From all of us at BASH Capital and from my family to yours, we wish you a happy New Year and hope you were able to close out 2022 with friends and family.

The beginning of a calendar year is often the time when the previous year’s reflections transition to a new year of hopes. Given the market’s continued instability during 2022 and a resulting tough period for stock and bond prices, everyone is hoping for a fresh start. And history gives us cause for optimism. While each new year brings its own unique circumstances–and having a well-balanced plan helps–more often than not, bad market years are followed by good ones.

Investors have been carefully dissecting Federal Reserve (Fed) officials’ words for decades and depending on the composition of the Federal Open Market Committee, its bark is often worse than its bite. But this time was different. One of the lessons learned in 2022 was to never underestimate our central bank’s resolve to squelch inflation.

Another corresponding teachable moment was never overestimate the speed of price declines. At the start of 2022, markets expected the upper bound of the fed funds rate to stay below 1%. The expectation was predicated on the view that inflation pressures would ease as global economies recalibrated to a post-pandemic environment. But inflation was stickier than anyone anticipated, and the inflation dynamics were further exacerbated by Russia’s invasion of Ukraine and COVID-19-related lockdowns in China.

As inflation accelerated in early 2022, especially housing prices, members of the FOMC started warning investors about the need for aggressive action to fight inflation. As shown here, policy response was as aggressive as policymakers’ speeches. Policy makers were more intent on tightening financial conditions than virtually anyone anticipated. Investors have never seen four consecutive 75 basis point (0.75%) rate increases by the FOMC since the Fed started explicitly targeting the fed funds rate to implement monetary policy.

After underestimating the inflation surge last year, the Fed and markets may be erring on the other side this year. The forces now pushing down on inflation are getting stronger, which may keep interest rates down and stock valuations supported this year.  Optimism can also be viewed when looking at market reactions to the year after mid-term elections.

Since 1950, there have been 18 mid-term election years, and in each instance, the S&P 500 Index has been higher in the subsequent year. Not only have stocks been positive in those cases, but the Index has been higher by 14.7% on average. Stocks also typically perform well when two parties share power in Washington, D.C., and November’s election ushered in a Republican majority in the House, balancing the power once again.

Let’s look at all calendar years following negative S&P 500 Index returns.  The S&P 500 had back-to-back negative years four times since 1930. Those occasions occurred during the Great Depression, World War II, the 1970s, and the dot.com bubble years or early 2000s—periods perhaps more economically dismal than what we face today. So, while we cannot rely on history repeating itself, it does tend to rhyme which give us a reason for optimism.

We remain mindful that the coming year will not be without fundamental challenges. While falling, inflation remains high, and a mild U.S. recession is expected in 2023. Corporate profit growth is expected to be flat, and consumer spending growth should also slow. Meanwhile, deteriorating U.S. relations with China and the ongoing Russia-Ukraine conflict add risks for the economy and markets. But we believe these challenges are offset by still-strong consumer and corporate balance sheets and the likelihood that the Federal Reserve will stop hiking interest rates in the first half of 2023, which may help give stock prices a boost.

The volatile market in 2022 has lowered stock valuations relative to their earnings, suggesting many of the above concerns may have already been priced in. This leads us to believe that 2023 is unlikely to be a repeat of the year just passed. While it is always a good idea to have a plan for stormy weather, history tells us that the winds may be a bit more in our favor this year.

Please contact me if you have any questions. Stay Safe and Stay the Course.

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