The worst is over for the stock market, in my view. I base that prediction on the expectation that the Federal Reserve is close to the end of its interest rate hikes and that a full-blown recession will not materialize this year.
Mark Zandi – Moody’s
I expect the market to be moving definitively higher by year’s end. Not that the market will come roaring back. It will not. And not that investors should time its recovery. They cannot, given how quickly the market moves.
As a refresher, stocks are ultimately worth the present value of the expected future growth in corporate profits. Stock prices fall if interest rates rise and/or investors anticipate a tough economy and weaker corporate profits.
The stock market took it on the chin in 2022, falling sharply after hitting its all-time high on the first trading day of the year. By early summer, it was down more than 20% — the informal definition of a bear market. Stocks have traded more or less sideways ever since, up some weeks and down others.
Last year’s decline in stock prices was due mostly to the surge in interest rates. This time last year, the federal funds rate, the rate the Fed directly controls, was near zero as the Fed was still shoring up the pandemic-ravaged economy. Today, seven rate hikes later, the funds rate is near 4.5%, and based on guidance from Fed officials, economists believe it will soon be at 5%.
Tech stocks for companies like Facebook and Google have taken the biggest hit from the runup in interest rates. That is because investors expected huge profits from these companies long into the future. Those future earnings are worth a lot less today when interest rates are a lot higher.
Stock prices will remain more or less stuck until it is clear the Fed is done raising interest rates. And that, in turn, depends on inflation. The Fed has promised to keep raising rates until it is certain inflation is quickly headed back to its target of 2%. That’s on track to happen as soon as this spring.
Most encouraging is that oil prices are back down to where they were before Russia’s invasion of Ukraine. The global oil market has adjusted admirably to the sanctions imposed on Russian oil and OPEC’s production cuts. With gasoline prices dropping, closing in on $3 a gallon, workers are less worried about future inflation and should soon scale back their demands for higher wages. Price increases in labor-intensive service industries such as health care and hospitality should then moderate.
China’s recent move to end its zero-Covid policy — which locked down its economy at the first sign of the virus — will allow supply chains to normalize. Shortages of everything from vehicles to building materials will abate and their prices will recede. This may take a few months, as the sudden change in policy has led to lots of sick workers, but China should be back to speed by spring.
Optimism that the stock market will find its groove later this year also rests on the economy skirting recession. Unlike many CEOs and economists, stock investors do not appear convinced that a recession is dead ahead; they are not forecasting corporate profits to significantly decline. But if they are wrong, stocks will almost surely suffer another big leg down. In a typical bear market during recessions, stocks fall at least 30% from their highs.
How could the economy remain recession free? It will depend on the underlying resilience of consumers and businesses. Recession looks improbable unless consumers pull back on their spending, and it is not clear why they would. Aside from the sturdy job growth and low unemployment, most households have substantial cash holdings built up during the pandemic when they could not spend.
Many households also have notably light debt loads and did a commendable job of locking in the previously record-low interest rates by refinancing their mortgages. Those that did are now insulated from the higher rates. To forestall recession, consumers simply need to do their part and spend as usual. There is no compelling reason to think they will not.
Moreover, recession seems unlikely unless businesses engage in mass layoffs. Businesses are sure to cut the significant number of open positions and rein in hiring (indeed, they have already begun to do so), but they will be loath to lay off workers. With the large baby boom generation aging out of the labor force and restrained foreign immigration, firms realize their number-one problem through the vagaries of the business cycle will be finding and retaining good workers. In the absence of significant layoffs, consumers will continue to have the wherewithal and confidence to keep spending, and the economy will avoid recession.
Attempting to time the ups and downs in the stock market is unwise. Gauging when the Fed will end its rate hikes or if the economy will avoid a recession is also risky and will bear little on stock returns in the near term. Instead, the wise course is to steadily save and invest through thick and thin. Consistent and patient stock investors have always been handsomely rewarded.
For more CNN news and newsletters create an account at CNN.com