As markets look ahead to 2023, putting the awful 2022 behind, the plurality of investors are neither bullish nor bearish, but rather are “biding their time” until market visibility improves. That visibility comes in many possible forms, including market capitulation, EPS inflection, Fed pivot, or inflation contracting markedly.

Basically, most investors believe the “crisis” environment of 2022 is spilling over into 2023, seeing a litany of headwinds from Fed hikes to a slowing economy to EPS contraction. So most investors and pundits, including many of the team at Fundstrat, believe stocks will go “nowhere” in 2023.

Question: How common is a “flat” year?

Our team calculated the data:

• Since 1950, there are 19 instances of a negative S&P 500 return year. In the following year,
• Stocks are “flat” (+/- 5%) only 11% of the time (n=2)
• Stocks are up >20% 53% of the time (n=10)

So after a down year, stocks are 5X more likely to rise 20% than be flat, and more than half of the instances are >20% gains.

As shown below, these probabilities are far higher than compared to typical years. Since 1950, based upon all 73 years:

• Stocks are “flat” 16% of the time vs 11% post-negative years — BIG DIFFERENCE
• Stocks are up >20% 27% of the time vs 53% post-negative years — BIG DIFFERENCE

The odds of a >20% gain are double because of the decline in 2022.

3 POSSIBLE CATALYSTS: What are the possible catalysts/drivers for a “positive surprise” in 2023

Naturally, the question is, what are the possible factors that would enable equities to produce >20% gains in 2023, versus a “flat” year? We believe there are 3 possible catalysts:

• First, we think US inflation undershoots Fed and consensus, by a wide margin in 2023. In fact, we think the December CPI report could see core CPI as low as 0.1% MoM and bring annualized inflation to below 2%. By the way, inflation is also set to collapse in Euro-area as well falling to 2%-range in early 2023. So this is a global “disinflation” underway. This would be a “step” function change in the path of inflation versus what the Fed expects. And as a consequence, would arguably set the stage for the Fed to lower the path of forward rates and even change the view regarding “higher for longer.”
• Second, despite what look like “strong” jobs markets, leading indicators already suggest wage gains are set to slow. It is visible even in the Atlanta Fed wage tracker (3M annualized slowing) and in leading surveys, as highlighted by Goldman Sachs Economists.
• Third, equity (VIX) and bond volatility (MOVE) are likely to fall sharply in 2023, in response to a step function downwards in inflation and a consequently less hawkish Fed. Our analysis shows this drop in VIX is a huge influential factor in equity gains.
• If VIX even falls modestly in 2023, the median gain is 22% (see below) with a win-ratio of 83%. This is far higher than equity markets overall. Thus, if the trajectory drop in inflation, along with easing wage gains transpire, we expect equity and credit volatility to drop sharply. As such, this would further support >20% gains.

• SPX and QQQ snapped back Friday, but still appear vulnerable to breaking down into late January. Despite the resilience lately in groups like Financials, Industrials and Discretionary, the lagging in Technology is likely to continue to exert downward pressure in indices for the next few weeks.   
• QQQ along with AAPL, AMZN, MSFT are getting closer to downside exhaustion. In plain English, markets are growing closer to bottoming, but they aren’t quite there yet. 
• If historical cycles are any guide, this year is likely to be far more positive. Pre-election year performance on SPX going back since 1927 shows Q1 performance averaging +5.75%, the best of any of the 16 quarters of the four-year Presidential cycle. Pre-election gains appear quite robust and better in all months except May and September.

• The new year has started with S&P 500 trading within the 3800-3900 range as the economic data tug of war appears to be in full force.
• On one hand there has been and will likely be more dovish signals coming from inflation related data releases while more hawkish signs are probably coming from labor related metrics. Thus, there will be something for both Doves/Bulls and Hawks/Bears to point to for their outlooks, with the outcome still very much uncertain.  
• My research is still suggesting that the Fed path as higher for longer, and I am still targeting 5.25-6.0% as the most likely terminal rate, with a high bar for flipping back to accommodation.  
• Based on my work, the forward profit outlook still looks to be overly optimistic and valuation levels not yet at attractive levels.  
• Bottomline is that I continue to reiterate that there is a high amount of risk for equity investors and that caution and vigilance remain key.  I am still advising that investors sell rallies rather than buy dips.  

Please note that Brian will be doing his 2023 Portfolio Strategy Outlook on Thursday, January 12th, when he will also be including his monthly sector allocation update.  

• Our market valuation methodology shows equities are overvalued relative to investment-grade fixed income, as they have been since March 2022. However, this is improving a little bit.  
• We still expect muted returns and elevated volatility for the equity market in the coming months.
• Idiosyncratic risk has been rising since its trough in August, which means that the environment is improving for strategies that emphasize stock-picking. 
• Our Reddit sentiment index, which acts as a contra-indicator for the market, is currently at a high level. High levels for this index tend to forecast a downturn in the market in the near term.

• Despite favorable price action for several altcoins to start the year, volumes, volatility, and fundamental on-chain activity remain subdued.
• Ethereum core developers held their first call of the year and decided to prioritize staking withdrawals in Q1. This de-risks Ethereum staking and should be constructive for liquid staking tokens.
• A liquidation-fueled bounce from Solana this week garnered attention. Despite having a steep hill to climb in regaining investor confidence, spot volumes over the past couple of weeks suggest that SOL may have found a long-term bottom. 
• On-chain UTXO data indicates an impressive buy wall has formed around current BTC price levels.