Having correctly called for a slump in stocks, a normalization of ‘meetings’ post-COVID, and a resurgence in the nuclear alternative for power generation in 2022, Byron R. Wien, Vice Chairman together with Joe Zidle, Chief Investment Strategist in the Private Wealth Solutions group at Blackstone, today issued their list of the Ten Surprises of 2023.

This is the 38th year Byron has given his views on a number of economic, financial market and political surprises for the coming year. Byron defines a “surprise” as an event that the average investor would only assign a one out of three chance of taking place but which Byron believes is “probable,” having a better than 50% likelihood of happening. Byron started the tradition in 1986 when he was the Chief U.S. Investment Strategist at Morgan Stanley. Byron joined Blackstone in September 2009 as a senior advisor to both the firm and its clients in analyzing economic, political, market and social trends. In 2018, Joe Zidle joined Byron Wien in the development of the Ten Surprises.

Byron and Joe’s Ten Surprises of 2023 are as follows:

1. Multiple candidates on both sides of the aisle organize campaigns to secure their party’s presidential nomination. There are new headliner names on the respective tickets for 2024.

2. The Federal Reserve remains in a tug-of-war with inflation, so it puts the word “pivot” on the shelf alongside the word “transitory.” The fed funds rate moves above the Personal Consumption Expenditures price index and real interest rates turn positive, a rare phenomenon relative to the last decade.

3. While the Fed is successful in dampening inflation, it over-stays its time in restrictive territory. Margins are squeezed in a mild recession.

4. Despite Fed tightening, the market reaches a bottom by mid-year and begins a recovery comparable to 2009.

5. Every significant correction in the market has in the past been accompanied by a financial “accident.” Cryptocurrencies had a major correction and that proved not to be a systemic event. This time, Modern Monetary Theory is fully discredited because deficits have proven to be inflationary.

6. The Fed remains more hawkish than other central banks, and the US dollar stays strong against major currency pairs, including the yen and euro. This creates a generational opportunity for dollar-based investors to invest in Japanese and European assets.

7. China edges toward its growth objective of 5.5% and works aggressively to re-establish strong trade relationships with the West, with positive implications for real assets and commodities.

8. The US becomes not only the largest producer of oil, but also the friendliest supplier. The price of oil drops primarily as a result of a global recession, but also because of increased hydraulic fracking and greater production from the Middle East and Venezuela. The price of West Texas Intermediate crude touches $50 this year, but there’s a $100 tick out there sometime beyond 2023 as the world recovers.

9. The bombardment, destruction and casualties in Ukraine continue for the first half of 2023. In the second half, the combination of suffering and cost on both sides necessitates a ceasefire and negotiations on a territorial split begin.

10. In spite of the reluctance of advertisers to continue to support the site and the skepticism of creditors about the quality of the firm’s debt, Elon Musk gets Twitter back on the path to recovery by the end of the year.

The “Also Rans” of 2023

Every year there are always a few Surprises that do not make the Ten, because we either do not think they are as relevant as those on the basic list or we are not comfortable with the idea that they are “probable.”

• Because of medical breakthroughs across the board, many people decide on a cryogenic burial, expecting to be defrosted when a cure for the disease that caused their demise is discovered. Funeral homes across the country advertise that “It’s Nice to Be On Ice.”

• A technology breakthrough in reducing the carbon emissions of coal-fired plants takes the edge off the climate / global warming scare. This lowers the political pressure on emerging markets to make a rapid transition to renewable energy sources.

• India begins to compete seriously to win/retain the manufacturing base that started looking for a new home after becoming increasingly uneasy with the uncertainty that has continuously surrounded US–China policies. The country initiates a campaign to attract global multinationals, focusing on its young population, relatively low income and growing consumer market, and prioritizing policies that incentivize investment in the auto, energy, pharma and tech sectors. Apple and Samsung are a proof of concept after successfully producing their respective flagship phones for global markets.

China’s semiconductor industry has suffered a major blow as investments to compete with the US have been paused, as economic turmoil grips the world’s second-largest economy. 

Last month, Reuters reported China was set to roll out a 1 trillion yuan ($143 billion) support package for its semiconductor industry following the Biden administration export controls on the sale of cutting-edge semiconductor chips and advanced equipment needed for domestic semiconductor manufacturing. The plan was to boost domestic chip production that would one day be superior to the US. 

Now Bloomberg reported top Chinese policymakers are discussing ways to pivot away from massive subsidies for the chip industry “that has so far borne little fruit and encouraged both graft and American sanctions.” 

Some policymakers are exploring alternatives to the investment-led approach, such as lowering the cost of semiconductor materials. 

The pivot would mark a dramatic shift in Beijing’s approach to supercharging an industry to challenge American dominance while safeguarding Chinese economic and military competitiveness. It suggests that Beijing’s zero Covid policy, even though it’s ending, has amplified economic turmoil that is beginning to impact spending in critical industries. 

“It’s unclear what other chip policies Beijing is considering, or whether it will ultimately decide to ditch the capital investment-heavy approach that’s worked so well in propelling its manufacturing sector over the past decades,” Bloomberg noted. 

What’s come under intense scrutiny by Beijing is the billions of dollars it has poured into chipmaking companies, including Semiconductor Manufacturing International Corp. and Yangtze Memory Technologies Co., which has yet to produce technology breakthroughs to put China on the same level as the US. And the Biden administration’s sanctions on China’s chip industry have been another setback.  

A perfect storm of factors might have delivered a significant blow to China’s chipmaking ability that Western countries have been hoping for. Suppose Beijing pivots away from its investment-led approach to support chips. In that case, it will give the US some time to ramp up investments at home to revive its chip industry and become less dependent on Asia — another sign supply chains are being rejiggered. 

By Michael Msika, Bloomberg Markets Live reporter and commentator

It might be very early days, but it seems investors don’t want to start the year being heavily short on European stocks, especially not when it comes to the worst laggards of 2022.

The biggest losing stocks of last year are looking to put their awful performance behind them, starting 2023 in the best way possible. A basket of the 20 biggest stragglers of 2022 is up about 6% this week, more than three times the performance of the Stoxx 600.

“We are seeing strong evidence of the January effect,” says Cowen head of EMEA trading Carl Dooley, noting that the last time European stocks had a similarly poor year — in 2018 — underperformers “rallied hard” in the first month of the next year. This time round, he pointed to Faurecia, HelloFresh, SBB, Kion, Just Eat Takeaway, Zalando, GN Store Nord, Aroundtown and AMS as among those off the list of unloved 2022 names enjoying the brightest start.

There’s another common theme linking some of these stocks: a high quantity of shares out on loan, an indication of short-selling interest. Take Swedish real estate company SBB for example, with almost 23% of the free float available to borrow, according to S&P Global data. It’s up 10% this year, extending a rally since Dec. 20 to about 25%. Elsewhere, Zalando, Ocado, Aroundtown and HelloFresh all have more than 9% of their free float out on loan.

A similar picture of losers turning winners is evident in European sectors. Autos, real estate and retail are among the pace-setting industry groups, after they all severely underperformed in 2022. Banks look like the exception in the top six performing groups so far. Real estate was the second most-shorted sector after food retail by mid-December, according to S&P Global data.

“I think investors should be on really high alert for a short squeeze before we see another leg lower in equities,” says Vanda Research global macro strategist Viraj Patel. “Part of the reason for that is that we’ve got bond markets trading on recession fears, while equity markets are in this pessimistic, bearish sentiment state.”

Patel sees a possibility of a “Goldilocks state environment,” where inflation moves lower and economic activity holds up somewhat. “Could that be the template for the next couple of months? That’s certainly not priced in at the moment,” he said in a Bloomberg Television interview.

The short-covering trend shows up in the futures market too. For example, net futures positioning from asset managers and leveraged funds turned positive on the S&P 500 at the end of December, rising from a multi-year low. Meanwhile, European futures positioning has been relatively stable over the past two weeks, with investors marginally net long Euro Stoxx, while positioning in the FTSE 100 and DAX is moderatey net short and rising, according to Citigroup strategists.

“Investors have returned to their trading desks with some confidence about this new year,” says Pierre Veyret, technical analyst at ActivTrades. “It is, however, still hard to say if the current price action is being driven by real directional motivations from portfolio managers or if it is just a liquidity bull trap, covering some of last year’s short positions.”

Veyret cautions that a combination of high volatility and lower market liquidity is often treated as a dangerous indicator for stock traders.

The Manhattan residential real estate market is slowing as high borrowing costs, stock, bond, and crypto turmoil, recession fears, and inflation woes have led to the first quarterly price decline since the early days of the virus pandemic. This a welcoming sign for prospective homebuyers who might catch a break this year as prices are expected to slide, but the question remains how much, mainly because of tight inventory. 

A new report by appraiser Miller Samuel Inc. and brokerage Douglas Elliman revealed the median price for co-ops and condos was around $1.1 million in the fourth quarter, a 5.5% decline versus the same period in 2021, according to Bloomberg. 

The quarterly drop was the first since the second quarter of 2020, when the virus pandemic shuttered the economy and resulted in a mass exodus of people from the metro area and turmoil in the real estate market. 

Jonathan Miller, president of Miller Samuel, expects “a modest decline” in residential real estate in Manhattan this year, “but not a correction.” 

Miller pointed to the tight inventory as a key “underpinning” of what’s preventing property values from crashing amid soaring borrowing costs and an affordability crisis that has crushed demand. 

During the quarter, 6,523 homes were listed on the market, up 5.1% from the year but down 16% from the previous three months. The borough has a tight inventory problem. 

Miller Samuel and Douglas Elliman’s data showed the share of Manhattan buyers paying all cash was 55%, the highest since they began tracking the type of payments in 2014. The increase in cash buyers comes as the 30-year fixed mortgage rate soared above 7% for the quarter.  

High borrowing costs dramatically slowed down deals. Closed purchases totaled 2,546, down 30% from the third quarter and a year ago. 

“The quarter, though, doesn’t appear to be the start of a steep tumble,” Bloomberg said. However, tight supply is the last pillar holding up the Manhattan residential real estate market. 

By Bas van Geffen, Senior Macro Strategist at Rabobank

Price comes before the fall

Of course, the decline in Europe’s TTF gas price benchmark and the increase in gas storage over the Christmas holidays wasn’t only observed by this daily yesterday. French PM Borne stated that she is now more confident that energy supplies in the coming weeks will be sufficient. And a Dutch late night talk show discussed whether this meant that households would soon be seeing a drop in their utility bills again.

Certainly, such a drop in energy costs would be a welcome development for many Europeans. However, it also risks complacency. Firms have stopped certain production processes or have even shuttered entire plants due to the lack of availability and/or high costs of gas. Households have been looking for ways to self-ration as well, driven by concerns over the costs of electricity and gas use. Companies may be reluctant to reopen their production facilities as long as significant uncertainty over gas availability remains. But if consumers see energy prices decline again, that could easily make them complacent. And, worse, what if this lowers governments’ incentives –either on the national or EU level– to press on with structural improvements in Europe’s energy security? That could leave Europe more vulnerable next winter or in winters to come.

European equity markets extended their New Year’s gains and outperformed their US counterparts yesterday. Perhaps this resembles some of the optimism regarding the energy outlook, and a lower probability of forced rationing/blackouts in the near term. That said, it is too early after the holidays to draw much of a conclusion, and EUR’s underperformance compared to its G10 peers suggests that this may just be mere ex post rationalisation on our end as the continent’s outlook remains fragile.

In a sneak preview of the Eurozone inflation data released on Friday, German inflation dropped notably in December. HICP inflation slowed from 11.3% y/y to 9.6%; the lowest reading since August. That’s a softer than expected headline number, with markets anticipating a drop to 10.2%. Yet, as welcome as this stronger retreat to single-digit headline numbers is, the reading is affected by some unusual factors. Most importantly, the German government provided one-off compensation for energy bills last month. Meanwhile, prices of e.g. services have re-accelerated to 3.9%, in a sign that any retreat back to the ECB’s 2%-target may be a long process.

Supporting optimism about peak inflation, and perhaps casting some doubt over the ECB’s latest guidance that it will have continue to hike aggressively, French inflation came in significantly softer than expected as well. The country’s HICP declined to 6.7% from 7.1% in November. The French data show a similar trend as the German inflation figures; a slowdown in energy prices, while Insee notes that prices of services should accelerate, notably those of transport services.

Indeed, market-implied expectations of the ECB’s next few rate hikes have shifted marginally lower since the release of the data, with a cumulative 120bp of hikes priced by May, down from 126bp before the turn of the year.

That said, adding to the ECB’s concerns that it could take significant time before inflation returns to the central banks’ target, labour markets remain tight in various countries. Specifically, German unemployment unexpectedly fell in December. According to the Federal Labour Agency, there were 13,000 fewer unemployed after adjusting for seasonal factors and the inflow of Ukrainian refugees. With employment at a new high (latest data is for November), staff shortages continue to support employees’ bargaining power as they try to recoup some of the real incomes lost to high inflation.

Given the upside risks, it’s not surprising that the ECB’s hawks have not been muted by these recent inflation data. Kazaks repeated that he sees “significant” rate increases at the February and March meetings, after which “of course the steps may become smaller as necessary as we find the level appropriate to bring the inflation down to 2%.”

Elsewhere, China is still trying to cope with the surge in Covid infections after restrictions were eased. Some news outlets are reporting a potential peak in new infections, whereas reports of over-full hospitals and morgues paint a much bleaker picture. Some countries have already imposed inbound travel restrictions for passengers from China, and the EU will discuss a joint-policy today. 

The recent surge in Covid infections is not only straining the Chinese health care system. Bloomberg reports that it may now also stifle Beijing’s plans to kick-start a domestic semiconductor industry to compete with US-controlled supply chains. According to Bloomberg, the virus’ impact on the government’s budget forces government officials to reconsider its subsidies for the sector, which have been expensive and have yielded relatively few results.

It’s yet unclear what alternative policies the government may unveil but new strategies could include lowering the costs of materials, according to the news agency’s sources. This may slow the country’s path towards self-sufficiency in the chip sector, as it seeks to untangle itself from the US – which has increasingly been limiting its strategic rival’s access to key chip resources.

The weekend strike on a Russian conscript barracks in Makiivka in Donetsk region which left possibly hundreds killed has sparked rare backlash and fury inside Russia, with even hardcore nationalists demanding answers and accountability of the military and government. 

Russia had initially given an official death toll from the attack, which was allegedly conducted with US-supplied HIMARS rocket launchers, of 63 soldiers killed while Ukraine claims that it was actually up to 400. Later on Tuesday, the defense ministry upgraded the death toll to 89.

Some Russian military bloggers agree that it was likely more in the hundreds range, and have condemned military commanders for garrisoning troops in what’s being widely described as an unprotected building easily exposed to strikes, which also may have had an ammunition depot positioned dangerously next to it.

The anger has risen to the level of lawmakers in Russia’s parliament, who are demanding an internal investigation in order punish officers responsible for the decision-making which led to what may have been the single deadliest attack suffered by Russia since the invasion began.

The Hill on Wednesday cites one of these leading parliament figures as follows: 

Sergey Mironov, a member of the Russian parliament’s State Duma, said the attack “should be the last of its kind.”

In a Telegram post, he called for an investigation and “personal criminal liability” for any Russian officers or personnel responsible.

“And no, not Ukrainian,” Sukonkin wrote on Telegram. “The Armed Forces of Ukraine are acting as they should — they are trying to kill our soldiers. But their real killer is the scoundrel who positioned the fighters in such a way that it was easy for the enemy to shoot them.”

Interestingly, the narrative coalescing from top Kremlin officials is that it was the soldiers’ fault for breaking bans on cell phone usage…

The confirmed death toll of Ukraine’s New Year’s Day strike on Russian barracks in Makiivka has now reached 89, according to the Russian Defense Ministry. The attack was only possible, the ministry said, because soldiers violated a ban on cell phone use.https://t.co/yT4JIvW5xO

— Meduza in English (@meduza_en) January 4, 2023

Some Western military analysts have also weighed in from a strategic perspective, including the UK Royal Air Force’s Retired Air Vice-Marshal Sean Bell, who points out Russian commanders grew lax over the holiday: 

On New Year’s Eve, a large number of Russian soldiers were gathered in an abandoned school and seeing in 2023 together. Bell says many would have been trying to contact home just after midnight – making their phones “light up”. 

It would have been enough for Ukraine to locate the barracks and target it on New Year’s Day, Bell says. 

He puts further blame on Russia’s military command, saying there can be a “temptation to relax your guard” on New Year’s Eve, but such a large number of troops should not have been housed together.

It’s believed that in total some 600 troops had been crammed into the barracks, which is why the death toll is believed to be far greater that the 89 since confirmed by the Russian defense ministry.

Meanwhile, simultaneous to the growing internal criticisms, President Vladimir Putin continues to find significant displays of public support for the war. Reuters has picked up on one movement making waves this week, writing Tuesday that “A little known patriotic group which supports the widows of Russian soldiers has called on President Vladimir Putin to order a large-scale mobilization of millions of men and to close the borders to ensure victory in Ukraine.”

In the days following the Makiivka barracks attack, Russia hit back, including the below major airstrike caught on a live French TV broadcast…

Druzhovka explosion caught on live French TV channel pic.twitter.com/n5WRMsuTjl

— LogKa (@LogKa11) January 2, 2023

While Putin long ago warned that the Ukraine special operation, which only at the end of last year he called a “war” for the first time, would be a long haul mission, many hawks in Russia believe the military is holding back too much, and that a larger-scale operation should be ordered. 

Despite the prior Sept.21 ‘partial mobilization’ – the group called Soldiers’ Widows of Russia is asking for more in order to finish the job: 

“We ask our President, Vladimir Vladimirovich Putin, to allow the Russian Army to carry out a large-scale mobilization,” the Soldiers’ Widows of Russia group said in a post on Telegram.

“We ask our President, our Supreme Commander-in-Chief, to prohibit the departure of men of military age from Russia. And we have a full moral right to do this: our husbands died protecting these men, but who will protect us if they run away?“

Given local media is amplifying the messaging of this group at a moment the Russian media landscape in general is being tightly controlled in a wartime setting, this could be a coordinated Kremlin media campaign to pave the way for just such a full-scale mobilization plan ordered by Putin.

With the Russian invasion stalemated, and huge losses such as suffered at Makiivka in the New Year attack, are we about to witness a full formal declaration of war by Putin?

Via Remix News,

The Polish government is expressing anger after Germany responded to demands for World War II reparations with a one-sentence answer, which included no substantive or legal arguments.

Poland’s deputy foreign minister, Arkadiusz Mularczyk, has described the curt response as disrespectful to the Polish government and the Polish people.

“To dismiss that with just one sentence means that all assurances about excellent German-Polish relations are false,” said Mularczyk.

The Polish Ministry of Foreign Affairs revealed on Tuesday that the German government’s response to Poland’s €1.3 trillion reparations demand simply reiterated that the Germans consider the matter of reparations to be closed. The German government also indicated it has no intention of entering into negotiations on the matter. 

Polish Deputy Foreign Minister Arkadiusz Mularczyk slams Germany’s one-sentence rejection of Poland’s WWII reparations claim. (Source: TVP Info)

In response to the German position, the Polish Ministry of Foreign Affairs replied that the Polish government would continue its efforts to obtain compensation for the invasion and occupation suffered by Poland between 1939 and 1945. 

Deputy Foreign Minister Mularczyk stated that Poland had suffered losses on an unimaginable scale and that Germany had received a very detailed report on the matter.

The position of the @GermanyDiplo on our note is false. The case of unsettled compensation for Poland for the effects of WWII remains open; morally, politically, and legally. We have an international campaign ahead of us, but I am sure that we will win for both Poland and Poles!

— Arkadiusz Mularczyk (@arekmularczyk) January 3, 2023

He also accused Germany of double standards, as it is willing to pay Namibia for the colonial period and return artifacts to Egypt, whereas it is not prepared to do anything for Poland. 

However, the Polish minister said he was not surprised by the German response, saying it was indicative of how “Germany treats Poland as a vassal” and instrumentally as part of the German sphere of influence.

Mularczyk said Poland would not be deterred and would continue to internationalize the campaign for reparations until Germany is forced to change its stance.

US-listed shares of e-commerce giant Alibaba Group Holding Ltd. jumped in premarket trading after Jack Ma’s Ant Group Co.’s plan to raise 10.5 billion yuan ($1.5 billion) for its consumer unit was approved by Chinese regulators. This is a critical pathway forward after Ant, a financial technology firm, was forced into a government-ordered overhaul that halted its planned IPO two years ago. 

Bloomberg provided more color on the approved fundraising plan. 

The China Banking and Insurance Regulatory Commission division in Chongqing green-lit the company’s plan to lift its capital to 18.5 billion yuan, according to a notice on Dec. 30. Ant, which contributed 5.25 billion yuan as part of the plan, will control half of its shares after the deal, while a unit owned by the city of Hangzhou will hold 10%, becoming the second-biggest shareholder.

The deal resolves a key hurdle for Ant as it seeks to meet requirements from regulators following a crackdown on its business after its record initial public offering was torpedoed in 2020. Chinese regulators have reined in shadow banking over the past years to reduce economic risk and Ant is still waiting to obtain a financial holding license that will regulate it more like a bank. 

Alibaba, which owns a stake in Ant, jumped nearly 7% on the news as China’s regulatory crackdown on its internet sector appears to be easing.

Last week, authorities approved a batch of new game releases for Tencent Holdings Ltd., which added to the optimism the crackdown is abating heading into the new year. 

Other major US-listed Chinese companies were higher, with JD.com +6.2%, Baidu +5.7%, NetEase +4.8%, Bilibili 4.7%, and Trip.com 4.2%. 

The exchange-traded KraneShares CSI China Internet Fund (KWEB) was up 4.2% before the bell. The basket of China tech stocks collapsed by more than 82% since peaking at around $102 per share in early 2021 and likely bottomed at $18 in October. 

The Nasdaq Golden Dragon China Index remains below the 2007 high.

JPMorgan’s strategist Marko Kolanovic urged investors to buy the dip in October. The quant guru’s bullish call is betting that a massive rout will be reversed as there could be light at the end of the tunnel following more than a year of tech reforms by Beijing. 

Authored by Michael Lebowitz via RealInvestmentAdvice.com,

As we anticipate what 2023 might have in store for investors, we must first consider what the Fed may or may not do. We think there are three potential paths the Fed might follow in 2023. The three paths determine the level of overnight interest rates and, more importantly, liquidity for the financial markets. Liquidity has a heavy influence on stock returns.

Let’s examine the three paths and consider what they might mean for stock prices.

The Road Map for 2023

The graph below compares the three most probable paths for Fed Funds in 2023. The green line tracks the Federal Reserve’s guidance for the Fed Funds rate. The black line charts investor projections as implied by Fed Funds futures. Lastly, the “something breaks” alternative in red is based on prior easing cycles.

Scenario 1 The Fed’s Expectations

To provide investors transparency into Fed members’ economic and policy outlooks, the Fed publishes a summary of each voting member’s economic and Fed Funds expectations for the next few years. The latest quarterly guidance on the Fed Funds rate, as shown below, is from December 14, 2022 (LINK).

The dots represent where each member expects the Fed Funds rate to be in the future.

The range of Fed Funds expectations for 2023 is between 4.875% and 5.625%. Most FOMC members expect Fed Funds to end the year somewhere between 5.125% to 5.375%. Based on comments from Jerome Powell, the Fed seems to think Fed Funds will increase in 25bps increments to 5.25%.

While investors place a lot of weight on the Fed projections, it’s worth reminding you they do not have a crystal ball. For evidence, we only need to look back a year ago to its 2022 projections from December 2021.

Their misguided transitory inflation forecast grossly underestimated inflation’s lasting power and how much they would have to raise rates. The point of sharing the graph is not to belittle the Fed but to highlight its poor ability to predict the future.

Scenario 2 Implied Market Expectations

Fed Funds futures are monthly contracts traded on the CME. Each contract price denotes what the collective market implies the daily Fed Funds rate will average each month. For example, when writing the article, the June 2023 contract traded at 95.05. 100 less 95.05 produces an implied rate of 4.95%. We can arrive at an implied path for Fed Funds by stringing the monthly implied rates together.  

The market thinks the Fed will raise rates to just shy of 5% in May and hold them there through July. After that, the market implies increasing odds of a Fed pivot. By December, the market believes the Fed will have cut interest rates by about 40bps.

Like the Fed, the Fed Funds market can also be a poor predictor of Fed Funds.

In late 2019 we wrote an article studying how well the Fed Funds futures market predicts Fed rate hikes and cuts. Per Investors are Grossly Underestimating the Fed:

As shown in the graphs, the market underestimated the Fed’s intent to raise and lower rates every time it changed monetary policy meaningfully. The dotted lines highlight that the market has underestimated rate cuts by 1% on average, but at times during the last three rate-cutting cycles, market expectations were short by over 2%.

During the last three recessions, excluding the brief downturn in 2020, the Fed Funds market misjudged how far Fed Funds would fall by roughly 2.5%. Implied Fed Funds of 4.6% today may be 2% by December if the market similarly underestimates the Fed and the economic and financial environment.

Scenario 3 Something Breaks

The first two alternatives assume the Fed will tread lightly, be it raising rates a little more or a slight pivot in 2023. The third path is the outlier “something breaks” forecast.

There is a significant lag between when the Fed raises rates and when the effect is fully felt. Economists believe the lag can take between nine months and, at times, over a year. In March 2022, the Fed raised rates by 25bps from zero percent. Since then, they have increased rates by an additional 4%. If the lag is a year, the first interest rate hike will not be fully absorbed into the economy until March 2023.

The third path, in which the Fed aggressively lowers rates, would be a response to a significantly weakening economy, inflation falling much more rapidly than expected, or financial instability. It could also be a combination of any or all three factors.  

In The Foghorn is Blowing, we discuss how an inverted Treasury yield curve that un-inverts has been a great predictor of recessions, stock market drawdowns, and corporate earnings declines. The re-steepening of the yield curve is almost always the result of the Fed lowering interest rates.

The yield curve is currently inverted to a level not seen in over 40 years. It will un-invert; the only question is when and how quickly. As we wrote:

The financial foghorn is blowing. Historical odds greatly favor a recession, stock market drawdown, and a much lower Fed Funds rate.

If it un-inverts as violently as it has in the past, the 2% Fed Funds for the year-end scenario may prove too high!

Asset Performance in The Three Paths

Stock investors expect the second path with a slight pivot during the summer. Currently, corporate earnings are expected to grow by 8% in 2023. Such implies economic growth. Therefore, it also intones the Fed will not over-tighten and cause a recession. This goldilocks scenario may provide investors with a positive return.

The first alternative, the FOMC’s expected path, may entail more pain for stock investors as it implies rates will rise higher than market expectations with no pivot in sight.

The third “something breaks” scenario is the potential nightmare scenario. While investors will receive the pivot they have been desperately seeking, they will not like it. Historically, rapidly declining economic activity and financial instability do not bode well for stocks, even if the Fed adopts a more accommodative policy stance.

The graph below shows that the yield curve steepens well before the market bottoms. Likely, the steepening will result from the Fed quickly slashing interest rates in response to “something breaking.”

Don’t Forget About QT

Another Fed policy facet to consider is QT. The Fed is removing liquidity at a sizeable clip. Like interest rates, QT has a lag effect. In time, economic and financial market liquidity diminishes with QT.

Leveraged investors must often reduce exposure as liquidity becomes harder to obtain and more expensive. Usually, the deleveraging process starts slowly with fringe assets and overly leveraged investors feeling pain. However, deleveraging can spread quickly to the well-followed broader markets. The U.K. pension fund bailouts and failing crypto exchanges like FTX are likely signs of liquidity exiting the system.

Even if the Fed stops raising rates or marginally lowers them, QT will present headwinds for stock prices.

Summary

The unprecedented influx of liquidity that drove asset prices higher in 2020 and 2021 is quickly leaving the market. The lag effect of higher interest rates and fading liquidity will likely play a prominent role in determining stock prices in 2023.

Based on the Fed’s determination to quash inflation via higher interest rates and QT, we think the “something breaks” scenario is the likely path ahead.

World renown investor Stanley Druckenmiller seems to agree with us per a recent quote- “I would be stunned if we didn’t have a recession in 2023.”

Given the dynamic nature of economic and financial market activity and the difficulty of predicting the economic future, the Fed’s projections and the other two paths we discuss should be monitored closely throughout the year.

Expect the unexpected in 2023 and keep the Fed’s path top of mind.

Salesforce Inc. shares rose in premarket trading after the company announced a broad restructuring plan “intended to reduce operating costs, improve operating margins, and continue advancing the Company’s ongoing commitment to profitable growth.” 

Add Salesforce to the growing list of technology companies decreasing headcount amid recession threats. The company plans to reduce the current workforce by 10%. The latest SEC filings show the company has 73,541 employees. 

Salesforce plans to scale back on real estate and slash office space in certain markets. All of this was disclosed in a filing with the SEC.

Total costs of the restructuring are expected to be “approximately $1.4 billion to $2.1 billion,” of which about $800 million to $1 billion is expected to be incurred in the 4Q23.

These charges consist primarily of $1.0 billion to $1.4 billion in charges related to employee transition, severance payments, employee benefits, and share-based compensation; and $450 million to $650 million in exit charges associated with the office space reductions. Of the aggregate amount of charges that the company estimates it will incur in connection with the Plan, the company expects that approximately $1.2 billion to $1.7 billion will be in future cash expenditures. –SEC filing 

Also in the filing was a letter by Chief Executive Officer Marc Benioff addressed to employees that read: 

Letter to Employees

Date: January 4, 2023

Subject: Important Company Update

As one ‘Ohana, over the last 23 years, Salesforce has built the #1 CRM that drives incredible customer success across every line of business for every industry around the world. We have never been more mission-critical to our customers. We have an unparalleled ecosystem, with thousands of partners and millions of Trailblazers building their companies on our platform.

However, the environment remains challenging and our customers are taking a more measured approach to their purchasing decisions. With this in mind, we’ve made the very difficult decision to reduce our workforce by about 10 percent, mostly over the coming weeks.

I’ve been thinking a lot about how we came to this moment. As our revenue accelerated through the pandemic, we hired too many people leading into this economic downturn we’re now facing, and I take responsibility for that.

Within the next hour, employees who are initially affected by this decision will receive an email letting them know. Our leadership will reach out directly to these employees, and provide clarity for their teams about changes within their organizations.

For those who will be leaving Salesforce, our priority is to fully support them, including by offering a generous package. In the U.S., affected employees will receive a minimum of nearly five months of pay, health insurance, career resources, and other benefits to help with their transition. Those outside the U.S. will receive a similar level of support, and our local processes will align with employment laws in each country.

The employees being affected aren’t just colleagues. They’re friends. They’re family. Please reach out to them. Offer the compassion and love they and their families deserve and need now more than ever. And most of all, please lean on your leadership, including me, as we work through this difficult time together.

I’m grateful for every single one of you who has contributed to our continued success as a company, and the hard work and sacrifices you have made to generate success for our hundreds of thousands of customers. You’ve built our company — for all of our stakeholders — and you’ve shown incredible resilience every step of the way.

With gratitude,     

Marc

News of the restructuring plan sent Salesforce shares up nearly 3% in premarket. 

Add Salesforce to the growing list of tech companies slashing headcount and costs ahead of what could be a recession.