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Market Commentary

Weekly commentary providing analysis with an outlook for the equity market.

December 7, 2022

Scott Wren, Senior Global Market Strategist

Don’t fight the Fed or chase this market

Key takeaways

  • The Federal Reserve (Fed) strives to engineer a “soft landing” for the economy in an effort to avoid a recession. Based on past history, that is not an easy task.
  • Bear market rallies have always tested the patience of investors. We believe the stock market may retreat from the recent highs as we expect more buying opportunities at lower levels in 2023.

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There was a chart title that caught our strategist’s eye a few weeks ago in our Investment Strategy publication (dated November 14, 2022). It stated, “Stock markets have not bottomed before the last Federal Reserve rate hike.” Think about that for a minute. The Fed has told investors that more rate hikes are likely coming at the December monetary policy meeting and beyond. When the Fed tightens monetary policy and makes borrowing and spending more expensive, they are seeking to slow the economy, slow earnings growth, and, of course, knock down inflation to a more manageable level. Historically, that has usually spelled trouble for the equity market. Year-to-date in 2022, the result has not been any different.

Of course, the Fed strives to engineer a “soft landing” for the economy in an effort to avoid a recession. Based on past history, that is not an easy task. The data shows soft landings have usually not occurred. As we have said many times before, it is tough to fine tune a $22 trillion dollar economy. It is especially difficult in an environment where trillions of stimulus dollars were pumped into the economy during the pandemic. We ultimately believe that at some point, likely early in the new year, the U.S. economy is likely to slip into a moderate recession. In terms of rate hikes, we believe the Fed will increase the fed funds target rate by 50 basis points (100 basis points equals 1%), followed by one or two smaller hikes at the beginning of next year (there are policy meetings in January and March).

So, using this don’t-fight-the-Fed rationale, we do not believe investors should chase the rally we have seen over the last two months. Our work continues to suggest that consensus earnings estimates for this year and, particularly, next are too high in our view. We began to move toward a more defensive stance in March of this year and made a number of portfolio adjustments in April and May based on our outlook for recession, and an earnings contraction next year as we expect.

Bear market rallies have always tested the patience of investors. We believe the stock market could retreat from the recent highs as we expect more buying opportunities at lower levels in 2023. We feel comfortable with where we are positioned given what we expect the next few months to bring. For now, we believe in keeping portfolios positioned defensively and seeking to exploit of any big down days or weeks to incrementally put funds to work in the market. We continue to like U.S. over international stocks; quality large- and mid-capitalization equities over small; and the Energy, Health Care, and Technology sectors.

Risk Considerations

Forecasts are based on certain assumptions and on views of market and economic conditions which are subject to change.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions. Some of the risks associated with investment in the Health Care sector include competition on branded products, sales erosion due to cheaper alternatives, research and development risk, government regulations and government approval of products anticipated to enter the market. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market.

General Disclosures

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability or best interest analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. The material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee to its accuracy or completeness.

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