jump in national credit card debt in over 20 years (totaling $925 billion in card balances). On the corporate earnings front, companies are preparing to report quarterly results soon, with analysts predicting lower profits for the fourth quarter as well as negative guidance for earnings in 2023. Even the tight labor market could be vulnerable, with leading companies like Microsoft and Amazon moving forward with recently announced staff reductions, in turn jeopardizing the healthy 5% average wage growth enjoyed by the American worker.
There has been much speculation about the prospects of a global recession, and what impact that would have on the U.S. economy. In an ominous message recently published by the Organization for Economic Cooperation and Development (OECD), their leading indicator for the world’s economies is pointing to at least a mild recession in 2023. On a more hopeful note, economists point to the re-opening of the Chinese economy next year as a potential catalyst for improved business conditions around the world. After all, China is home to 1.4 billion consumers who have been exhibiting signs of pent-up demand during their country’s lockdowns and zero-COVID policy. While China’s economic might has the capacity to fuel global growth, there is an accompanying concern that their demand-driven rebound could further exasperate inflation in both commodities and goods prices.
Turning our attention to the markets, while lower stock and bond investment returns are roundly unwelcomed by investors, there is a silver lining in the form of improved buying opportunities. With U.S. stock indexes down 20% for the year, and bond yields higher by 2 to 3 percentage points, investors can visualize higher returns on new investments. In fact, high quality company stocks can now be bought for a reasonable valuation multiple of 16x price to earnings.
Looking ahead to 2023, markets are expected to be volatile as investors face the prospects of a global recession, continued high interest rates, and declining profits for companies. As it relates to interest rates, the Jay Powell led Federal Reserve has been steadfast that the federal funds rate will need to sustain 5% to tame inflation. This approach by the Fed and their peer central bankers poses a downside risk for the global economy, as overly tight monetary policy can stifle business conditions and amplify a potentially painful recession. The Fed’s stated goal is for long-run inflation of 2%, and they appear steadfast in achieving this target, even if it means a recession and hard landing for the U.S. economy. Of course, there will be surprises in the New Year as well, reinforcing both the importance and effectiveness of diversification, risk management, and planning in the pursuit of long-term investment objectives and goals.
