The inflation story is driving the 2023 stock market forecast for now

Published Fri, Dec 2 20229:14 AM EST

What's going to happen in the stock market in 2023? For the moment, it still depends on the inflation narrative. Futures are down Friday morning as November nonfarm payrolls came in stronger than expected — 263,000 versus 200,000 estimated, according to Dow Jones — but more importantly average hourly wages were higher than expected, up 0.6% from the prior month (0.3% expected) and 5.1% on a year-over-year basis (4.6% expected). That is playing against the "inflation data is improving" narrative that has been powering the stock market recently. What about 2023? Judging by some of the comments from strategists, 2023 sounds pretty gloomy. Here's JPMorgan: In the first half of 2023, "we expect S & P 500 to re-test this year's lows as the Fed overtightens into weaker fundamentals," they said in their note, citing "disinflation, rising unemployment, and declining corporate sentiment" which will force the Fed to begin cutting rates later in 2023. JPMorgan is not alone. Michael Hartnett at Bank of America said the 2022 "inflation shock" story is over, but that 2023 will see a "recession shock" for Main Street and that job losses in the new year will likely be "as shocking as inflation in 22." Across the board, most Wall Street strategists — who are paid to examine the economy and then extrapolate where the stock market will go — have been lowering their earnings estimates for 2023. Mike Wilson at Morgan Stanley, who has been bearish for some time, thinks earnings will shrink 15% to 20% in 2023. Analysts currently expect earnings to rise roughly 4%, but most strategists do indeed think earnings will be flat to down next year. Here's the problem: Traders don't seem to want to believe it. This week, the pain trade — the move in the market that would cause the greatest shock to traders — has been for the market to go higher. That's a lot different than last week. A few days ago, the trading community had been loading up on protection, expecting Federal Reserve Chair Jerome Powell to sound uber-hawkish in his Wednesday speech. There were fears of a repeat of the December 2018 disaster , when Powell was last raising rates, and the S & P 500 dropped 16% from the start of December into Christmas. The Fed is still raising rates, far more aggressively than 2018, but the opposite is happening. Market breadth — the number of stocks advancing each day versus those declining — has been expanding dramatically. The S & P 500 is above its 200-day moving average for the first time since April. Seven of the 11 sectors of the S & P 500 are above their 200-day moving average. The dollar is collapsing, and bond yields are in a downtrend. The chattering classes (analysts, strategists, bloggers) are mad, anticipating the markets would drop, and it's not. "People have been calling me up and yelling at me... the markets can't go higher, there's a recession coming!" one trader told me. So keep this in mind when you read about all those "2023 forecasts" from the big firms that are now flooding your inbox: They were assembled by committees over a month ago. Since then, the data has become more mixed. The inflation forecast for some data points has improved, for others it has not. The problem for stocks now: Prices are rising, while earnings estimates are dropping. That's a problem, because the market multiple (P/E ratio) is now expanding into territory that implies a soft landing and a relatively benign economic environment in 2023.