The past 12 months have been a year of escalating inflation, escalating interest rates and escalating questions about a future recession.
Prices rose while stock markets and savings accounts fell, leaving consumers and investors dizzy and hurting their wallets.
There could be more financial pain, that’s pretty sure, but it may not be as bad as feared, according to Vanguard’s 2023 outlook.
The likely recession won’t cause unemployment rates to spike, sticker shock will fade for the price of goods, and rent and mortgage increases will also ease, Vanguard said.
“On Tuesday, inflation data for November showed prices cooling further. Analysts say a 50 basis point increase rather than a 75 basis point increase is more likely.”
The good news: This opens opportunities for stocks to recover, the asset manager added.
The outlook, released this week, comes as Americans try to guess what 2023 has in store for their finances as they manage their holiday budget and investments for 2022.
On Tuesday, inflation data for November showed prices cooling further. From October to November, the cost of living rose 0.1%, lower than the 0.3% forecast, the consumer price index showed. According to CPI data, annual inflation fell to 7.1% from 7.7% in October.
On Wednesday, the Federal Reserve will announce its final decision on rate hikes. A 50 basis point increase is widely expected after four massive 75 basis point increases by the central bank.
Here’s a roadmap for the future, as far as Vanguard’s researchers and experts can see.
Hot inflation will cool
Inflation rates have risen in 2022 to the highest levels in four decades. There are signs of easing, such as less than expected price increases in October.
“As we enter 2023, early signs of a recovery in goods supply and declining demand could help balance consumer goods supply and demand and drive prices down,” the authors noted ahead of Tuesday’s CPI data. .
But costs and demand for services will prevent a rapid decline, they noted. Signs of tapering price increases are already visible in rents and mortgages, but they will take longer to subside than consumer goods prices, the authors said.
That echoes the view of Treasury Secretary Janet Yellen, who said on Sunday there will be “much lower inflation” with no unexpected shocks to the economy.
But while hot inflation will cool, it will still feel warm. The Fed says 2% inflation is the target; Vanguard sees 3% inflation by the end of 2023.
A recession is looming
As “generation-high inflation” slowed economies around the world, the Fed and other central banks pushed interest rates to dampen price increases. That “will eventually work out, but at the cost of a global recession in 2023,” according to the Vanguard 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?
According to Vanguard, it’s not too bad. “Households, businesses and financial institutions are in a much better position to cope with the eventual recession, so drawing parallels to the 1970s, 1980s, 2008 or 2020s seems misplaced,” the authors wrote.
Job losses may be clustered
For now, the unemployment rate in a tight labor market is 3.7%, just above the lowest level in five decades. That is at odds with the list of companies where layoffs are on the rise, especially in the technology sector.
If a recession is likely to come next year, “unemployment could peak around 5%, a historically low rate for a recession,” according to the Vanguard outlook. As interest rates rise, job losses “should be most concentrated in the technology and real estate sectors, which were among the biggest beneficiaries of the zero-rate environment.”
The unemployment rate moving from 3.7% to 5% is “a big step,” Roger Aliaga-Díaz, Vanguard’s chief U.S. economist, said at a news conference Monday about the report. “But it may be a less dramatic increase than compared to previous recessions.”
Spotting the opportunities
When interest rates rise, bond prices fall. So this year has been tough for lower-yield bonds and “short-term pain” for investors, according to the Vanguard outlook.
“However, the positive side of higher rates is higher interest payments. This has caused our return expectations for US and international bonds to more than double,” the report said.
Vanguard said projections for US bond yields could be 4.1% – 5.1% pa over the next year, compared to last year’s estimate of 1.4% – 2.4%. For US equities, the forecast could be 4.7% – 6.7% per annum, while returns for emerging market equities could be between 7% and 9%.
On Tuesday morning, stock markets are surging higher on cooler-than-expected inflation data, igniting hopes of a year-end rally before Santa.
““There is a bright spot in our outlook for a modest global recession. And it is the clear silver lining of higher expected returns for investors.””
Yet the Dow Jones Industrial Average DJIA,
is down nearly 5% so far. The S&P 500 SPX,
is down 14% during that time and for the Nasdaq Composite COMP,
has dropped more than 26%.
When the market will bottom is impossible to know, the outlook said, but it noted that “valuations and yields are clearly more attractive than a year ago.”
“There is a bright spot in our outlook for a modest global recession. And it is the clear silver lining of higher expected returns for investors,” said Joseph Davis, Vanguard chief economist.
“We have long been concerned that low interest rates were both unsustainable and ultimately a burden and a headwind for savers and long-term investors,” Davis said.
But even with all the turbulence this year, “we are definitely starting to see the dividends from higher real interest rates around the world in the higher expected returns we expect for investors over the next decade.”