What's next for the markets and economy?

Jan. 2, 2023

2022 was a bumpy year for investors. Will 2023 be more of the same — or should investors expect improved conditions in the 12 months ahead? Below, our chief market strategist and chief economist provide their insights on key narratives and themes to watch for in the year ahead.

As always, the environment is fluid and new developments may require investors to reset their expectations.

The markets

Investors should continue to brace for more market volatility

At the start of 2023, economic pressures could build as consumers and businesses continue to pare back activity in response to elevated inflation, restrictive monetary policies, and higher interest rates. This could result in lower-than-expected profit growth for the next several quarters. As a result, stocks and bonds could continue to grapple with volatility until the Federal Reserve pauses its tightening cycle and interest rates find an equilibrium. Notably, absent a steady risk-free rate, such as the 10-year U.S. Treasury yield, we believe investors may struggle to confidently price risk assets as the new year begins.

After a transition period, 2023 may finally bring relief to equities

Stock and bond prices spent much of 2022 reacting to deteriorating macroeconomic conditions. In 2023, we believe investors may at some point look past ongoing challenges and on to the next phase of the business cycle when growth prospects improve. Historically, stock prices often begin to turn higher before it is clear economic/profit conditions have reached their lows. For example, during the Financial Crisis, the S&P 500 Index bottomed in late March 2009. By comparison, the National Bureau of Economic Research (NBER) didn't call the end of the Great Recession until three months later. Importantly, S&P 500 corporate earnings, on a trailing 12-month basis, didn't bottom until January 2010.

Bottom line: Stocks may turn higher before the data is clear there is reason to hold a more constructive view on future growth. We believe investors can avoid becoming whipsawed during this transition period by utilizing a well-diversified investment strategy and focusing on high-quality, income-producing assets. During transition periods, we believe this strategy can help investors weather the potential for further downside and participate in the eventual recovery.

The environment could become more favorable for stocks as 2023 wears on

Stocks may see further pressure in the months ahead before possibly participating in a more prolonged recovery phase later in the year. Our base case forecast calls for flat-to-negative S&P 500 earnings growth in 2023. Combined with a modest expansion in the multiple investors may be willing to pay for earnings growth later in the year, we anticipate the S&P 500 Index to finish 2023 higher than 2022 levels.

Inflation, the Fed, and earnings will be the ultimate arbiters of stock performance

If inflation begins to subside at a faster pace, the Fed holds rates at a lower level than most expect, and profit growth remains flat-to-positive, stocks could see more robust returns in 2023, particularly after a challenging 2022.

Conversely, if inflation remains sticky throughout the year, Fed policy tightens aggressively than anticipated, and earnings growth deteriorates more rapidly, the S&P 500 could finish 2023 materially lower than current levels. In our view, investors should balance these dynamics and enter 2023 with a cautious, pragmatic approach to return expectations accompanied by a well-diversified investment strategy.

The economy

An economic slowdown is likely to persist through the start of 2023

U.S. economic growth is likely to slow in 2023 as the cumulative effect of Federal Reserve interest rate hikes weighs on the pace of activity. Currently, we forecast 2023 full-year real Gross Domestic Product (GDP) growth at +0.5% versus 2022 estimated growth of +1.8%. We believe most of the weakness could come in the first half of the year, when we believe interest rates may be at their peak.

Inflation will play a pivotal role in the direction of the economy

In our view, the more important narrative for 2023 will be declining inflation pressures, assuming prices generally follow our forecast. We believe inflation remains the predominant problem as we enter the new year, but recent evidence has been encouraging. Further taming of inflation could enable a more balanced Federal Reserve monetary policy stance sooner rather than later.

We forecast inflation, as measured by the Consumer Price Index (CPI), to decline quickly in the first half of the year. The accelerated pace is partially due to tough year-ago comparisons but combined with improved supply-chain functioning and a slower pace of price appreciation for most goods and services.

While a recession is possible, it’s not necessarily probable

Conditions at some point could meet the definition of “recession,” and we believe the odds of such are slightly better than 50%. If a recession were to arrive, however, we believe it would be relatively shallow considering strong consumer finances, sound corporate balance sheets, and (what we believe would be) a relatively modest increase in unemployment. 

Periods of heightened recession risk have historically been associated with heavy consumer debt burdens. Contrary to that historical pattern, consumers are in strong financial shape with low debt-to-income ratios and ample savings.

The year ahead

Investors should hold a flexible view of the macroeconomic environment at the start of the new year and be willing to modestly adjust portfolios/return expectations as conditions change.

Periods of transition are often tricky to navigate and increase the risk of timing errors that can throw portfolios off track. We believe investors are best served by remaining disciplined, fully invested, defensively biased, and prepared to change course once the storm clouds lift.

If you have questions about current conditions and want to discuss your investment portfolio, consider a review with your Ameriprise financial advisor.