For investors, 2022 will not be missed. The year presented a series of firsts and worsts. The tragic war in Ukraine hugely distorted global food and energy supply chains, further emphasized the divide between the US and China – see A greater separation between East and West: G2 polarization intensifies – and accelerated the onshoring of critical business infrastructure. The Fed instigated its fastest set of interest rate increases ever. In doing so, it responded to the inflation it caused by adding excessive liquidity to counteract the effects of the pandemic. As the safe-haven US dollar strengthened, goods almost everywhere else became more expensive, adding to global central bank tightening pressures. These are all sources of instability.

In this environment, equities and bonds declined in tandem by the most ever in 2022, with joint losses of about 20% at the low point. Cash outperformed almost every asset class. As we look ahead, however, we need to remember that markets lead economies. The poor market returns of 2022 anticipate the economic weakness we expect in 2023 – see Roadmap to recovery: Markets lead, the economy follows.

We believe that the Fed’s rate hikes and shrinking bond portfolio have been stringent enough to cause an economic contraction within 2023. And if the Fed does not pause rate hikes until it sees the contraction, a deeper recession may ensue. The most recent inflation data and Fed minutes suggest that the Fed is aware of these risks. Yet Fed policymakers’ tendency toward excess gives us pause as we plan for 2023.

With perfect hindsight, sitting out 2022 would have been worthwhile. But to think that way is dangerous for wealth preservation and creation. One year is just a “moment” in the lifetime of a portfolio. Sidestepping the pandemic and war-laden past three years would have been a major mistake for equity investors. Between December 2019 and November 2022, the S&P 500 Index rose 25% and the MSCI World 15.4%. For 2023, we reiterate the fundamental wisdom of keeping fully invested portfolios – see for example, It is time to put excess cash to work. 

Remember, the world economy is highly adaptive and resilient. So too are markets.

Thinking about 2023

Markets in 2023 will lead the economic recovery we foresee for 2024. Therefore, we expect that 2023 may ultimately provide a series of meaningful opportunities for investors who are guided by relevant market precedents.

First, though, we need to get through a recession in the US that has not started yet. We believe that the Fed’s current and expected tightening will reduce nominal spending growth by more than half, raise US unemployment above 5% and cause a 10% decline in corporate earnings. The Fed will likely reduce the demand for labor sufficiently to slow services inflation just as high inventories are already curtailing goods inflation.

The relative health of corporate and personal balance sheets has delayed an economic downturn, for now. Household borrowing is sustaining growth presently, but this dissaving is likely unsustainable, especially given financial market and real estate price deflation. Also, when short-term rates are higher, there is a natural bias to deferring purchases.

We remind investors that over the past 100 years, no bear market associated with a recession has bottomed before the recession has even begun. (Of course, there is a first time for everything.) We believe that the current bear market rally is based on premature hopes that the recession will not occur – a so-called “soft landing” – and that there will not be a meaningful decline in corporate earnings.

Second, we need to get through a deeper recession in Europe as it struggles through a winter of energy scarcity and inflation. We also need to see a sustained economic recovery in China, whose prior regulatory policies and current COVID policies curtail domestic growth.

Third, we need to see the Fed truly pivot. Ironically, when the Fed does finally reduce rates for the first time in 2023 – an event that we expect after several negative employment reports – it will do so at a time when the economy is already weakening. We think this will mark a turning point that will portend the beginning of a sustained economic recovery in the US and beyond over the coming year.

Source: Citi Global Wealth Investments - 29 Dec 2022