With just a few weeks left in 2022, investors are likely ready to put this year behind them. The S&P 500 is down close to 18% this year, and market conditions have been extremely volatile.
Although some analysts and economists don't think we are out of the woods just yet, there have only been four instances since 1929 when the S&P 500 has dropped two or more years in a row.
But with inflation still high, a bleak economic outlook, and the Federal Reserve unwinding its balance sheet, there is a lot of uncertainty out there. Here are three things that could turn the market green next year.
1. Further signs of easing inflation
The big story of the year has obviously been some of the highest levels of inflation seen in more than 40 years, leading to high prices everywhere from the grocery store to the gasoline pump. The Federal Reserve has moved quickly to combat this inflation by raising its overnight benchmark lending rate, the federal funds rate, from practically zero at the beginning of the year to now inside a range of 3.75% and 4%. Rising rates have pummeled stocks this year.
Image source: Getty Images.
This run has included an unprecedented four consecutive 75-basis-point rate hikes. Now, Fed chairman Jerome Powell has indicated that the Fed is on track to only raise the federal funds rate by 50 basis points at its final meeting of the year. That's after the Consumer Price Index (CPI), which tracks the prices on a market basket of consumer goods and services, fell more than anticipated in October. The CPI is one metric investors use to gauge inflation.
While the drop in October was welcome news for the market, it doesn't necessarily mean the Fed has won its war with inflation just yet. During this year, there have been times when the CPI looked to be easing, only to come in hotter than expected the following month, leading some to believe inflation might be more persistent than some thought.
The market needs to see several CPI reports in a row, as well as other supporting data that shows inflation is easing and will fall closer to the Fed's 2% target. The quicker this happens, the quicker the Fed can stop hiking rates, which would help stocks.
2. Avoiding a deep recession
Most experts and economists are expecting the U.S. economy to enter some kind of recession next year or in 2024. But I think the bigger question is how severe that recession will be. The U.S. economy could probably handle a mild recession -- and one might even be somewhat helpful in bringing down sky-high prices.
But a severe recession could be ugly when you think about where the consumer is and how companies are positioned. The U.S. personal savings rate in October had hit some of its lowest levels ever, and the consumer is also loading up on debt right now, with revolving credit now well above pre-pandemic levels. Still, the consumer has held up relatively well with the unemployment rate still below 4%, and there has also been a good amount of wage growth this year. But a severe recession, where unemployment jumps, could hit the consumer hard, especially if prices stay elevated.
Corporations also don't seem to have a lot of margin for error right now. Saxo Bank's head of equity research, Peter Garnry, recently noted that earnings projections for the S&P 500 in 2023 are 7% above that of this year, which is too high considering many of these companies are experiencing or likely to soon face margin pressure. A hard-hit consumer also makes it difficult for companies to pass their higher costs on to the consumer.
But if the U.S. economy can avoid a severe recession and unemployment only rises marginally, then consumers and businesses could withstand the blow until there is further price stability.
3. An end to the Russia-Ukraine war
Russia's ongoing invasion of Ukraine has led to significant increases in the price of oil and energy, largely because the U.S., European Union, Canada, and the United Kingdom have stopped buying Russian oil as part of sweeping sanctions imposed at the beginning of the war.
Additionally, the Organization of Petroleum Exporting Countries has been curbing the global supply of oil, which is also driving prices higher. The war has also led to price increases on other commodities and supply chain issues that have contributed to the high levels of inflation.
If the war ends, that would definitely help markets next year. However, if there's anything we've learned from the war, it's that it has been very unpredictable. Many surmise that it will continue through 2023 because President Vladimir Putin seems to be digging in. But others think an end to the war is possible next year, with Russia taking heavy casualties.
It's hard to predict one way or the other, but the invasion earlier this year caught the market off guard, so an end next year could certainly lift the market as well.
