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Stock Market Outlook for 2023: Odds of a Crash Increasing Lombardi Letter 2022-11-21 09:49:28 stock market inflation interest rates federal reserve While the stock market has been volatile in 2022, it could get worse in 2023. A stock market crash could even be in the cards for next year. Here’s why the stock market could fall and what investors can do about it. Analysis & Predictions https://www.lombardiletter.com/wp-content/uploads/2022/11/2023-year-financial-crisis-concept-2022-10-19-04-10-26-utc-150x150.jpg

Stock Market Outlook for 2023: Odds of a Crash Increasing

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Expect Lots More Volatility on the Stock Market

2022 has been a rough year for investors so far. Key stock indices have come down a bit from their highs, and throughout the year, there was a significant amount of volatility. As the year comes to an end, you might be wondering where the stock market is headed in 2023.

It’s important to keep the overall economic picture in mind when trying to figure out where the stock market will go. It matters a lot. Sometimes you could be holding shares of a few of the best companies, but if the overall economic conditions are dire, your investment portfolio could still get hurt.

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Don’t be shocked if the volatility continues in 2023. It could even be worse than what we’ve seen in 2022. But don’t for a second think it means investors should run for the exits and sell all their stocks. There are always opportunities, no matter how the overall stock market looks.

Inflation Is Biggest Threat to Corporate Earnings & Stock Market

There are a few risks to corporate earnings, and earnings are hands down the most basic reason why stocks go up or down.

The first risk that shouldn’t be ignored is inflation. In the past few months, there have been indicators suggesting that inflation in the U.S. could be cooling off a bit.

However, the inflation rate remains extremely high compared to what we’ve seen in previous years—and well above what the Federal Reserve aims for. Inflation in the U.S. is currently about eight percent. Meanwhile, the Fed targets inflation of two to three percent. Inflation also remains a giant problem globally.

Why does inflation matter to business earnings? Inflation essentially dampens demand. When inflation is high, individuals and businesses buy a lot less for the same amount of money. On a grand scale, when consumers and businesses buy less, companies sell less, and ultimately that hits their earnings.

In their recent quarterly reports, many companies that are traded on the stock market mentioned inflation as one factor that could be having a negative impact on their financial performance.

The effects of inflation usually take time to show up in earnings reports because sometimes businesses are able to pass on their increased costs to their customers. This can only go on for so long, though. Once companies are unable to pass on their higher costs, there will be bad news for the stock market.

Interest Rates Could Send Stock Market Tumbling

The second risk to corporate earnings that’s worth noting is interest rates. Basic economics state that, to fight inflation, central banks need to raise interest rates.

In theory, this makes perfect sense. Here’s the problem. What happens when there’s already too much debt out there, savings are minimal and dwindling, and inflation is persistent? In this situation, higher interest rates hurt the economy a lot.

Americans’ savings have been falling over the past year. Take a look at the chart below. It plots the U.S. personal saving rate, which is a percentage of disposable income saved.

In September 2021, Americans were saving roughly eight percent of their disposable income. As of September 2022, the U.S. personal saving rate was 3.1%, the lowest it had been since early 2008.

(Source: “Personal Saving Rate,” Federal Reserve Bank of St. Louis, last accessed November 18, 2022.)

American consumers have been falling deeper in debt. In the third quarter of 2022, credit card balances jumped by 15% year-over-year. This was their biggest jump in about 20 years! (Source: “Balances Are on the Rise—So Who Is Taking on More Credit Card Debt?,” Liberty Street Economics, November 15, 2022.)

As for corporate debt, it has increased significantly over the past few years. Corporate America took advantage of low interest rates and accumulated a lot of debt. That included a significant amount of junk debt that was issued at extremely low rates.

As the Federal Reserve and other central banks around the world keep increasing interest rates to fight inflation, things could end up extremely bad. Consumers could struggle to pay for things and businesses might even default. That would have direct implications on corporate earnings and the stock market. A financial crisis could be another scenario, but that’s a topic for another day.

Chances of Stock Market Crash in 2023 Are Rising

Dear reader, I believe what we’ve seen in 2022 so far could be a preview of what’s ahead in 2023. As I see it, the stock market is swimming in dangerous waters.

Each day, I can’t help but see significant similarities between now and 2006 and early 2008. We all know what followed back then: a severe stock market crash. The odds of it happening again in 2023 are increasing.

If a stock market crash becomes a reality in 2023, there could actually be some great investment opportunities. When panic strikes the stock market, many investors sell their shares, even those of the greatest companies. So, during those times, one can find amazing discounts on excellent stocks.

In the meantime, a lot of caution is required. Placings stops on existing positions could be the first line of defense in case the stock market keeps falling. Furthermore, picking quality stocks is important. In times of sell-offs, quality stocks don’t fall by as much as speculative stocks do.

Finally, investment allocation is important. Having some cash reserves might not be a bad idea, as it could allow you to buy fabulous stocks when their prices are down.

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