The Federal Reserve played a major role in moving the markets into 2022 and sparking a campaign of monetary tightening as it attempted to combat inflation that had been high for decades.
Many who had money in stocks and even bonds struggled as liquidity was sucked out of the market with every Fed rate hike — seven in the past year alone. In mid-December, the central bank raised its benchmark interest rate to its highest level in 15 years and brought it to a target range of between 4.25% and 4.5%.
Before that, the US saw four consecutive three-quarter point increases – the most aggressive policy decisions since the early 1980s.
Fed officials and economists expect rates to remain high next year, with cuts unlikely until 2024. But that doesn’t mean the Fed will remain the main driver of the markets. Patrick Armstrong, chief investment officer at Plurimi Wealth LLP, sees several financial drivers taking control again.
“Next year I think it’s not going to be the Fed that sets the market. I think it’s going to be companies, fundamentals, companies that can grow their earnings, defend their margins, probably move higher,” Armstrong told CNBC’s ” Squawk Box Europe” on Friday.
“Bond yields now give you real returns, above inflation. So it’s a reasonable place to put capital now, when it didn’t make much sense at the beginning of the year. It was hard to expect a return above inflation where yields were. “
The return on the US Treasury at 10 years stood at 3.856% on Friday, a rapid increase from 1.628% at the start of 2022. Benchmark note yields hit an all-time low of 0.55% in July 2020. Bond yields move inversely to prices.
Screens on the trading floor of the New York Stock Exchange (NYSE) show Federal Reserve Chairman Jerome Powell at a press conference after the Federal Reserve announced that interest rates will rise by half a percentage point, in New York City, December 14, 2022.
Andrew Kelly | Reuters
“What happened this year was driven by the Fed,” Armstrong said. Quantitative tightening, higher interest rates, they were pressured by inflation, and everything liquidity driven was sold off. If you were stock and bond investors, you came into the year getting less than a percent on a 10- year government bond, which makes no sense Liquidity was the engine of the market, [and] the liquidity, the carpet has been pulled from under investors.”
Armstrong did suggest that the US is “probably flirting with a recession by the end of the first half of next year”, but noted that “it’s a very strong job market there, wage growth and consumption make up 70% of the US economy, so it’s not even certain that the US will go into recession.”
The key for 2023, the CIO said, will be “to find companies that can defend their margins. Because that’s the real risk for stocks.”
He noted that analysts expect a 13% profit margin for the S&P 500 in 2023, which is an all-time high.
But inflation and Fed tightening could still challenge that, Armstrong argued.
“I don’t think you can achieve that with a consumer having their wallets pulled in so many directions, from energy costs, mortgage costs, food prices, and probably dealing with a little bit of unemployment starting to creep up as the Fed continues to hike , and it’s designed to destroy demand,” Armstrong said. “So I think that’s going to be key in equities.”
– CNBC’s Jeff Cox contributed to this report.