Wall Street had a brutal 2022, as surging U.S. inflation has prompted the most aggressive Federal Reserve rate hike campaign in decades, raising fears about a potential recession.

All three major indexes suffered their worst year since 2008. The Dow dropped 8.8 percent in 2022, while the S&P 500 tanked 19.4 percent and the technology-heavy Nasdaq slumped 33.1 percent.

Despite the steep sell-off, many analysts believe that the market’s pain may not be over yet, warning of downside risks, especially in the near term, as lagging effects of tighter monetary policy work their way through the economy.

The S&P 500 Index is expected to fall about 9 percent in the next three months before rebounding after the Fed’s tightening cycle ends in May, strategists at Goldman Sachs Research said in the team’s year-ahead outlook.

They forecast the benchmark to turn out flat returns and no growth in earnings in 2023.

The Fed has raised interest rates by a total of 425 basis points since March 2022 in an aggressive bid to rein in inflation and signalled more rate hikes on the way through next year.

The rapid increase in interest rates has sharply driven up the cost of capital for U.S. firms, which has translated into a drop in valuations, especially in growth stocks.

Goldman Sachs strategists expect the weighted average cost of capital for U.S. companies to remain high in 2023.

“The Fed will likely seek to keep financial conditions sufficiently tight to maintain below-trend economic growth and contain inflation,” they said, noting “this policy means limited valuation expansion and limited upside to equities, a key component of financial conditions.”

“While not our economists’ base case, a U.S. recession is forecast to spark around a 20 percent decline in the S&P 500,” they added.

The average forecast expects the S&P 500 to end 2023 at 4,009, according to Bloomberg, representing an increase of 4.4 percent from Friday’s close of 3,839.5. While varying in their predictions of the target price, most analysts warned that the market could get worse before getting better amid a challenging macro picture.

Economists and strategists at Bank of America Global Research said the upcoming year should be a story of two halves with corporate earnings and economic growth under pressure in the next several months.

They expect to see the S&P 500 dipping to as low as 3,000 in the first half on recession risks, earnings cuts, and elevated rates, adding “the backdrop for stocks should be better in the later half.”

The bank sets a 2023 year-end target of 4,000 on the benchmark index as annual earnings per share for the S&P 500 are seen declining 9 percent next year to 200 U.S. dollars.

“This sell-off combined with disinflation, rising unemployment and declining corporate sentiment should be enough for the Fed to start signalling a pivot, pushing the S&P 500 to 4,200 by year-end 2023,” said Dubravko Lakos-Bujas, chief equity strategist at J.P. Morgan.


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