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Well, certainly the markets have had kind of an up and down year in 2022. Part of that can be tied to the state of the economy, the levels of inflation we've seen, the policy decisions by the Federal Reserve, and much more. What lies ahead though for 2023? We ask that on both sides of the question to our good friend Professor Jeremy Siegel, uh Professor Emeritus at the Wharton School.
Jeremy, great to talk to you again. Happy to see you and uh happy holidays to you, Dan. Thank you very much, Jeremy. And I guess let's start out looking back at 2022. And you and I have talked a good bit over the course of the year and how the markets react. In In your opinion, how have they reacted to all that has gone on?
Well, certainly it's been a disappointing year uh for equities. Um uh worse for bonds actually relative to their historical performance. Uh one of one of the few times in the past 15 or 20 years when both bonds and stocks have moved decisively lower. And the reason for that is very clear. The Fed, as we talked about a year ago, Dan, was extremely late in its uh tightening mode.
It should have started tightening early in 2021. Uh in fact, it didn't begin until March of this year. More than a year later uh than it should. Um then it seemed like the Fed, which was ultra dovish, I I remember uh on the networks I called J. Powell the most dovish uh chair of the central bank that uh I had ever seen.
Uh suddenly he got religion and uh became ultra hawkish. Um at first, of course, I uh I cheered uh in uh my you know last November when the pivot was voiced. It didn't really start till March. It was fine April, May. He should have started raising it faster. But then and surprising many people in the middle of the summer, I got alarmed that Powell and the Fed were raising it too fast.
Because I saw a slowdown in the price increases. And I began warning that the danger now is over tightening. Nonetheless, this has been the fastest increase in the Fed funds rate that we have seen uh probably in the post-war period. And as as every finance student at Wharton and around the world knows financial assets are discounted at the interest rate plus a risk premium.
And when the Fed sharply raises the interest rate uh those valuations must go down and they did. Um I uh attribute therefore most of the decline that we see to the rise in interest rates not the fear of recession. Not that there isn't a fear of recession. There most certainly is. But if you take a look at it, it's mostly a interest rate phenomenon that has caused this decline.
In your opinion then, if the Federal Reserve had acted earlier might they have needed to not act as aggressively with some of the rate increases and then maybe we would have had a little bit of a different impact along along the path over the last year and a half? Oh, most certainly. Without question.
Um if they started increasing the end of 2020 even or beginning of 2021, we wouldn't have to go as high. Uh we wouldn't have had at the inflation that we had and they wouldn't have to go as high as they had. Um and equities uh in my opinion would not have had as big a burst as they had in 2021. Uh but we probably would uh have an increase in this year, a milder increase last year, and uh an increase in this year.
Uh had they actually started earlier. So, it feels like right now we're at a point where we've had these 75 basis point increases. Uh it feels like December's going to probably be a little less than and then we'll we'll wean it down in in the early months of of 2023. Is that your expectation and and where might the target rate end up landing at least in the short term?
I think now uh we're going to get an awful lot of data, as you know, um uh uh before the meeting. My my expectation is a 50 basis points and honestly, Dan, I would like them to stop there and pause and look around. Uh truthfully, I don't even think another 50 is uh is called for, but uh I think that that is certainly uh what what is in the cards at this point for the December 14th meeting.
Um the Fed has inverted the yield curve, which of course means that uh they've sent short-term rates above long-term rates. That has not been a good sign in the past for economic activity. My feeling is is that uh the vast majority of inflation is behind us. Um I have also voiced uh strongly the opinion in the media uh that the Fed is misreading current inflation um particularly because of the way the government collects housing statistics.
Uh they still think housing inflation is going on a very rapid rate when in fact all the evidence on the ground is that house prices and rental prices are now declining not rising. Um but because of the lagged way in which the government collects those statistics uh they show uh they'll they'll see the housing sector which is an very important sector of core inflation um continue to rise throughout the rest of this year and and early 2023.
What's your expectation then as we go into next year uh of of the mindset around recession? Are are is it is it a certainty at this point? At what level might we see it? What what are your thoughts? No, it's not a a certainty at this point. Um uh if the Fed continues to hike next year or stays high, I I I think they are going to start bringing down the Fed funds rate by midyear.
Now, some economists don't think it's going to happen until 2024, but I think that that would remain tight way too long and I think they're going to see the evidence of the slowdown um once they see that uh unemployment rate rise, jobless claims rise, and the real economy soften, they're going to back away and start talking about decrease.
That's going to really encourage the market. We all know the market turns uh up um 4 to 5 months before the economy actually bottoms. And and don't forget this year we had a a technical recession in the first half of the year. So, uh two declining quarters of GDP. Now, uh we had a mild increase in the third quarter.
Fourth quarter looks positive. However, we don't have all the Christmas sales in yet as we speak. We'll see how it is, but this has been a very poor year for GDP growth. I think we're going to be growing maybe only 1% this year, which is again, normally you have recessions following booms. Um, so I don't think we we may not we may just have a period of slow growth in the first half.
The Fed then lowers the rate um, and then we uh, can commence growing again in the second half of 2023. So then do you think that some of the questions asked right now about the labor markets uh, are they on point in terms of, you know, potential concern? I mean, we obviously have seen a variety of companies come out and say that they were going to cut their labor force.
Uh, but to a degree that may even be companies that kind of overshot at the heights of the pandemic, especially the tech companies, uh, that are just kind of right-sizing at this point. Yeah, well, there there there was a lot of hit labor hoarding, not only by the tech companies, but by many others because all they heard about is impossible to hire, impossible to hire.
If you get someone a body, a warm body, you keep them. Um, and um, and I think there was over-hiring. And one of the reason why I think there was over-hiring is uh, we we take a look at the productivity statistics in the first half of the year, they were the worst uh, six-month productivity uh, statistics in 75 years.
Um, they were hiring a lot of people, they were training them, the people weren't working uh, effectively. When the economy slows, they could and if they see a labor market out there, they could start getting rid of these excess people quite quickly. Uh, and we really could see a a softening of of the labor market Um, uh, as they realize that they don't have to hoard labor anymore.
What's your message then to equities investors for next year with all of these potential impacts on the table? I think we've seen the low. Um either in June or October, sort of a double low. Uh we do have some wild cards that are being thrown in, particularly China now. Um which I think is a significant issue, but I think when the Fed starts bringing rates down um even a mild recession would not cause earnings to go down enough, I think, to cause a new low in the stock market.
Now, you know, I say that, Dan, because no one in the short run uh will should ever put their uh their life at stake on what they say about what's going to happen in the in the stock market. My feeling is is the stock market is anywhere from 10 to 15% undervalued on a long-term basis. Um uh and I think 2022 is 2023 is is actually going to be a very good year for equities.
And and I was going to ask you on top of that you have obviously the components of of the midterm elections where you now are going to have Republicans controlling the House of Representatives, Democrats still in control of the Senate. Historically, having a split like that, what has that meant for for Wall Street, for equities?
Not that at all. Uh actually, you know, they often say gridlock Wall Street likes gridlock because they think the government interferes too much with business. So, if they don't get a lot of things done except for, of course, national emergencies, uh that that isn't a bad thing. I think uh of course everybody is going to be positioning towards 2024.
Those elections, what are the Republicans going to do? Are the Democrats going to keep Biden? Is it going to be new faces? I really think that that is going to be the most interesting political events of the next 2 years. I mean there will I mean the fact that Dems keep the Senate, they will get some appointments.
Uh Uh perhaps no Supreme Court justices in these 2 years. No no pending um retirements there, but fed some federal judges, some commissions, appellate judges, etc. and so on. The House will effectively block any tax increases, but we also have to be reminded that after the 2024 election, the tax cuts that Trump put into effect, many of them expire.
So, what the makeup of Congress will be after the 2024 election, it will be critical to see what kind of tax regime we have by the middle of this decade. Finally, I wanted to ask you, you mentioned about China and and that's obviously an ongoing issue right now. You also still have the war in Ukraine.
How much do these global elements impact what is thought about on Wall Street? I mean we know that Wall Street loves certainty and and there's nothing more uncertain than a war and and where that is going to take us and seemingly what the leadership in China feels about COVID and and zero COVID restrictions.
Yeah, I think China's a bigger issue now than the Ukraine. Um Uh I mean we see oil prices really down to pre-invasion levels. Uh which is basically good for the the world economy. I mean now there's a lot of stress in Ukraine and I'm not trying to minimize the human suffering that's occurring there.
What's going on in China though I would have never guessed a year ago the zero COVID policy. I think it's a total disaster. It seems like Chinese are seeming to agree with that conclusion. That that they you know with with over a billion people an economy that's just about equal to ours in in total size to go into this zero COVID is could be a big a big negative shock.
I'm concerned about it. I think there's potentially some good things come of it. I think that some of the great minds and entrepreneurs are going to leave China and come to the west and decide I'm not staying back in China like many of our former students our Chinese students or Asian students often thought they'd learn in the United States and then then they go back and and make their fortunes in China.
A lot of them are now wondering whether they want to go back. So for 2023 cautiously optimistic best way to describe your your opinion right now? Yeah, I I'm definitely cautiously optimistic. Some people say that that that this is the most anticipated recession going into next year ever because so many people are forecasting it and when when too many people forecast something you know my my feeling is is that often that drives the market below its fundamental values.
So it might a lot of bad news is now factored in I think the prices. I think the surprises are more likely on the upside than the downside. Too many chefs in the kitchen, right, Professor? Well, they always say the stock market climbs a wall of worry. Yeah. So, if you wait for the skies to be blue to invest, you will never invest.
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