All across Wall Street, on equities desks and bond desks, at giant firms and niche outfits, the mood was glum. It was the end of 2022 and everyone, it seemed, was game-planning for the recession they were convinced was coming.
Over at Morgan Stanley, Mike Wilson, the bearish stock strategist who was rapidly becoming a market darling, was predicting the S&P 50O Index was about to tumble. A few blocks away at Bank of America, Meghan Swiber and her colleagues were telling clients to prepare for a plunge in Treasury bond yields. And at Goldman Sachs, strategists including Kamakshya Trivedi were talking up Chinese assets as the economy there finally roared back from Covid lockdowns.
And, once again, the consensus was dead wrong. What was supposed to go up went down, or listed sideways, and what was supposed to go down went up — and up and up. The S&P 500 climbed more than 20% and the Nasdaq 100 soared over 50%, the biggest annual gain since the go-go days of the dot-com boom.
It’s a testament in large part to the way the economic forces unleashed in the pandemic — primarily, booming consumer demand that fueled both growth and inflation — continue to bewilder the best and brightest in finance and, for that matter, in policy making circles in Washington and abroad.
And it puts the sell side — as the high-profile analysts are known to all on Wall Street — in a very uncomfortable position with investors across the world who pay for their opinions and advice.
“I’ve never seen the consensus as wrong as it was in 2023,” said Andrew Pease, the chief investment strategist at Russell Investments, which oversees around $290 billion in assets. “When I look at the sell side, everyone got burned.”
Money managers at shops like Russell came out looking alrightthis year, generating returns in stocks and bonds that are slightly higher on average than the gains in benchmark indexes. But Pease, to be clear, didn’t fare much better with hisforecaststhan the stars on the sell side. The root of his mistake was the same as theirs: a nagging sense that the US — and much of therest of the world— were about to sink into arecession.
This waslogical enough. The Federal Reserve was in the midst of its most aggressive interest-rate-hiking campaign in decades and spending by consumers and companies seemed sure to buckle.
There have been few signs of that so far, though. In fact, growthactuallyquickened this year as inflationreceded. Throw into the mix a coupleof breakthroughs in artificial intelligence — the hot new thing in the world of tech — and you had the perfect cocktail for a bull market for stocks.
The year started with a bang. The S&P 500 jumped 6% in January alone. By mid-year, it was up 16%, and then, when the inflation slowdown fueled rampant speculation the Fed would soon start reversing its rate hikes, the rally quickened anew in November, propelling the S&P 500 to within spitting distance of a record high.
Through it all,Wilson, Morgan Stanley’s chief US equity strategist, was unmoved.
He had correctly predicted the 2022 stock-market rout thatfew others saw coming—a call that helped make him the top-ranked portfolio strategist for two straight years in Institutional Investorsurveys—and he was sticking to that pessimistic view. In early 2023, he said,stocks would fall so sharply that,even with a second-half rebound,they’d end up basically unchanged.
He suddenly had plenty of company, too. Last year’s selloff,sparked by the rate hikes,spooked strategists. By early that December,theywere predicting that equity prices would dropagain in the year ahead, according to the average estimate of thosesurveyedby Bloomberg.
That kind of bearish consensus hadn’t been seenin at least 23 years.Even Marko Kolanovic, the JPMorgan Chasestrategist who had insisted through much of 2022 that stocks were on the cusp of a rebound, hadcapitulated. (That doursentiment has extended into next year, with the average forecast calling for almost no gains in the S&P 500.)
It was Wilson, though, who became the public face of the bears, convinced thata2008-type crashin corporate earnings was on the horizon. While traders werebetting that cooling inflation would be good for stocks, Wilson warned of the opposite — saying it would erode companies’ profitmargins just as the economy slowed.
In January, he said even the downbeatWall Street consensus was too sanguine andpredictedthe S&P could drop more than 20% before finally snapping back. A month later, hewarnedclientsthe market’s risk-reward dynamic“is as poor as it’s been at any time during this bear market.”
And inMay, withthe S&P up nearly 10% on the year, he urged investors not to beduped:“This is what bear markets do: they’re designed to fool you, confuse you, make you do things you don’t want to do.”
Wilson declined requests to be interviewed for this story.
Similar resolvehad taken hold among bond mavens. Yields on Treasuriessurged in 2022 asthe Fed put an end to its near-zero interest-rate policy, pushing up the cost of consumer and business loans. It was all happening so fast, the thinking went, that something was bound to break in the economy, drivingit into recession.
And when it did, bonds would rallyas investors rushedinto haven assets and the Fed came to the rescue by reopening the monetary spigot.
SoSwiber and her colleagues onBofA’srate-strategy team —likethe vast majorityofforecasters— predicted solidgains forbond investors who had just been dealt theirworst annual lossin decades. The bankwas among a handful of firmscalling forthe yieldon the benchmark 10-yearnotetodrop all the way to 3.25% by the end of 2023.
For a moment, it looked like that was about to happen. Something indeed broke: Silicon Valley Bank and a few other lenderscollapsedin March after sufferingmassive losses on fixed-income investments —a consequence ofthe Fed’s rate hikes — and investorsbraced for an escalating crisis that would throttlethe economy.
Stocksswooned and Treasuries rallied, driving the 10-year yield down to BofA’starget. “The thought was that this would be a tailwind to this view for a harder landing,” Swiber said.
But the panic didn’t last long. The Fed managed to quicklycontain the crisis,and yields resumed their steady climb through the summer and early fallas economic growth re-accelerated. A late-year rebound in Treasuries pushedthe yield on the 10-year note back down to 3.8%,just about the same levelit was at a year ago.
Swiber said the year has been humbling, not just for her but “for forecasters across the board.”
At the same time,Wall Street was being handed another humbling inmarkets overseas.
Chinese stocksgainedduring the last two months of 2022 as the government ended its strict Covid controls. With its economy unleashed, strategists atGoldman, JPMorgan and elsewherewere predictingChina would help propel arebound inemerging-market stocks.
Goldman’s Trivedi, the head of global currency, rates and emerging-markets strategyin London, concedes things haven’t goneasexpected. The world’s second biggest economy has faltered asa real-estate crisis deepened and fears of deflation grew. And rather than pile in, investors pulled out, sendingChinesestocks tumbling anddraggingdown returns on emerging-market indexes.
“The boost from reopening faded very quickly,” Trivedisaid. “The net positive effect from reopening was smaller and you did not see the same kind of growth rebound that you had in other parts of the world.”
Meanwhile, the US equity market continued to defy naysayers.
By July, Morgan Stanley’s Wilson acknowledgedhe’dremained pessimisticfor too long,saying“we were wrong”in failing to see that stock valuations would climb as inflation receded and companies cut costs. Even so, he was stillpessimistic about corporate earnings,and later said a fourth-quarter stock rally wasunlikely.
When the Fed held rates steady for a second straight meeting on Nov. 1, however, it set off afurious rallyin both stocksand bonds. The advances accelerated thismonthafter policymakersindicated that they’re finally done hiking, prompting traders to anticipateseveral rate cuts next year.
Markets have repeatedly erred in expecting such a sharp pivot in the past couple years, and they could be doing so again.For some on Wall Street’s sell-side, doubts are creeping in.At TD Securities, Gennadiy Goldberg, now the head of US rates strategy, said he and his colleagues “did some soul searching” as the year wound down. TDwas among the firmspredicting solid 2023 bond gains. “It’s important to learn from what you got wrong.”
What did he learn?That the economy is far stronger and far better positioned to cope with higher interest rates than he had thought.
And yet, he remains convinced that a recession looms. It will hit in 2024, he says, and when it does, bonds will rally.