Monthly Outlook 202212 - Timing the Recession and the Fed‘s Pivot： Bullish and Bearish Views on the 2023 US Stock Market

Monthly Outlook 202212 Equity Research·Strategy Research·Monthly Outlook [Table_Main] Timing the Recession and the Fed's Pivot: Bullish and Bearish Views on the 2023 US Stock Market Report Thesis: ◼ Although the Fed has indicated that it has no intention to cut rates in 2023, the market is still clinging to the hope that policy rates will peak in May 2023 the earliest and then start to decline. Investors’ outlooks for overseas market in 2023 are divided, and we are more sympathetic to the bearish views. Report Abstract: ◼ An Overview of the Bullish Views: ◼ The trend is becoming more pronounced that inflation is peaking or reaching a peaking soon. In addition to the moderating PCE, consumers' inflation expectations for the year ahead fell sharply in December 2022. However, we are waiting for this trend to become more visible. ◼ Average household equity allocation in the US has fallen sharply. Historically, this indicator is negatively correlated with stock-market returns. In the current bear market in which bonds have performed just as poorly, the decrease in the proportion of stock allocation more clearly shows that investors have been actively selling off their equity assets. Bullish investors expect the US stock market to bottom out in the first quarter of 2023. ◼ Since 1946, most years in which US stocks have fallen have been followed by bullish returns in the following year. A 19% drop in the S&P 500 this year could mean a rebound in 2023. However, we consider this type of inductive reasoning to be risky, as even though it is improbable that the market will be bearish for two years in a row, every instance that the market fell for two consecutive years, it fell hard. ◼ An Overview of the Bearish Views: ◼ Even if inflation falls, it is still far from the Fed's 2% inflation target, and hopes of a rate cut in 2023 are likely to be dashed. However, we do believe that the key element for the 2023 stock market will be the timing of the Fed's policy shift, which will create structural opportunities similar to those seen in November 2022, although a sustained bull market is less likely to occur. ◼ There is going to be a headwind for investors in either direction of earnings or valuation. The risk to earnings is that the Fed’s possible pivot to an end of its rate hikes in 2023 would be based on the fact that the economy will enter recession by the first half of 2023, meaning that downward pressure on stock earnings will hit the market. The risk to valuation is that if the US economy does not fall into recession in 2023, the expectations of rate cuts will have to be adjusted. ◼ Market sentiment is gloomy and outflows from risk assets are likely to continue. Global funds have taken the recent rally as an opportunity to sell and fled the US stock market over Christmas. In addition, most institutions view bonds as a relatively better bet in 2023 amid a recession. We believe that as inflation is likely to be sticky, investors should remain conservative on the space for long-term bond yields to fall. ◼ Risks: The Fed could remain hawkish and does not cut rates in 2023 even if inflation cools down; Market sentiment is pessimistic and outflows from risk assets continue. Research Analyst Shirui Ouyang (852) 3892 3120 ouyangshirui@dwzq.com.hk [Table_Report] Related reports 1. Embracing Risks and Opportunities 2022-04-11 2. The US Stock Market Has Not Fully Priced in Inflation Data and Interest Rate Hikes 2022-06-29 3. Fading Inflation and Growth: What Are the Signals Delivered by US Economic Indicators? 2022-07-20 4. Negative Interest Rate Era is Over, and Where is Europe Headed? 2022-08-09 5. Be Prepared for Further Aggressive Fed Rate Hikes 2022-09-16 6. Reduce risk exposure to European markets and beware of liquidity shortage in the US 2022-10-17 7. Reduce risk exposure to European markets and beware of liquidity shortage in the US 2022-11-28 We would like to acknowledge the contribution and support provided by Hanruo Feng(冯涵若). [Table_Author] 12 January 2023 2 / 11 东吴证券（香港） 请务必阅读正文之后的免责声明部分 [Table_Yemei] Monthly Outlook Table of Contents 1. An Overview of the Bullish Views .................................................................................................... 5 2. An Overview of the Bearish Views ................................................................................................... 8 3. Risks Highlight ................................................................................................................................... 9 3 / 11 东吴证券（香港） 请务必阅读正文之后的免责声明部分 [Table_Yemei] Monthly Outlook Table of Figures Figure 1: The Fed’s dot plot in December 2022 shows that official expectations for the peak interest rate in 2023 is up from the prior roun