To The Moon

Happy Holidays! After a turbulent 2022, there will be a lot of factors affecting the investment market in 2023. I have picked the three most important ones to talk about. 

• When will the Fed stop hiking rates?
• Will we have a global recession?
• How will China's reopening impact the market? 

Welcome to Read：2022 Review: War & Fed

When will the Fed stop hiking rates?

I respect the Fed's pivot table showing that the Fed Fund Rate will go up to 5.1%, but I don’t think it will go any higher, nor will it go below that level by the end of 2023. The pattern of interest rate hike could be (1) three 25 bp hikes or (2) one 50 bp followed by one 25bp. The market will cheer if the next Fed hike is 25 bp since it opens the door for the terminal rate to go below 5%, but my bet is on two hikes of 50 and 25 bp each that will end the hiking cycle by Q1.  

Obviously, inflation has already peaked in the US. Gas prices have now normalized and the drop in housing prices will eventually press rents. The cash consumers accumulated during the pandemic is exhausting and the layoff will make consumption more cautious. A high base will also have a negative effect on annual inflation change. We will see inflation in a down trend in 2023, but we might not see the annual inflation rate drop to the 2% target by the end of the year. However, a “positive” real interest rate will allow the FED to stop hiking rates, especially as the threat of recession is coming closer.  

US inflation (Blue) vs CME Unleaded Gas Futures (Orange) vs CME Fed Futures Rate (Green)

The Fed funds futures are currently reflecting differently and presenting a good opportunity to trade if 5% is the terminal rate by Q1. Short the April month now is a direct bet on this scenario.  

Will we have a recession?

Yes, we will have a recession. The aggressive rate hike by the global central bank put a strong brake on economic growth. High interest rates prevented many lending activities, especially on high price tag items such as mortgage and car loans. Recession is also a self-fulfilling prophecy. When everyone is talking about recession, and your banker is telling you there will be a recession, the preventative measure you take will contribute to the recession. Corporates will reduce capital expenses/investment and lay off people to reserve capital, and consumers will restrict spending to reserve cash flow. Not to mention the way companies handled the supply chain issue during the pandemic also backfired. Some companies expanded the capacity because there was a shortage, but this became excessive when activity returned to normal. Semiconductor is a good example, and you can now easily get a PS5 without a crazy markup.

The financial markets haven’t factored the risk of recession, except the yield curve inversion. The stock market is still focusing on Fed policies and lacks enough attention on recession. We might have more recession discussion in Q1, which might offset some of the positive effects of the Fed’s accomplished mission. A recession might officially occur in the 2H 2023, which will have a material impact on company revenue and earnings. I don’t foresee a deep and prolonged recession, as sufficient room for the Fed to cut rates can prevent it. Since the stock market is forward looking, we might see the lows of the stock market in 1H, and some recovery in the 2H, but I don’t think we will revisit the new highs. After a significant underperformance in 2022, growth stocks might perform better when the Fed stops hiking rates. 

S&P Index in the downtrend

Nasdaq Composite Index in the downtrend but pre-pandemic high @ 9838 could be an interesting support

• 2023 US Equity Index Range Forecast (Please allow the large range since it is a full year forecast)
• Dow: 27,000 to 35,800
• S&P: 3,400 to 4,330
• NASDAQ Composite: 8,400 to 13,200

How will China's reopening impact the market?

I am pessimistic about China's economy. Reopening can end the pain but doesn’t mean the economy will be boosted immediately. The three-year covid zero restriction had already hurt the root of the economy, and depleted most of the confidence and purchasing power of consumers, corporates, and the government. I don’t foresee the same “revenge consumption” situation that happened in the west when the economy was reopened, since Chinese consumers didn’t receive cash from the government, nor any wealth effect from the stock and property market. The Chinese government is good at stimulating the economy by infrastructure investment, but not much on consumer demand. Even if the government wants to do something, they will first need to find enough cash. Companies with diversified consumption lines will not come back just because of the reopening since they already learned in the pandemic it is harmful to put all the eggs in one basket. Not to mention the political tension with the US will make things worse. 

Comparatively, opening-up is still better than continuing the lockdown, but the positive impact might be less than many expected. We might see some commodity prices such as crude oil and copper go up because of the reopening, but the threat of global recession might offset some of the positive effects. Since China is now experiencing the peak of the pandemic, we might have a clearer picture after Chinese New Year. We can use commodity prices as leading indicators to assess how strong the positive impact is. 

NYMEX Light Crude Oil didn’t respond to China reopen yet

Happy trading and wish you a fruitful year of 2023.  

Disclaimer: The above information is for illustration only and there is no guarantee on the accuracy of the information. They should not be treated as investment recommendations or advice.