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The last 12 months was a year of fast-rising inflation, fast-rising interest rates and fast-rising questions about a future recession.
Prices went up while stock markets and savings account balances went down, leaving consumers and investors dizzy and their wallets hurting.
There may be more financial pain, that’s pretty sure — but it might not be as bad as feared, according to Vanguard’s look ahead to 2023.
The likely recession will not send jobless rates charging sharply higher, sticker shock will fade for the price of goods, and the rise in rent and mortgages will also ease, Vanguard said.
“On Tuesday, inflation data for November showed prices are continuing to cool. Analysts say that makes a 50-basis point increase, rather than a 75-basis-point increase, more likely.”
The good news: This opens up chances for stocks to rebound, the asset-manager added.
The outlook, released this week, comes as Americans are trying to guess what 2023 holds for their finances while they manage their holiday shopping budgets, and 2022 investments.
On Tuesday, inflation data for November showed prices are continuing to cool. From October to November, the cost of living nudged up 0.1%, lower than the 0.3% forecast, the Consumer Price Index showed. Year over year, the inflation rate receded to 7.1% from 7.7% in October, according to the CPI data.
On Wednesday, the Federal Reserve will announce its latest decision on interest rate increases. A 50-basis point increase is widely expected after four jumbo-sized 75-basis point hikes from the central bank.
Here’s one roadmap for what’s next, as far as Vanguard’s researchers and experts can see.
Hot inflation will cool
Inflation rates during 2022 climbed to four-decade highs. There have been signs of easing, such as smaller-than-expected price increases in October.
“As we step into 2023, early signs of a recovery in goods supply and softening demand could help balance supply and demand for consumption goods and bring prices lower,” the authors noted ahead of Tuesday’s CPI numbers.
But the cost and demand of services are going to prevent a quick fall, they noted. Signs of slowing price increases are already emerging in rents and mortgages, but they will take longer to ease than prices of consumer goods, the authors said.
That echoes the view from Treasury Secretary Janet Yellen, who said Sunday there will be “much lower inflation,” absent any unanticipated shocks to the economy.
But while hot inflation will cool, it will still be warm to the touch. The Fed says 2% inflation is its target goal; Vanguard sees 3% inflation by the end of 2023.
A recession is very much on the cards
As “generationally high inflation” slowed economies across the world, the Fed and other central banks have countered with interest-rate increases to tame price increases. That “will ultimately succeed, but at a cost of a global recession in 2023,” according to Vanguard’s report. Vanguard sees a 90% chance of a recession in the United States by the end of next year.
Vanguard is hardly alone in the recession call, so the question is how bad could the big picture look?
In Vanguard’s view, it’s not so bad. “Households, businesses, and financial institutions are in a much better position to handle the eventual downturn, such that drawing parallels with the 1970s, 1980s, 2008, or 2020 seems misplaced,” the authors wrote.
Job losses may be clustered
For now, the jobless rate in a tight labor market is 3.7%, which is just a little above the lowest levels in five decades. That stands against the headline-grabbing list of companies where layoffs are mounting, notably in the tech sector.
When a recession, in all likelihood, lands next year, “unemployment may peak around 5%, a historically low rate for a recession,” the Vanguard outlook said. As interest rates climb, the job losses “should be most concentrated in the technology and real estate sectors, which were among the strongest beneficiaries of the zero-rate environment.”
The unemployment rate going from 3.7% to the 5% vicinity is “a sizable move,” Roger Aliaga-Díaz, Americas chief economist for Vanguard, said in a Monday press conference on the report. “But it is less dramatic of a rise than compared to past recessions perhaps.”
Spotting the opportunities
When interest rates go up, bond prices go down. So it’s been difficult for bonds with lower returns and “near-term pain” for investors this year, the Vanguard outlook said.
“However the bright side of higher rates is higher interest payments. These have led our return expectations for U.S. and international bonds to increase by more than twofold,” the report said.
Vanguard said U.S. bond return projections could be 4.1% – 5.1% annually over the next year versus its 1.4% – 2.4% return estimate last year. For U.S. stocks, the forecast could be 4.7% – 6.7% annually, while returns in emerging market equities could be between 7% and 9%.
On Tuesday morning, stock markets are soaring higher on the cooler than expected inflation data, igniting hopes of an end of year Santa Claus rally.
“‘There’s one silver lining of our outlook for a modest global recession. And it’s the clear silver lining of higher expected returns for investors.’”
Still, the Dow Jones Industrial Average
DJIA,
is down nearly 5% year to date. The S&P 500
SPX,
is off 14% in that time and for the Nasdaq Composite
COMP,
is down more than 26%.
When the market hits bottom is impossible to know, the outlook said — but it noted “valuations and yields are clearly more attractive than they were a year ago.”
“There’s one silver lining of our outlook for a modest global recession. And it’s the clear silver lining of higher expected returns for investors,” said Joseph Davis, Vanguard’s chief global economist.
“We’re long concerned that the low rate environment was both unsustainable and ultimately a tax and a headwind for savers and long term investors,” Davis said.
But even with all the turbulence this year, “we certainly are starting to see the dividends to higher real interest rates around the world in the higher projected returns that we anticipate for investors over the coming decade.”
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