Almost everyone on Wall Street and in Washington got 2022 wrong.
The Federal Reserve expected 2021’s inflation surge to be transitory. It wasn’t. Core inflationclimbed to a four-decade highthis fall, nearly tripling the Fed’s full-year forecast.
Top Wall Street analysts predicted markets would have a so-so year. They didn’t. With just a few trading days left in 2022, the S&P 500 is down 19% and on course for its biggest annual loss since the 2008 financial crisis. Bonds are headed for their worst year on record.
The extent to which many investors, analysts and economists were wrong-footed has left many looking at the coming year with a sense of unease. The big debates of 2023 are already under way: The Fed has signaled it expects to keep raising interest rates, and yet traders have been pricing in rate cuts. Companyexecutives are sounding the alarm about a potential recession, but economists at some banks, includingGoldman Sachs GroupInc. andCredit Suisse GroupAG, see the U.S. economyavoiding a downturn in 2023.
If there is a lesson to be taken away from the past 12 months, some investors and analysts say it is this: Be prepared for more surprises.
“We all approach the coming year with a certain level of humility,” saidChristopher Smart, chief global strategist and head of the Barings Investment Institute.
Like many other strategists, Mr. Smart had expected inflation to moderate in 2022. But he didn’t foresee that Russia would invade Ukraine, sending oil prices and energy shares briefly soaring. He also didn’t anticipate how long China would stick to its zero-Covid policy, which prolongedsupply-chain issuesfor companies around the world.
“You can always say in retrospect, you knew those were risks. But those were thought of as unlikely going into the new year,” Mr. Smart said.
So what does Wall Street consider unlikely next year?
Right now, it appears to be another pickup in inflation. Roughly 90% of investors expect global inflation to be lower within the next 12 months, according to Bank of America Corp.’s December survey of fund managers. That is the highest share in the survey’s history.
Growing confidence that inflation might have peaked has many investors betting on a market reversal in 2023. Fund managers reported having a larger-than-average share of bonds in their portfolios for the first time since 2009, according to Bank of America’s survey. In other words, many investors are counting on waning inflation to make this year’s loser—bonds—one of next year’s big winners.
“I think if you’re a betting person, you have to conclude from the data that inflation is coming down,” saidNancy Tengler, chief investment officer for Laffer Tengler Investments.
Fed ChairmanJerome Powellhas said it is too early to conclude that inflation has peaked. But Ms. Tengler, among others, is skeptical.
Prices for everything from airfare to used cars to shipping have dropped in recent months, Ms. Tengler said. That has helped consumers become more optimistic about the outlook for the economy. Data on Wednesday showedconsumers’ expectations for inflationin the year ahead fell to the lowest level in more than a year in December, while their level of confidence rose to an eight-month high.
Bond traders have taken note. In one sign that many believe the Fed might not have much further to go on its rate increases, the yield on the two-year U.S. Treasury note was at 4.321% on Friday, up substantially for the year but down more than one-third of a percentage point from its November peak.
Shorter-term yields tend to track traders’ expectations for monetary policy, moving higher when traders anticipate the Fed raising rates and falling when they expect the Fed to start to pause or pull back.
“It won’t go down in a straight line, but I do think inflation will surprise many on the downside,” said Ms. Tengler, whose firm has been putting more money into risky assets such as stocks in recent months.
What investors consider the biggest 'tail risks' to marketsSource: Bank of America's December global fund-manager surveyInflation stays highDeep global recessionCentral banks stay hawkishGeopolitical tensions worsenA systemic credit event0%510152025303540Central banks stay hawkish16%
Others remain unconvinced. The past year’s twists and turns have made them wary of second-guessing the Fed. If anything, it pays to question what the crowd believes has become the consensus, they say.
Fund managers surveyed by Bank of America say high inflation ranks as the top “tail risk” to markets, followed by a deep global recession and central banks keeping monetary policy tight. In market parlance, tail risks are generally negative events that investors view as unlikely to happen.
“The market has continued to believe that each interest-rate hike is hopefully one of the last ones, even though the Fed keeps telling markets, it’s not,” saidScott Colyer, chief executive of Advisors Asset Management. “I think if you fight the Fed, you do so at your own risk.”