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The Odds Favor a Return to Normalcy

Markets tend to be most volatile when unexpected events occur. In 2022, the surprises were bearish. In 2023, the odds favor bullish surprises.
Predictions for 2023

In early 2022, few market participants expected the world would face the first significant war on European soil since World War II. The most significant price volatility tends to occur from unforeseen events, because surprises cause panic. Greed and fear are emotions that drive asset price.

One year ago, the U.S. and other countries were emerging from the COVID-19 pandemic and facing rising inflation caused by a tidal wave of central bank liquidity and a tsunami of government stimulus programs. In early 2022, the U.S. Federal Reserve was beginning to realize that inflation was far more structural than temporary. However, an early February handshake in Beijing changed the world. The Russians invaded Ukraine in late February, bifurcating the nuclear powers. Sanctions and retaliation only increased inflationary pressures as Russia is a leading energy exporter, and Russia and Ukraine are critical for the world’s agricultural supply chain.

In early 2022, there was optimism that the pandemic’s end would lead to a return to normalcy. But the year turned out to be anything but ordinary. The S&P 500 reached a record high on January 4, the second day of 2022. Since then, the most diversified U.S. stock market index has made lower highs and lower lows. There was no Santa Claus rally in stocks in late 2022 as the market’s sentiment was as negative at the end of the year as it was positive the previous year. Predictions being what they are, and 2022 being what it was, time will tell if the market’s mood will be wrong for the second consecutive year.

An Ugly Year for Leading Stock Indices

  • The DJIA posted an 8.78% loss in 2022.
  • The S&P 500, the most diversified U.S. stock market index, fell 19.44% in 2022.
  • The tech-heavy NASDAQ plunged 33.10% in 2022.
  • Passive investors experienced losses after double-digit percentage gains in the three leading indices in 2021.

Interest rates and USD Soared

  • The nearby U.S. 30-Year Treasury bond futures contract fell 22.07% in 2022.
  • The nearby 3-Month Eurodollar futures fell from 99.8025 at the end of 2021 to 94.9250 on December 30, 2022, as short-term rates moved from under 20 basis points to over 5%.
  • The nearby dollar index futures contract rose 8.03% in 2022, closing at just under the 103.30 level after reaching a two-decade high of 114.745 in September 2022.

Commodities Were Volatile, But Prices Rose

  • A composite of the top 29 commodities traded on futures and forward markets in the U.S. and the U.K. gained over 3.75% in 2022.
  • Copper and base metals, gold, CBOT wheat, and palladium reached all-time highs, while many other commodities rose to multi-year peaks in 2022 before correcting.
  • Rising interest rates and a strong dollar are typically bearish for raw material prices, but 2022 was anything but an ordinary year.

The Crypto Winter Turned Arctic

  • Bitcoin fell 64.02% in 2022, while Ethereum dropped 67.23%.
  • The leading cryptos slightly underperformed the asset class’s market cap, which declined 63.33% for the year.
  • The number of tokens trading increased by 36.44% to 22,155.
  • High-profile bankruptcies of FTX, Voyager, and Three Arrows Capital shook the crypto market’s confidence.

Positive Factors for 2023?

  • Sentiment is bearish going into 2023, which may be the most bullish commentary at the end of 2022.
  • An end to the Ukraine war would be a welcome surprise.
  • Detente and rapprochement between the U.S. and China would be a welcome event for the global economy.
  • The end of China’s COVID-19 protocols would increase trade and economic activity.

Markets tend to provide the most significant volatility when unexpected events occur. In 2022, the surprises were bearish. In 2023, the current sentiment suggests that the odds favor bullish surprises. Walt Whitman, the American poet, essayist and journalist, may or may not have said: “Keep your face always toward the sunshine, and the shadows will fall behind you.”

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