US stock market 2023 outlook: Can a soft landing still be achieved?
14:05, 22 December 2022
2022 has been quite the ride for the stock market as geopolitical tensions, macroeconomic uncertainty and interest rate hikes took over market sentiment. As expected on the back of the Russia-Ukraine war, the best-performing sector has been energy, whilst technology, consumer discretionary and communications have been the worst performers.
2022 S&P 500 sector performance
2022 S&P 500 sector performance. Photo: capital.com. Source: tradingviewS&P 500 sector weights:
- Information technology: 28.1%
- Health care: 13.3%
- Consumer discretionary: 11.8%
- Financials: 11.5%
- Communication services: 9.6%
- Industrials: 8%
- Consumer staples: 6.2%
- Energy: 3.7%
- Real estate: 2.6%
- Materials: 2.6%
- Utilities: 2.6%
US stock indices: 2022 in review.
Throughout 2021 we saw a post-covid economic recovery that gave a boost to stocks as bottlenecks in supply chains were starting to clear. The rally gather such momentum that most major indices reached new all-time highs in the first few trading sessions of 2022 as the S&P 500 (US 500) broke above 4,800, the Dow Jones (US 30) above 36,950, and the Nasdaq (US 100) and Dax 40 (DE 40) above 16,000.
S&P 500, DJIA, Nasdaq, DAX 40, FTSE 100 performance (March 2020 - December 2021)
S&P 500, DJIA, Nasdaq, DAX 40, FTSE 100 performance. Photo: capital.com. Source: tradingviewBut the rally quickly faded as we started the year and US stock indices entered a bearish cycle that is still holding at the time of writing in December. The theme throughout 2021 was that inflation was rising which was signalling a recovering economy as consumer spending picked up all whilst central banks were reluctant to raise rates, with Fed Chairman Jerome Powell claiming repeatedly that price pressures were transitory.
Then in the first quarter, we saw war break out in Eastern Europe which sent energy prices soaring, causing more inflation that would end up sending the consumer price index (CPI) to 40-year highs in the summer. Markets started to catch on to the fact that prices were not going to come down on their own and the Fed would have to start hiking sooner than later, which intensified the selloff that had already started at the beginning of the year on the back of massively overvalued stock prices.
The first rate hike from the Fed came in March, which saw the fund's rate increase 25 bps to 0.25%-0.50%, followed by 50bps in May, and 4 consecutive 75bps hikes in June, July, September and November, taking the rate to 3.75%-4%. The final meeting of the year saw an increase of 50bps to 4.25%-4.50%, meaning there has been a total of 425bps of tightening in 2022.
Since the highs seen on January 3rd, most major indices are looking to end the year in negative territory, with the Nasdaq being the most heavily hit of the three major US indices, dropping over 17% as of the end of December.
What is your sentiment on US500?
S&P 500, DJIA, Nasdaq, DAX 40, FTSE 100 performance YTD
Year-to-dat performance of S&P 500, DJIA, Nasdaq, DAX 40, FTSE 100. Photo: capital.com. Source: tradingviewFundamental forecast: can a soft landing be achieved?
Stocks are directly influenced by the amount of liquidity in the economy, the more cash there is to spend the more stock prices rise. Central banks are the gatekeepers to this liquidity and so that is why traders pay so much attention to their meetings and decisions, and 2023 is unlikely to be any different.
The performance of US stock indices in 2022 can be divided into two parts. The first one, from January to September, when the Fed showed peak hawkishness and delivered back-to-back rate hikes which saw a continued selloff in stocks. The second one, from October until mid-December, when markets tried to front-run a pivot from the Fed and started buying back into these stocks at more favourable levels.
The key question now is what is going to happen to interest rates in the first half of 2023. If we take the comments from the December meeting it seems pretty clear that the Fed is not yet done raising rates but even when they are they expect to keep the terminal rate in place for a while, with minimal cuts priced in. This is also evidenced in the latest dot plot chart.
FOMC dot plot comparison September/December 2022. Source: federalreserve.orgOnly two FOMC members see rates below 5% in 2023, a stark contrast to what markets are pricing in. And no, the dot plot isn’t a strict path to follow and doesn’t always predict rates accurately, but it is a good measure to gauge how policymakers are shaping top their expectations for the following months.
So taking in the fact that markets are expecting the fund’s rate to be closer to 4% in December next year, there is a clear mismatch between Fed and market expectations that can be a good opportunity for stock traders.
Market implied December 2023 fed funds rate. Source: bloombergThe Fed hopes a soft landing can be achieved, but that would need to see inflation coming down strongly whilst the economy and labour market remain resilient. Powell and his team are not taking any chances with loosening monetary conditions too soon, which would only aid inflation further, and that is why they are gearing up for elevated interest rates for longer. Given that markets haven’t yet priced this in they don’t have much faith that a soft landing can be achieved and therefore rates will need to be cut in order to aid growth, thus increasing liquidity in the economy.
Soft landing vs hard landing scenarios
So how will stocks fare in both these situations? If the latter is true, then inflation is expected to come down close to the 2% target throughout 2023 which enables the Fed to lower rates as unemployment picks up and growth stagnates. This would indeed reduce the tightness in monetary policy and increase the flow of money, which would be positive for stocks. But this scenario also poses the risk that the economy suffers more than anticipated and, whilst inflation does come down and enables rates to follow, the impact of the rate hikes has a detrimental effect on consumer spending and employment, and thus a deeper recession ensues, which could be damaging for stock valuations.
There is also another thing to consider in this scenario. Whilst softening inflation is good for markets, lower producer prices (PPI), which leads to lower CPI, is a leading indicator of falling earnings per share (EPS), which would also limit the gains in stock prices given price-to-earnings ratios would signal that shares are overpriced.
Now let’s explore what could happen to stocks if the Fed is in fact on the right path and interest rates will remain elevated for longer. As we know because of the pricing in the bond market, traders think that the bank’s hawkishness is a mistake, therefore going against the Fed’s predictions. This gap in pricing would have to be adjusted with yields on longer-dated bonds rising, and thus stocks would suffer. A good way to measure the change in expectations is the economic data releases, so if we see CPI data that remains elevated and a resilient jobs market then expectations will slowly adjust and stock indices will see strong selloffs, the inverse of what we saw back on November 10th when the CPI undershot expectations.
This means that stocks are going to remain highly sensitive to economic data and speeches from policymakers in 2023 as expectations about long-term rates get adjusted along the way.
There are also other risk events that could impact the performance of stocks in 2023, most notably the development of the Ukraine-Russia conflict and the re-opening efforts in China. The latter is expected to aid global growth if successfully achieved, but the resurgence of covid cases following the initial relaxation of restrictions may make the government less reluctant to follow through, meaning there may still be some negative sentiment to be priced into stocks.
Technical analysis
S&P 500
The S&P 500 (US 500) has remained resilient in December despite the hawkish tone from Powell being ramped up once again. It seemed like stocks had managed to successfully pull away from the 2022 lows back in October but the rally run out of steam as it faced the descending trend line that had been set up from the highs back in January.
The December Fed meeting has been the main catalyst behind the recent pullback from that trend line, but the 4-day losing streak was quickly snapped with a good old-fashioned turn-around Tuesday. But the 50-day SMA (3890) is looming up ahead and has already proved its capability to provide resistance for buyers, making the bearish retracement even more valid.
That said, the index has been reluctant to give in to sellers even when it first hit the 200-day SMA back in October, meaning that losses have been limited even when sentiment has been dampened. Traders are likely still trying to convince themselves that 3492 was the low for the year but the seeming lack of conviction that rates will remain higher for longer and the risk of lower earnings in Q1 2023 means there is potential for a further reversal towards 3,500 in the coming months.
But if we do see a recovery in the S&P 500, the 200-day SMA (4012) and the descending trend line are starting to converge, meaning there is a greater capacity for resistance to break a bullish rally. Because of that, the 4,000 mark is likely going to be a tough area for buyers to navigate in the coming weeks. Even if the trend line is cleared, it will take a formation of daily closes and higher highs and lows above this area for the rally to consolidate and build higher.
S&P 500 daily chart. Photo: capital.com. Source: tradingviewNASDAQ
As the major US index with the most price appreciation during 2020 and 2021, the Nasdaq (US 100) has also had the most room to fall in 2022 which has led it to face the biggest drop in the major US and European indices since the highs in January. The Nasdaq is a tech-heavy index and given the perfjoamcne of technology stocks this year, there is no surprise that it fell to 2-year lows during the summer.
The daily chart is showing a similar pattern to the S&P 500 whereby the descending trend line has shown significant resistance and selling pressure. The key difference is that it has not managed to break above its 200-day SMA since April, meaning the rally had less firepower behind it.
The current price is 10% below its 2022 trend line and is hovering around the 11,200 mark, a key area of consolidation back in October. This suggests that there is some indecision as to where the move goes next, but with the RSI below 50, there is an inclination to follow the path of least resistance lower once again.
That said, there may be a short-term ascending trend line forming from the lows in October that could continue to offer support to buyers in the first few weeks of 2023. If that is the case, the index would have to face breaking above the 50-day, 20-day, and 100-day moving averages once again before coming back into contact with the descending trend line and the 200-day moving average, meaning there is plenty of resistance up ahead.
If, however, the Nasdaq break below the short-term ascending trend line (10,955 - 11,120) then the path is open for a retracement back to 10,500 and even possibly the 10,000 mark if market pricing catches up to long-term Fed rate expectations.
Nasdaq daily chart. Photo: capital.com. Source: tradingviewDOW JONES
Whilst the Dow Jones Industrial Average (US 30) was the index that rallied the least on the back of the pandemic recovery out of the US majors, it has also been the one that has held up best in 2022. In fact, contrary to the S&P 500 and Nasdaq, the Dow has managed to break above its 2022 trend line. It is also holding above its 200-day SMA (32,438) so this alone suggests there is a better chance of a followthrough in the rally than in the S&P and Nasdaq.
In fact, the trend line has started offering some support at 32,490 which has allowed buyers to start undoing the post-FOMC selloff. Nonetheless, there are still challenges ahead for the Dow so it is not a clear path higher in Q1, but there may be room for a bounce back towards 34,000 in the short term.
On the other hand, high inflation and a hawkish Fed remain as headwinds heading into 2023 so the descending trend line will be a key test of the strength of sellers. If we see a break below it and the 200-day SMA simultaneously then the other moving averages will likely be breached.
Dow Jones daily chart. Photo: capital.com. Source: tradingviewMarkets in this article
