In 2022, U.S. financial markets experienced unusual volatility due to the confluence of higher interest rates, inflation, Russo-Ukrainian war, and fears of global and U.S. recession, leading to significant losses in most asset classes except for commodities. However, it appears that markets may be stabilizing in the year ahead, as inflation continues to fall, the Federal Reserve nears the end of its tightening cycle, and a U.S. recession is likely to be moderate rather than devastating.
U.S. GDP increased by 2.9% annualized in Q4 2022, exceeding prior expectations of 2.8%, and exceeding the 20-year average of 2.0%. Domestic consumption remained strong through the end of the year, with personal consumption (67.9% of GDP) being the largest contributor to quarterly GDP.
There are clear signs that the U.S. economy is likely to step into recession in 2023. Higher interest rates have started to weigh on business investment, private investment, and the real estate market. Home building and home sales have slowed down considerably due to the higher interest rates, as mortgage rates have more than doubled during 2022. Unemployment is still near historical low, but labor job market is showing signs of cooling off. The strength of the U.S. dollar, which rose by approximately 9% for 2022, combined with economic weakness internationally, will likely inhibit net exports in the near term.
Federal Reserve, Inflation, and Employment
The rate of inflation appears to be under control by the end of 2022, after a strong 2-year hike. Consumer prices rose by 7% and 6.5% in 2021 and 2022, respectively, but are expected to fall below 5% for 2023 by consensus estimate.
From a longer-term perspective, the inflation cycle in 2021-2022 seems more like part of a long-term economic cycle than an outlier. In the past 10 years from 2013-2022, the average annual increase in consumer prices has been 2.6%, which is still well below the 3.8% average price increase from 1960 to 2022.
The labor market remained strong in Q4, as unemployment rate remained at 3.7% in November 2022, which is near the historical low. However, it is clear that the market is slowing down. Hiring has slowed, as 263,000 jobs were added during November, the lowest number since April 2021. Unemployment claims have risen from their low in the first half of 2022, as workers who are laid off are taking longer to find new jobs.
The Fed’s final rate hike of 2022 was a 0.50% increase in December, as expected. This is after four consecutive 0.75% tightening moves throughout the year. The Fed remained firm on continuing its tightening cycle at the December meeting, however, the median expectation among FOMC members indicates that rates will rise to a range of 5.00% to 5.25% by the end of 2023, which is “only” 0.75% higher than at end of 2022. This data, coupled with recent inflation trends, seem to suggest that the tightening cycle is likely coming to an end in 2023.
U.S. Stock Market
U.S. corporate earnings have declined 5.7% during 2022, driven by rising labor costs and production costs, higher interest rates, and slowing nominal sales growth during the year. The consensus expectation is for earnings to be flat or down modestly in 2023 compared to 2022. A closer look at S&P 500 earnings data suggests that the rise in production costs, rather than a decrease in demand, was the main driver for declining earnings. This is evidenced by a sharp reduction in profit margins while revenue growth remained healthy and positive on average.
Higher interest rate, a recession (or the fear of one), and low consumer confidence will make the year ahead challenging for corporations and consumers. The Fed will likely continue raising rates until inflation comes down much further. Labor market appears to be cooling off but employment level is expected to remain strong compared to historical average. Asset values in general are likely to decline or stay flat amidst the weakening fundamentals and high cost of capital.
A recession in 2023 seems more likely than not at this time, but its extent may not be as devastating as some have feared. Corporate finances are in reasonably good shape and employers in general are not planning for excessive layoffs or downsizing (except for parts of technology sector). Household debt level is also low compared to the start of previous recessions. Inflation will likely be significantly lower by the end of 2023, allowing the Fed the possibility of quantitative easing. These factors altogether suggest a moderate recession if one should take place. Furthermore, if the current economic headwinds eventually lead to lower wages and easing monetary policy, they would also stage the U.S. companies for long-term growth.
Data Sources：CBRE Research, CBRE Econometric Advisors, J.P. Morgan Asset Management, CoStar Realty Information Inc., Bloomberg, WSJ.com, Zillow Group, Redfin, Bureau of Labor Statistics, & U.S. Census Bureau
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