December 21, 2022
Darrell Cronk, CFA®, Chief Investment Officer
The straw that stirs the drink
“An optimist stays up until midnight to see the New Year in. A pessimist stays up to make sure the old year leaves.”
— William E. Vaughan
Year end brings reflection and perspective. With the passage of time and the swing of the pendulum, perspective has a habit of reintroducing itself to us — sometimes when we least expect or welcome it. 2022’s swing brought some amazing and difficult moments, including:
- The U.S. Consumer Price Index (CPI) hit a 40-year high at 9.1%.
- The unemployment rate at 3.5% was the lowest witnessed since 1969.
- The 30-year U.S. Treasury bond, at its low, sunk to a negative 35% return, the worst in over a century.
- Central banks across the globe hiked interest rates, collectively, more than 200 times.
- Natural gas prices rose 90%.
- Global equity market capitalization declined $33 trillion from its peak.
I could go on, but needless to say, we felt the hard vibrations of global shifts in key themes throughout this past year. As we happily close the books on 2022, what is crystal clear to us is that as inflation goes, so will 2023. Indeed, inflation will be the straw that stirs the drink — whether that drink is champagne or bitter medicine, remains to be seen. Undoubtedly, inflation’s path will chart the course in 2023 for central bank policy, economic growth, stock prices, interest rates, earnings growth, and the trajectory of the U.S. dollar.
As I have repeated frequently, bear markets are a function of price and time. The bear market this past year has been no different. Often knowing what not to do is as important as knowing what to do. Bear markets don’t end simply because the calendar turns, or because enthusiastic investors hear what they want to hear and begin lining up to deploy cash. We advocated for defensive posturing in portfolios starting in the first quarter of 2022, and we arrive in the first quarter of 2023 with the same guidance. What we believe is different about 2023 is that we anticipate markets should provide opportunities to once again turn more bullish.
What has been challenging for investors is that numerous times throughout 2022, markets experienced bear market rallies as they “listened” to Federal Reserve (Fed) Chair Jerome Powell’s press conferences, but simply did not “hear” what he had to say. Markets often mistook his message as one of dovish optimism, only to be disappointed later by a steady dose of hawkish medicine that had those bear market rallies failing into resistance, leading to lower lows through 2022. As the holidays arrive, we’re left with a fitting and timeless lesson of the substance of things hoped for.
So, let’s “hear” what Chair Powell had to say at his December 14 press conference when asked if the Fed would need to reconsider its 2% inflation target:
“Changing our inflation goal is just something we’re not — we’re not thinking about and it’s not something we’re going to think about. We have a 2% inflation goal, and we’ll use our tools to get inflation back to 2%. I think this isn’t the time to be thinking about that. … The committee — we’re not considering that, we’re not going to consider that under any circumstances.”
We have no illusions that getting back to 2% inflation will be pain-free. We believe that there is promise, however, that a combination of slowing global demand, easing supply chains, elevated inventory levels inviting discounts on many core goods, and a cathartic slowdown (if not a nearly complete stop) in housing activity should apply downward pressure on inflation in 2023. Chair Powell understands that he has to break inflation, as history has taught us well that no economy has flourished for any extended period of time under high rates of inflation.
For much of the past decade, markets were conditioned to believe central banks were their friends. The Fed’s job was clearly defined: Ensure financial stability, infuse liquidity to stabilize capital markets, step in to curb volatility when it arose, and protect growth and jobs at all costs. Even the slightest reduction in central bank support left markets frowning with concern. That is not the place we are at today. Secular shifts away from seemingly endless central bank liquidity, a world now challenged with limited supply instead of limited demand, and geopolitical risks that have companies focused on resiliency — and not just productivity — have changed the calculus of how we believe investors should think and engage.
As the economic wheel turns and central banks around the globe fight the good fight in an effort to arrest inflation, investors want to forget about 2022 as soon as possible — and as Mr. Vaughan says above, “make sure the old year leaves.” They want to pull down the calendar and start fresh. But in our view this cycle isn’t likely to end so cleanly; it has appeared to be in no hurry to curl up and disappear into the history books.
Chair Powell has a tough battle ahead, and I don’t for a moment envy him or the challenges that will come his way in 2023. He must balance financial stability with protecting growth and jobs and bringing inflation down. Not an easy task for even the most skilled. As many a world leader has said, “You don’t choose the time. The time chooses you.” Perhaps time has chosen Jerome Powell to have his own Paul Volcker moment — this generation’s choice to break the back of inflation seeking to return the U.S. economy to prosperity and growth. We do not yet know with full certainty. What we do know is the greatest strength of a wise investor is intellectual flexibility, the ability to assess fundamental, technical, and behavioral factors and apply it all with wisdom and discipline to portfolio management. That we aim to do in earnest in 2023 no matter what may come investors’ way.
To be clear, we believe better days do lie ahead. If you squint your eyes, you can almost see it through the winter mist, a powerful U.S. economy finding its footing once again. As the Fed’s bitter medicine takes hold, inflation has begun its journey. We anticipate that it may take all of springtime, maybe even much of the summer, for the U.S. economy to regain its strength, but capital markets will likely not wait for an overwhelming preponderance of evidence of a recovery to be revealed. They will look to price ahead as they have done historically. That’s why in 2023, investors need to stay alert and be ready for when the risk-reward dynamics change. We will be right there with you, with both feet in the fight and with our best clear-eyed guidance translated into practical portfolio action.
As we raise a glass to toast the new year, don’t lose sight of the straw, as it will prove vital in determining 2023’s path. We hope this holiday season you enjoy time with family, with old friends and new, and find peace and rest.
Forecasts are based on certain assumptions and on views of market and economic conditions which are subject to change.
Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation, and other risks. Prices tend to be inversely affected by changes in interest rates.
Consumer Price Index (CPI) produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services.
An index is unmanaged and not available for direct investment.
Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.
The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.
The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability or best interest analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. The material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee to its accuracy or completeness.
Wells Fargo Wealth and Investment Management, a division within the Wells Fargo & Company enterprise, provides financial products and services through bank and brokerage affiliates of Wells Fargo & Company. Brokerage products and services offered through Wells Fargo Clearing Services, LLC, a registered broker-dealer and non-bank affiliate of Wells Fargo & Company. Bank products are offered through Wells Fargo Bank, N.A.
Wells Fargo Private Bank offers products and services through Wells Fargo Bank, N.A. and its various affiliates and subsidiaries. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.
Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors.
Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company.