As a result of inflation proving to be much more than transitory starting in the latter half of 2021, the Federal Reserve hiked interest rates aggressively throughout 2022. This has had a negative effect on the stock market, as the S&P 500 and Nasdaq Composite Index lost 19% and 33%, respectively, last year.
But we could be seeing a turnaround happening. Both indexes are already up so far this year. The S&P 500 has climbed about 4% (as of March 7), while the Nasdaq is up about 11%. And I think it's likely that both indexes will produce a positive return in 2023.
Here's why.
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Two down years is a rare occurrence
Last year's negative performance was no doubt a major wake-up call for investors, after the market posted strong gains in 2020 and 2021. In fact, the S&P 500 and Nasdaq produced monster returns during the 10-year period that ended Dec. 31, 2021. And investors have become accustomed to seeing their portfolios move up and to the right. So it's no surprise that 2022 might have scared some investors out of the market.
Making matters worse is the fact that many leading companies are experiencing dramatic slowdowns in terms of revenue and earnings growth, thanks to worsening macro conditions. For example, massive retailer Home Depot posted meager revenue growth of just 0.3% in its latest fiscal quarter (fourth-quarter 2022 ended Jan. 31). And major tech companies like Alphabet, Amazon, and Microsoft have cut tens of thousands of jobs in an effort to reduce costs and stabilize margins.
However, investors shouldn't panic. History tells us that it's extremely rare for the market to have two straight down years. The last time this happened was when the tech bubble burst two decades ago, specifically in 2000, 2001, and 2002. That simple truth should hopefully ease investor worries right now.
Is inflation cooling?
There's no denying that a key factor driving stock returns in recent years has been the Federal Reserve. Chair Jerome Powell's words are closely scrutinized for any shift in tone. And it seems as though market participants can't get enough of the Fed minutes, which provide more details about the central bank's meetings.
Lately, the Fed has been on a path to tighten monetary policy by raising interest rates to curb soaring inflation. As we saw last year, this caused investors to sour on risky assets, as they expect a less accommodative central bank to be the norm for the foreseeable future. But based on the past few months' data, inflation could be cooling down.
In the month of January, the Consumer Price Index increased 6.4% year over year. This continued a downward trend since June of last year. Gas prices, in particular, have come down sharply.
If the Federal Reserve continues to make solid progress in its fight to tame inflation, we could see interest rates peak sooner rather than later. This could pave the way for future rate decreases. All told, the possibility of lower inflation could be a bullish sign for stocks throughout the course of 2023.
It pays to be optimistic
Warren Buffett, probably the greatest investor ever, usually makes the same statement in his annual Berkshire Hathaway shareholder letters: That it is totally foolish to bet against America, despite the problems that we have in this country.
This is the correct perspective that investors need to have. It's always a good idea to remain optimistic. The U.S. economy is in growth mode more often than it is in a recession. Even more importantly for the sake of this article, the stock market rises in more years than it declines in.
It's a good idea to continue investing money in the stock market, while strictly keeping a long-term mindset. After 2022's double-digit losses for both the S&P 500 and the Nasdaq, I think 2023 will end up being a nice bounce-back year.
