end of ’22/start of ’23 thoughts (v)

setting the macro stage

interest rates

The Fed Funds rate was effectively at zero from the onset of the 2008-09 financial crisis until the end of 2015. Two reasons: the extent of the economic havoc wreaked by extreme speculation by banks that wrecked their balance sheets, bringing world commerce to a standstill; and the equally extreme unwillingness of congressional Republicans to use fiscal policy to help repair the damage (an editorial note: in contrast with the savings and loan crisis, neither Republicans nor Democrats had any interest in holding bank officials to account for their criminal behavior).

The rate was just short of 2.5% in mid-2019, when then-President Trump began to pressure the Fed to lower rates, in what I read as an attempt to disguise the negative effects of his markedly anti-growth agenda, which had driven the real rate of expansion of the US economy to at best +1%.

Then the pandemic came, with Trump’s deer-in-the-headlights denial that there was any medical issue, supplemented with his anti-Asian hate rhetoric–again leaving monetary policy as the only tool to fight the economic contraction the pandemic caused.

The Fed Funds rate stayed at zero until early 2022, or about two years, before beginning its sharp rise to the current 4.5%. Again, two reasons: the willingness of the Biden administration to use fiscal stimulus as an adjunct to monetary; and the effectiveness of vaccines to bring covid under control.


Inflation in the US was 9.1% over the twelve months ending last June. That figure has fallen to 7.1% for the twelve months ending in November.

Price rises, which had been running at about +1.0% per month in mid-2022 have been +0.3% and +0.1% in the two last reported months.

Ex food and energy, prices are rising at about a 6% annual rate.

In other words, inflation appears to be slowly coming under control. Two factors involved–higher interest rates and supply bottlenecks easing, with previous shortages (and higher prices, like for used cars or hand sanitizer) turning into gluts.

what I think 2023 holds

The Fed has made it clear that it does not think that short-term interest rates are high enough yet. Let’s assume that Fed Funds gets to 5.0% and stays there through this year, before gradually declining next.

Just to get a ballpark number for interest rates–and derive from that what the market PE should be–let’s say that the trend rate of real growth in the US economy is 1%. Given that the domestic population is barely expanding and that we choose not to grow through immigration (shades of Japan!) that’s probably too high. Productivity growth might help, but the nation as a whole is anti-education as I think the deterioration of the public school attests, so it’s hard to see where big productivity gains will come from.

If we think, as I do, that the real policy target for the Fed is 3% inflation, then nominal growth will be, say, 4%–maybe less. If the target is in fact 2%, as the Fed seems to be saying, then nominal growth will likely end up at 3%-ish

In either event. it seems to me that a period of Fed Funds at 5% is enough to slow the economy to this level.

The 10-year Treasury note at 5% (yes, it’s below 4% now) would imply a PE for the S&P 500 of 20x. A 4% 10-year yield would imply 25x.

S&P 500 earnings for 2022 are projected by Ed Yardeni to be around 215. At a multiple of 20x, this would imply the index at 4300, or about 10% above where it ended last year.

He’s projecting earnings of 225 for the S&P in 2023, with yoy declines of about 4% in the first half being more than offset by a robust 4Q23–with earnings gains continuing in 2024. For the year as a whole, the earnings gain would be +4.6%, a number that to my mind is not that different from zero.

Can the S&P 500 index get to the projected result for December 2023 of more or les unchanged by remaining flattish for an entire 12 months? That would be highly unusual.

More tomorrow.

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