Historical data shows there’s a good chance the U.S. stock market will return 20% or more this year after the three major indices ended 2022 with their worst annual losses since 2008, according to Fundstrat Global Advisors.
Fundstrat’s head of research Tom Lee said stock market investors are more likely to see a year of positive returns than a flat year after stocks underperformed in the prior year.
The 19 instances of a negative S&P 500 index SPX, +2.28% return year since 1950, has been followed for more than half of those years by the large-cap index gaining more than 20%, according to Fundstrat data. Only two of those years were followed by a stagnant year with returns between 5% and minus 5%.
“Stocks are five times more likely to rise 20% than flat, and more than half of the cases will see gains of over 20%,” Lee said in a statement Friday.
Furthermore, these probabilities are far higher as compared to typical years. In all 73 years since 1950, the S&P 500 has only a 27% chance of ending up over 20%, compared to 53% odds in post-negative years.
See: No one knows which stocks will fuel the next bull market, but they probably won’t be the bear market winners
Here are three potential catalysts that would allow stocks to post gains of 20% in 2023:
Global “disinflation” underway
Lee and his team believe US inflation in 2023 will be well below the Fed and market consensus.
Economists polled by Dow Jones expect the December inflation report, due to be released next Thursday morning, will show headline inflation unchanged from the previous month or 6.5% yoy. The core price gauge, which excludes volatile food and fuel costs, is expected to rise 0.3% from November, or 5.7% yoy.
However, Lee believes that the forthcoming CPI report could see core CPI rising as much as 0.1% in December, which would mean a significant slowdown in the pace of inflation and bring the seasonally adjusted three-month annual rate (3M SAAR) to around 2% . . “From our perspective, this would be a massive upside surprise,” Lee said.
As a result, Lee and his team believe this could set the stage for the Fed to lower the trajectory of rate hikes and even change the view that the federal funds rate needs to stay “higher for longer.” Fed fund futures traders now see a 74% chance of a 25 basis point hike at their next monetary policy meeting, which ends on Feb to 4.75-5% -year, according to the CME FedWatch tool.
See: ‘Old habits die hard’: Traders take a second look at US interest rate above 5% through March
However, at its December meeting, the central bank signaled that its final interest rate could peak at 5.25% this year, while expecting no rate cuts until the end of this year.
Wage increases are phased out too slowly
“Despite seemingly ‘strong’ labor markets, leading indicators are already suggesting that wage growth will slow,” Lee said.
Friday’s jobs report showed that wage growth was weaker than expected in December, a sign that inflationary pressures may be easing. Average hourly earnings rose 0.3% this month and 4.6% year-on-year, slightly less than expected and down from 0.4% the previous month.
However, although job growth slowed in December, it was still better than expected, a sign that the job market remains strong even as the economy faces mounting headwinds from the Federal Reserve. Meanwhile, the unemployment rate fell from 3.6% to 3.5%.
See: Goldilocks Scenario? Slower wage increases could help the US economy stave off a recession.
Equity (VIX) and bond (MOVE) volatility will fall sharply
Equity and bond market volatility is likely to fall sharply in 2023 in response to a fall in inflation and a consequent less hawkish Fed, Lee and his team said. “Our analysis shows that this drop in the VIX is a huge contributor to stock gains, which would support further stock gains of over 20%.”
The CBOE volatility index VIX, -5.92%, fell 6.4% to 21.03 on Friday, while the ICE Bank of America Merrill Lynch MOVE Index, a measure of implied bond market volatility, was last seen at 119.53.
US stocks rallied on Friday after December’s jobs report raised hopes that Fed monetary policy is finally starting to have an impact on the economy. The Dow Jones Industrial Average DJIA, +2.13%, ended about 700 points higher, or 2.1%, at 33,629. The S&P 500 was up 2.3% and the Nasdaq Composite COMP was up 2.6%, up 2.56%.
See: After the 2022 sell-off, is a 2023 stock market recovery imminent? What history says about consecutive losing years.