There is a good chance the stock market will post a gain in 2023. The overarching reason is simple: A lot of the bad news has already been reflected in the market.
This year has been ugly for stocks: The S&P 500 is down about 16% from its all-time high, hit in early January. Over the summer, it entered bear market territory, defined as a 20% or greater drop. The declines came as the Federal Reserve steadily lifted interest rates and reduced liquidity from the financial system to squelch high inflation. Even before rate hikes, inflation itself was cutting into consumer demand and corporate profits. Higher rates also further reduce economic demand and make future profits less valuable, pressuring stock valuations. All in all, it has been a tough combination for equities.
But now, some of those factors are easing.
Inflation, for its part, is cooling, and that’s usually a positive setup for the stock market. In months when inflation moderates and economic growth is stagnant, the S&P 500’s average annualized return has been 13%, according to Evercore. In November, the consumer price index rose 7.1% year over year, below its 9.1% peak hit over the summer. To be sure, how quickly inflation continues to decline is still a question, but the expectation is indeed for falling inflation over the coming year.
Moderating inflation could also lead the Fed to pause its interest-rate increases. A simple “cross-asset” correlation this year has been that higher interest rates meant lower stock prices. So another factor behind possible stock gains next year would be if bond yields fall to reflect this Fed pause. (Of course, too slow a drop in inflation could mean the Fed will remain aggressive in lifting rates.) Stabilizing or falling rates typically mean there’s an end in sight to the damage to economic growth and earnings.
That’s the main factor that the stock market remains concerned about: earnings. Analyst’s earnings expectations, which have declined a bit recently, will likely fall more from here higher interest rates dent demand.
That brings us to the second reason 2023 should be a decent year for stocks. The market will likely price in the bottom in earnings before it arrives—and it’s entirely possible that the market is currently close to doing so. If earnings do decline next year, history shows the stock market can still gain. In the majority of 12-month stretches when aggregate earnings per share for
companies was down year over year, the index gained, according to Evercore. The bank observed more than 10 such stretches.
None of this means the stock market is going to rip higher in 2023, but it’s reasonable to expect that it will stabilize and then trudge higher.
Write to Jacob Sonenshine at email@example.com