(Bloomberg) — Across Wall Street, on stock and bond desks, at corporate giants and niche companies, the mood was gloomy. It was the end of 2022 and everyone, it seemed, was planning for the recession they were convinced was coming.
Most read on Bloomberg
At Morgan Stanley, Mike Wilson, the bearish stock strategist who was quickly becoming a market darling, predicted that the S&P 50O index was about to fall. A few blocks from Bank of America, Meghan Swiber and her colleagues were telling clients to prepare for a fall in Treasury yields. And at Goldman Sachs, strategists including Kamakshya Trivedi touted Chinese assets as the economy finally recovered from Covid-related lockdowns.
Together, these three calls – sell US stocks, buy Treasuries, buy Chinese stocks – formed the consensus on Wall Street.
And, once again, the consensus was completely wrong. What was supposed to go up came down, or tilted sideways, and what was supposed to go down went up – and up and up. The S&P 500 rose more than 20% and the Nasdaq 100 more than 50%, the biggest annual gain since the dot-com boom days.
This is largely a testament to how the economic forces unleashed by the pandemic – primarily the explosion in consumer demand that has fueled both growth and inflation – continue to confound the best and brightest players in the world. finance and, for that matter, Washington political circles. and abroad.
And that puts sellers – as all top analysts are known on Wall Street – in a very uncomfortable position with investors around the world paying for their opinions and advice.
“I’ve never seen consensus as wrong as 2023,” said Andrew Pease, chief investment strategist at Russell Investments, which oversees about $290 billion in assets. “When I look at the seller side, everyone got burned.”
Shop fund managers like Russell have performed well this year, generating returns on stocks and bonds that are slightly higher on average than benchmark index gains. But Pease, to be clear, didn’t do much better with his forecasts than the stars on the sales side. The root of his mistake was the same as theirs: a lingering sense that the United States – and much of the rest of the world – was on the verge of falling into a recession.
It was quite logical. The Federal Reserve was in the midst of its most aggressive interest rate hike campaign in decades and spending by consumers and businesses seemed inevitable.
There have been few signs so far, however. In fact, growth accelerated this year as inflation fell. Add to that some advances in artificial intelligence – the hot new thing in the tech world – and you have the perfect cocktail for a bull market in stocks.
The year started with a bang. The S&P 500 jumped 6% in January alone. By mid-year it was up 16%, then, when slowing inflation fueled widespread speculation that the Fed would soon begin reversing its rate hikes, the rally took off again. accelerated in November, propelling the S&P 500 close to a record high. .
Through it all, Wilson, Morgan Stanley’s chief U.S. equity strategist, remained unmoved. He correctly predicted the 2022 stock market rout that few others saw coming — a call that helped make him the top-ranked portfolio strategist for two years running in institutional investor surveys — and he delivered on it. held to this pessimistic vision. By early 2023, he said, stocks would fall so sharply that even with a rebound in the second half, they would remain virtually unchanged.
He suddenly had a lot of company, too. Last year’s selloff, triggered by rate hikes, spooked strategists. At the beginning of December, they predicted that stock prices would fall again in the coming year, according to the average estimate of those surveyed by Bloomberg. This kind of bearish consensus has not been seen for at least 23 years. Even Marko Kolanovic, the JPMorgan Chase strategist who had insisted throughout much of 2022 that stocks were poised to rebound, had capitulated. (This gloomy sentiment has carried into next year, with the average forecast calling for almost no gains for the S&P 500.)
But it was Wilson who became the public face of the bears, convinced that a crash in corporate profits, like that of 2008, was on the horizon. While traders were betting that slowing inflation would be good for stocks, Wilson warned otherwise, saying it would erode corporate profit margins just as the economy was slowing.
In January, he said that even the pessimistic Wall Street consensus was too optimistic and predicted that the S&P could fall more than 20% before ultimately reversing course. A month later, he warned clients that the market’s risk-reward dynamic “was as bad as it has ever been during this bear market.” And in May, as the S&P rose nearly 10% for the year, he urged investors not to be fooled: “That’s what bear markets do: They’re designed to fool you, confuse you, make you do things you don’t do. want to do.”
Wilson declined interview requests for this story.
A similar determination had set in among bond specialists. Treasury yields jumped in 2022 when the Fed ended its near-zero interest rate policy, raising the cost of consumer and business loans. Everything was happening so fast, it was thought, that something was bound to break in the economy, pushing it into recession. And when that happened, bonds would rally as investors rushed to safe haven assets and the Fed came to the rescue by reopening the monetary spigot.
So Swiber and his colleagues on BofA’s rates strategy team — like the vast majority of forecasters — predicted solid gains for bond investors who had just suffered their worst annual loss in decades. The bank was among a handful of firms calling for a cut in the yield on the benchmark 10-year bond to as much as 3.25% by the end of 2023.
For a moment it looked like this was going to happen. Something indeed broke: Silicon Valley Bank and a few other lenders collapsed in March after suffering massive losses on their fixed-income investments – the result of Fed rate hikes – and investors braced themselves to an escalation of the crisis which would strangle the economy. Stocks crashed and Treasuries rebounded, pushing the 10-year yield back toward BofA’s target. “The idea was that it would be a favorable wind to that view for a more difficult landing,” Swiber said.
But the panic didn’t last long. The Fed was able to quickly contain the crisis, and yields resumed their steady rise throughout the summer and early fall, as economic growth accelerated again. A rebound in Treasurys at the end of the year sent the yield on the 10-year Treasury note down to 3.8%, about the same level as a year ago.
Swiber said the year has been humbling, not only for her but “for forecasters at all levels.”
At the same time, Wall Street suffered a further decline in humility in foreign markets.
Chinese stocks rose in the last two months of 2022 as the government ended its strict Covid controls. As its economy sputtered, strategists at Goldman, JPMorgan and elsewhere predicted that China would help propel a rebound in emerging market stocks.
Goldman’s Trivedi, head of global currencies, rates and emerging markets strategy in London, admits things didn’t go as planned. The world’s second-largest economy collapsed as the housing crisis deepened and fears of deflation grew. And rather than pile in, investors pulled out, sending Chinese stocks tumbling and dragging down returns on emerging market indexes.
“The effect of reopening wore off very quickly,” Trivedi said. “The net positive effect of reopening has been less and you haven’t seen the same type of growth rebound as in other parts of the world. »
Meanwhile, the U.S. stock market continued to defy the naysayers.
In July, Morgan Stanley’s Wilson admitted he had remained pessimistic for too long, saying “we were wrong” to fail to see that stock valuations would rise as inflation receded and companies cut costs. Despite this, he remains pessimistic about company results and later said a fourth-quarter stock market rally was unlikely.
However, when the Fed kept rates unchanged for a second straight meeting on November 1, it sparked a furious rally in stocks and bonds. Advances accelerated this month after policymakers indicated they had finally completed their hikes, prompting traders to anticipate several rate cuts next year.
Markets have repeatedly made the mistake of expecting such a sharp reversal over the past two years, and they could well happen again.
For some Wall Street sellers, doubts are setting in. At TD Securities, Gennadiy Goldberg, now head of U.S. rates strategy, said he and his colleagues “did some soul searching” at the end of the year. TD was among the companies forecasting strong bond gains in 2023. “It’s important to learn from your mistakes.”
What did he learn? That the economy is much stronger and much better positioned to deal with higher interest rates than he imagined.
And yet he remains convinced that a recession threatens. It will arrive in 2024, he says, and when it does, bonds will recover.
–With help from Ye Xie, Sujata Rao-Coverley and Matt Turner.
Most read from Bloomberg Businessweek
©2023 Bloomberg LP