Allen Sinai, PhD
Allen Sinai, PhD, CEO and chief global economist at Decision Economics, Inc., a financial advisory firm based in Boston and New York City. He has been an adviser to several US presidential administrations. DecisionEconomicsInc.com
Have we seen the bottom of the bear market? Very likely, says renowned economist Allen Sinai, PhD. But he warns that the recovery for stocks will be long and slow. Dr. Sinai says investors must prepare for a vastly different environment than the past two decades—elevated inflation and interest rates will persist…single-digit annual stock returns will be the new bull-market norm…and returns on cash may outperform bonds. Here’s what Dr. Sinai sees for 2023 and beyond….
The stock market’s fate largely hinges on the Federal Reserve’s efforts to tackle runaway inflation without pushing the economy into a recession and deepening the bear market. The federal funds rate—a proxy for short-term interest rates and controlled by the Fed—began the year at 0% to 0.25% and is expected to rise above 4% by year-end 2022. Those are the central bank’s most aggressive moves since the late 1970s, when fast-rising rates and credit crunches led to multiple recessions in 1979–1980 and 1981–1982.
Raising interest rates can be a powerful tool to reduce high prices, making borrowing money expensive and resulting in less economic expansion, fewer jobs and lower consumer demand and price inflation. Problem: Higher interest rates can take six to 12 months to work. It is difficult for the Fed to know when to stop hiking rates and how much economic growth will be suppressed.
Sinai’s prediction: There’s a 60% chance the economy will experience a “Soft Landing”—economic growth slows and unemployment ticks up, but a recession is avoided or is only a mild one. I expect inflation to remain elevated and stay high this year, but it will moderate enough for the Fed to top out the federal funds interest rate at 6% by summer 2023. Reasons to expect a Soft Landing…
Resilient labor market. For the US to experience a deep recession, we would need a massive jump in unemployment. That’s unlikely because of the demand for labor and the changing labor supply as the economy becomes more “tech-centric.” Many business owners will continue to struggle to find and keep workers.
Strong household, business and bank balance sheets. Consumers will continue to buy goods and services at a brisk pace and prop up the economy, thanks to rising wages and the $2 trillion in savings built up in the pandemic. Business spending and bank lending will support capital spending and hiring.
Weak but positive world economic growth. While I expect the European economy to fall into a recession in 2023, the rest of the world will grow modestly at a 2.5% peak GDP growth rate. This assumes geopolitical hot spots in the East and West don’t worsen. If China makes aggressive military moves against Taiwan…or the US and NATO are drawn further into the Ukraine–Russian war…the US economy could see negative growth and the stock market could drop another 10% or more. Stronger Federal, state and local purchases on prior fiscal stimulus will be supportive.
Over much of the past 20 years, stocks benefited from low inflation (sub-2%) and near-zero interest rates—but that has undergone a secular change for the foreseeable future. Once high inflation gets into the system, it can be contained and managed but is difficult to eradicate. Also, several demographic and geopolitical trends will keep inflation elevated, including an aging work population and an increase in protectionism and isolationism in countries around the world, which is reducing free-trade efficiencies. What higher inflation and rates mean…
Equity returns will be lower. Expect modest, single-digit returns from the stock market for the next few years until inflation drops low enough for interest rates to also decline.
Adapt investment strategies. Pricey, fast-growing stocks in tech and other sectors that prioritize revenue growth over profits will be less attractive than cheaply priced ones with robust balance sheets, consistent earnings and ample free cash flow returned to investors as dividends.
Gross domestic product (GDP) should grow 2.7% in 2023 and 2.2% in 2024, assuming the US avoids a recession. These gains will be driven by steady consumer spending, which is likely to rise 3% in 2023, and by state and local government spending as pandemic stimulus money continues to be put to work.
Inflation will cool a bit as the economy slows. The Labor Department’s Consumer Price Index (CPI)—a basket of common goods and services as well as energy and food costs—will fall to 5.5% by the end of 2023, still high but down from the expected 8.2% in November 2022 and headed for 3%-to-4% in 2024.
Unemployment. The jobless rate—3.7% in October 2022—will end 2023 at 4.7%. A tight labor market means that the average hourly wage for private-sector workers will accelerate 5% to 6%, more than double the recent annual average.
Housing. Interest rates on 30-year fixed-rate mortgages will reach an 8% range by year-end 2023, versus about 7% in late November 2022. Sales of new and existing homes will continue to tumble, and I expect a recession in housing in 2023 with prices dropping 15% or more from 2022 peaks. But: Housing prices will not collapse as they did in the 2007–2009 recession.
Oil. A barrel of West Texas Intermediate crude should finish 2023 at $100, up from about $80 in November 2022. Barring geopolitical shocks that cut oil supplies, I expect slowing global economic growth to keep a lid on demand.
Including dividends, the Dow Jones Industrial Average likely will gain 6% in 2023…and the S&P 500, 7%. Stock valuations from an historical perspective are well below average but not nearly so attractive as they were coming off market bottoms during the 2007–2009 Great Recession or 2020 pandemic recession. Corporate earnings should grow to a 7% range even if there is a mild recession because companies have become skilled at cutting costs and maintaining profit margins in slow-growth environments.
Following the Congressional midterm elections, a divided government will be a plus for stocks as Republicans narrowly regain control of the House, so there will be no tax income increases before 2025. Legislative gridlock means less inflationary fiscal spending. This means no rollbacks of Trump tax reductions. Government spending will reflect geopolitical and prior fiscal policies that impact with long lags.
Best areas of the market for 2023…
Health care. Demand for care is relatively insensitive to the economy. Health insurers are able to pass on higher costs to consumers, which reduces inflation’s impact on most health-care businesses. Population dynamics and new technology will add to demand and sales.
Consumer discretionary and consumer staples. Consumer spending will remain strong for essential and luxury goods and services, bolstered by wage growth and high employment levels. Many of these companies can raise prices without losing customers.
Areas of the market to avoid…
Technology, especially market heavyweights with high price-to-earnings ratios and no/low dividend payments. As penetration rates for smartphones, digital advertising and streaming video slow, the robust growth needed by these companies to meet—let alone surpass—rising demand won’t happen. Wall Street expectations will be hard to come by.
Energy had gained 63% in 2022 through late November, one of the few S&P 500 components in positive territory. Although I expect continued strong profits in 2023, valuations look too rich and the geopolitical risk is significant.
Even after suffering the worst performance in four decades in 2022, the bond market faces an elevated interest rate environment for some time. By the end of 2023, the two-year US Treasury bond is likely to yield 5.58%…the 10-year, 5%. Bonds look unattractive compared with stocks. I think the benchmark Bloomberg US Aggregate Bond Index will have another losing year.
For small investors, it is tough to make money in bonds unless you are content to buy investment-grade debt and hold to maturity. Cash may offer the best risk-reward fixed-income scenario in 2023. Investors will be able to earn about a 5% yield risk-free in Treasuries and CDs without tying up money for a long time.
