Expect a year of shock and recovery as interest rates and prices rise
- The stock market will fall once the Fed finally raises rates, but it is not yet time for the next big monetary collapse
- While there are many reasons to be cheerful, events are still building to a crescendo of worsening conditions in 2023
As with any sporting contest, fortunes will ebb and flow. That could lead to investors getting whiplashed as we don’t know when the first knockdown will come.
The eventual winner might not be known this year, but whoever it is will dominate financial narratives for the next few years and radically change the kind of investments that should be held.
US politicians have consistently appointed economists to the Federal Reserve Board, when everybody knows that economists drive using the rear-view mirror. They should be appointing bankers or investment managers to the highest levels of the central bank as their whole careers depend on looking ahead. They need to have some guts with their forecasting, even if sometimes that is actually just indigestion.
In behavioural terms, the best thing for the stock market is for the Fed to increase rates frequently by small amounts – the “frog boiling” strategy. Shares will suffer in the short term, maybe falling as much as 20 per cent. They will not suffer as much the next time rates go up, though, and the market is likely to recover from those lows.
Analysts do not have the luxury of being as wishy-washy as the Fed and must put their views on the line. My core assumption this year is that inflation is going up and will be closer to 5 to 6 per cent, rather than the hoped-for 2 to 3 per cent, by the end of the year.
They should go up and down together since interest rates can be a big cost to business. This time is different, though. The normal bond-equity relationship has not held since at least 2018.
Investors in equities actually have several reasons to be cheerful. Inflation helps company earnings, which are typically not quoted in real terms and will be perceived to be going up, provided the company can continue to raise prices.
The massive liquidity stemming from support provided during the Covid-19 pandemic is still running through the financial system. There is no indication central banks won’t print money again if the economy is threatened.
The timing of the first punch is anybody’s guess. It could land in January, June or any time. The stock market will fall, but it is not yet time for the next big monetary collapse. If prices rise much more before the fall, investors won’t mind so much.
This year is therefore one in which we should expect a shock but also some recovery. It will mean investors holding their nerve. We might still be partying as if it’s 2021 – there are too many reasons to be cheerful, but events are building to a crescendo of worsening conditions in 2023.
What we do know is that markets do not tread water – the twin factors of greed and fear means they go up slowly and come down quickly. Fasten your seat belt and play the long game.
Richard Harris is chief executive of Port Shelter Investment and is a veteran investment manager, banker, writer and broadcaster, and financial expert witness