Another difficult year for trading: inflation, recession and high volatility

Early estimates of what could happen to the US economy in 2023 point to the obvious facts: high inflation, the possibility of a recession, and a high level of volatility.

However, despite the fact that traders will receive one last rate hike from the Federal Reserve in December, some economists believe that looking at data on consumer activity and the health of the economy will be more important in 2023 than central bank decisions.

Logically, monetary policy decisions throughout 2022 set the tone for trading. They were the Fed’s primary tool for fighting runaway inflation and started in the United States earlier than other developed economies.

But the latest inflation data is softening and this is reflected in the S&P 500 index with gains of more than 14% from the October lows. Meanwhile, fixed income declined, reflecting expectations of lower inflation and lower inflation-adjusted interest rates.

It’s not inflation, it’s a recession

Economists say investors who have targeted the Federal Reserve for their decisions have missed the delicate implications of tightening monetary policy: a recession or an economic slowdown.

The US economy is likely to start feeling the effects of interest rate hikes in 2023, as the economic results of these hikes are usually seen after six to 12 months.

Therefore, many economists predict that US economic growth in 2023 will be weak, with business volumes of companies, their ability to set prices and their profits, declining. Yet earnings forecasts and stock prices do not reflect these estimates.

For this reason, some economists recommend focusing trading on consumer activity rather than the Federal Reserve’s monetary policy decisions. That’s because consumer spending, which makes up two-thirds of US economic activity, will likely determine the timing and depth of the economic slowdown.

It is also likely to affect the timing of interest rate cuts, which have historically been a more reliable signal of the end of a bear market.

And when it comes to consumption, it must be admitted that the numbers were very strong throughout 2022. For example, the labor market held up well, with the unemployment rate at 3.7% in November, just below the minimum of 50 years .

On the other hand, wage growth, while not fully offsetting inflation, was strong at 5-6%. And personal spending has held up, with October data indicating a real consumption rate close to 6%.

Finally, inflation-adjusted retail sales have remained above trend since 2015.

First signs of slowdown

Despite all this good data, there are already some signs of an economic slowdown. For example, the personal savings rate, once supported by stimulus, fell from a peak of 33.8% in April to 2.3% in October, its lowest level since 2005.

Debt from revolving credit cards that finance purchases has soared to an all-time high of about $1.2 trillion. And the number of vacancies is declining, as evidenced by the survey of job openings and job turnover. There were 10.3 million vacancies in October, the latest figures available, 760,000 fewer than a year earlier.

The same survey also showed a downward trend in the level of rejections, which were pointing towards four million compared to the record 4.5 million collected in March 2022, suggesting that there is less confidence in the possibility of finding a job.

If we put all this data together, it can be seen that labor market data and consumer data are the most important from now on, as they will determine what comes next in terms of economy and trade.

Especially since this growing anxiety in the face of a slowing economy does not appear to be matched by current valuations and profit expectations. And since policy-driven bear markets typically don’t end until estimates break highs and the Fed starts cutting rates, that means it’s likely it will take some time to see the end of this stock bear market. .

Therefore, equity trading will have to be more bearish than bullish and it will be wise to focus on value rather than growth stocks, looking for that safer return they can provide investors during a difficult year.

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