Persistently higher interest rates combined with weaker earnings is a recipe for lower equity valuations in 2023.
- Rates are going higher for longer. It is difficult to imagine the equity markets bottoming before the Fed is done tightening, especially as QT runs in the background shrinking bank reserves and the monetary base. It is not difficult to imagine the Fed taking its Fed Funds Rate to 6% in 2023 if inflation remains stubborn at around 6%.
- No Fed pivot. I definitely do not see a Fed pivot in 2023 unless the credit markets seize up.
- CPI is too high no matter how you slice it. It is irrelevant if CPI comes in slightly higher or lower than consensus on Tuesday. 7% CPI is far too high and 2-3% CPI isn’t in the cards for next year. It is likely that the Fed Funds Rate will remain elevated for all of 2023 in our view. It is not clear how the Fed will approach QT in 2023. Will it maintain the current pace, accelerate the pace, slow or halt the effort? We do not expect a return to QE next year. We do expect QT to continue at some level.
- Earnings risk. In addition to inflation and interest rate risk, companies will have to navigate a softening global economy in 2023. Earnings estimates need to come down. This won’t happen until January when companies begin to provide Revenue and EPS guidance for 2023. We continue to believe that the NASDAQ will bottom at 9,000 in late Q1 2023.
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