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Should auld Fed chairmen be forgot? Investors carry recession fears into new year

Failing to build on the rally of 2021, Wall Street gave up most of last year’s gains as persistent inflation crashed against the fears of a Fed-driven recession.

MANHATTAN (CN) — Successes from the last 12 months failed to carry over to equities as investors traded their concerns about inflation for concerns about a pending recession.

Since the first day of trading in 2022 to its last, all three major U.S. indices have dropped significantly, leading to the worst year for Wall Street since the beginning of the Great Recession in 2008. The Dow Jones Industrial Average has shed 3,191 points for the year, about a 10% decline, while the S&P 500 fell 927 points for the year.

Without the Covid-related lockdowns driving technology stocks the same way as they did in 2020 and early 2021, the tech-heavy Nasdaq fared much worse this year, plummeting 5,178 points, or about one-third of its value, after starting off the year at 15,644 points. That said, all three indices still are coasting off the gains of 2021 and are still above the low points of 2020.   

As poor a year as 2022 was for stocks, analysts are now split on whether 2023 will be a better one.

“The U.S. economy will need a lot of luck to avoid a recession next year because the headwinds are about to intensify,” Ryan Sweet, U.S. chief economist at Oxford Economics, wrote in an investor’s note. Beyond luck, Sweet continued, investors will need the Federal Reserve to pause its interest rate hikes after February and keep the next hike at bat until 2024.

“The risk to our forecast is that the Fed Raises rates more than we expect and holds them higher for longer, raising the odds that the recession is more severe — but only slightly,” he wrote.

Sweet and his team predict two quarters of economic contraction in 2023, starting with a 3.7% decrease in gross domestic product in the second quarter of next year. But they also believe an impending recession will be short-lived as GDP increases by 1.1% during the fourth quarter of 2023.

Sweet noted that previous recessions associated with balance-sheet shocks led to more severe and longer-lasting recessions, but that a recession in 2023 likely would be quick. “Currently, household balance sheets in aggregate are in great shape, nonfinancial corporate balance sheets are also healthy, and state and local governments are flush with cash,” he wrote.

Without doubt, one of the biggest influences on the U.S. economy this year has been the actions of the Federal Reserve, which began hiking interest rates in March to bump the federal funds interest rate to the 4.25%-to-4.5% range, its highest point in 15 years.

Fed Chair Jerome Powell had gained notoriety in 2021 for claiming that inflation was transitory, but he has since become a born-again hawk and has aggressively and persistently said the central bank would remain nearly singularly focused on combatting decades-high inflation through a slew of 0.75% and 0.5% interest rate hikes.

Markets typically declined around each of the Fed’s seven rate hikes this year — June through November saw four particularly aggressive 0.75% increases — and sometimes even in the face of booming jobs data and significant economic growth.

Another major driver for Wall Street has been corporate earnings, which were unable to compete with the gangbusters performance in 2021. According to analysis by FactSet, the estimated year-over-year earnings growth rate for the S&P 500 was 5.1%, below the 10-year average earnings rate of 8.5%.

John Butters, senior earnings analyst at FactSet, noted that most of the earnings growth in 2022 came in the first half of the year. He also said that 8 of 11 of the sectors in the index are likely to report yearly growth, while financial services, communication services and consumer discretionary companies are likely to show a decline in earnings.

Some companies have fared much, much worse than others. Tesla, for example, has seen its stock drop about two-thirds from $382 per share to open the year to $121 at the closing bell this Friday. “Tesla’s stock just a few months ago was priced to perfection. Now as the wars appear … its stock price is adjusting,” James Meyer at Tower Bridge Advisors wrote. “It’s simply one more example of the purging of euphoria. The process is well underway, but it isn’t over.”

That process has been underway for other technology companies, as well. Amazon and Netflix each saw their stocks fall about 50% this year, after huge years for both companies in 2021. “All the biggest names, including Apple, have been underperformers year-to-date,” he wrote. “Some, eventually, will outperform once again.”

Other industries saw their stock soar. Oil companies like Chevron and ExxonMobil, spurred by groundbreaking profits caused in part by sky-rocketing gasoline prices, have had their stock jump exponentially over the last year. The former started the year at $117 per share and ended at $179 per share; the latter began at about $60 per share and closed out 2022 at $110 per share.

The boom in jobs from 2021 continued, albeit at a slower pace, this year. In 2021, the U.S. economy added 6.4 million jobs, according to the Bureau of Labor Statistics. While the data for 2022 isn’t yet complete, with December’s numbers still to come, the monthly federal jobs reports so far indicate the economy is still humming, adding 4.4 million jobs for the year.

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