Year End Special - Goodbye 2022; Hello 2023
The Year in Review vs The Year Ahead - Macro, Equities, Bonds & Commodities
Welcome to the Year-End issue!
We’ve almost made it through 2022 and I want to congratulate each and every one of you for staying strong and getting through the year.
Thank you to all who’ve read and subscribed to the newsletter this year. I am very grateful, and I hope we get through 2023 together. I’m also grateful to all who’ve switched to the paid offering. I am humbled.
As we move on to the new year, I wanted to take a look at:
What 2022 has been telling us about the markets
What 2023 could possibly look like in terms of the Macro, Equities, Bonds and Commodities
Closing thoughts on Cracks in the Market
The Year in Review vs The Year Ahead
It feels like this is the year when Macro really mattered. You know how I can tell? Twitter feeds and spaces turned into Macro-centric discussions. Not to mention, the number of new accounts that popped up. But Macro always mattered, we just started to take more notice this year.
After 13 years of easy monetary conditions, the Fed finally made a “pivot”. We saw aggressive tightening like we haven’t in decades, and all because of inflation. You know how people keep saying “this time is different”. Well, this time was different!
It’s been a long time since the US had a situation of roaring inflation. The last time was in the late 70s - early 80s, well before many of us can remember. The truth is, unchecked inflation remains a bigger threat to any economy than any other economic condition, and the Fed let it go on for too long. Could they have done things differently? Sure, but there were exogenous factors such as the return of the pandemic that gave them pause.
But, we’re not here to debate whether the Fed was right or wrong, we’re here to look at the facts. The fact is that the Fed will do anything to fight inflation, and we’ve now experienced that. Despite every message the Fed has sent about tightening, the market has been belligerent about believing that message. The truth is, financial conditions have worsened… significantly. We cover some of this later in this article.
The Housing Market has seen one of the sharpest declines in history and this is exactly what the Fed wants. The Housing Market bubble has driven inflation significantly and the decline will probably start to show up in the inflation data around May 2023, as I theorized in my November article on Shelter Inflation.
The Jobs Market however, has been signaling strength throughout 2022. We know it’s because of an imbalance of supply and demand but with inflation increasing, we’ve seen wages increase as well and now this has become a concern for the Fed.
I want to look at the Yield Curve. We’ve been talking about it endlessly this year and when I called the inversion a possibility back in October 2021, I never realized it could get this bad.
We’ve not only had the deepest inversion since the 1980s but as well one of the longest since then. The Yield Curve inverted on July 6th, 2022 and hasn’t corrected since then.
We know the Yield Curve inversion is a good predictor of a recession but, more importantly, the recession usually comes when the inversion starts to correct and the Yield Curve starts to steepen - something we should look out for in 2023.
And finally, this was the year of QT - Quantitative Tightening. The Fed started to run off the balance sheet, first at a lower level of $47.5B per month until August and then at $95B per month. I wrote a detailed article discussing how the run-off was being conducted because there was some skepticism among people. Suffice to say, we now have evidence that the balance sheet and M2 money supply is decreasing.
2023 Outlook - Macro
We know what’s next:
The Fed increases the Fed Funds rate to 5%-5.25% and holds it there. This is their forecast and lines up with what I’d calculated earlier this month.
Inflation will continue to rollover, and it will take a while before we see the 2% inflation target being met. The Fed suggests not before 2024 but, it’s possible we see this in late 2023.
What’s interesting is that the Fed is now focusing on wage inflation which means that without unemployment, we won’t see services inflation decline. Unemployment and jobs data will be a big theme for 2023, unfortunately.
QT - QT will probably remain one of the biggest factors next year. We’ve not seen an era of mass exodus of liquidity from the system, and we’re beginning to see the effect this make its way through the system.
The chart below is very telling. Quantitative easing has been a major driver of revenues for the S&P 500. The correlation isn’t precise but, we can see that the revenue increase comes with a certain amount of time lag. I surmise that the opposite will also be true. As liquidity starts to drain out of the system, we will see pressure on top line revenues. After all, the Fed’s whole point is lower consumption through demand destruction.
The decline in inflation is being brought about by higher cost of capital & lower liquidity → lower demand + higher unemployment → lower economic growth → lower GDP → recession.
Next, we look at Equities, Bonds and Commodities.