The stock market’s impressive rally in January, which saw the S&P 500® Index rise over 6% and the Nasdaq Composite climb nearly 11% for the month, brightened the mood among investors after last year’s volatility. Only twice since World War II has the stock market followed double-digit losses in the previous year, with a gain of over 5% in January. (It happened in 1967 and 1975.)
Much of the bullish perspective on this current rally centers on hopes that the Federal Reserve can engineer a soft landing for the economy. Among the bears, there are many questions about the strength of the recent rally following weak earnings reports from many companies. But history shows that strong performance for stocks in January is often a good omen for the rest of the year. As the accompanying chart illustrates, for years when the S&P 500 had gained 5% or more (since 1970), index returns for the next 11 months have averaged over 12%. However, not all subsequent periods have been positive. (See 1987 and 2018.)
As investors consider all the possible paths the stock market may follow in the coming months, they should consider several headwinds that could alter the market’s future direction. While the Fed has downshifted the pace of rate increases, most recently with the quarter-point hike in the Fed funds target rate on February 1, overall monetary policy remains restrictive. The cumulative tightening of financial conditions over the past year should significantly drag on consumer and business activity in 2023. We expect firms to cut back on hiring soon, with outright declines likely later this year. Cooling job prospects are likely to hit household incomes and consequently weaken spending. Ultimately, these trends may result in a moderate recession starting in mid-2023.
Both bears and bulls make credible arguments for potential market outcomes for 2023. Still, investors should never try to time the market or make investment decisions based on omens or narratives. They should instead follow the fundamentals of investing and a long-term strategy designed around each investor’s specific goals, time horizon, and risk tolerance.