Some of the biggest questions about the market’s performance in 2023 may find answers in the first quarter of the year. Investors wonder if the economy will go into recession, and if the stock market will continue to sell off and set new levels. Then the important, big question: Will the Federal Reserve pause rate hikes? In recent years, there has been a remarkable level of consensus among Wall Street strategists about the outlook for the stock market. The general view is that the stock market will underperform in the first quarter and possibly the second, carving out new levels before improving at the end of the year. But according to market history, this upcoming quarter could be the best for the next four years. The first quarter of the third year of the president’s term was consistently the best quarter for the performance of the S&P 500, according to CFRA data. The average gain index is 6.9% and is higher 90% of the time. For some perspective, the S&P 500 gained nearly 7.1%% in the fourth quarter, though investors may have felt a let-down from December’s poor performance. The quarter, the end of the second year of the president’s term, is the second best historically and the average gain has been 6.5%, according to CFRA. CFRA chief investment strategist Sam Stovall also expects the volatile first half to be worse than the second half, but calls the high level of agreement about this forecast on Wall Street “unnerving.” “It goes against the grain of history and against the grain of cynicism, where the bottom line is saying, ‘Look, the strategists are going to be wrong,'” he said. “If everyone says the first half is going to be bad and the second half is going to be good, maybe it’s the other way around. Maybe we’ll pop before the drop.” Recession questions The volatile and bearish market outlook in the first quarter is also consistent with many economists’ predictions that the US has entered or will enter a recession. The Fed’s series of rapid interest rate hikes is seen as a trigger for the anticipated slowdown, so what the central bank does in the next few months will be key. “This is one where the Fed, without announcing it, is trying to create a recession,” said Ethan Harris, head of global economic research at Bank of America. The risk is that the Fed will tighten too much, he added. “They can pull back. That supports a moderate recession unless something unexpected happens,” he said. The Fed is trying to slow the economy to cool inflation that has risen to the highest level in 40 years as the economy retreats after the pandemic and supply chains are snarled. The central bank has raised interest rates seven times since March, and the target range for the fed funds rate is now 4.25% to 4.5%, a 15-year high. The Fed estimates the benchmark rate will reach a peak of 5% to 5.25% in the first half of 2023, so two or three more hikes are likely. Consumer inflation has slowed down, and was at an annual rate of 7.1% in November after rising to a level of 9% in June. The December jobs report, due this Friday, and the consumer price index on Jan. 12 will be critical information ahead of the Fed’s next policy meeting on Jan. 31-Feb. 1. The Fed meets again on March 21-22, and before the January meeting, job data will be released on February 3 and February employment will be released on March 10. The CPI is reported on February 14 and again on March 14. “I think what has led some people to believe that the second half will be better is that they expect the Fed to relax after the March tightening,” Stovall said. “If it doesn’t happen, we can definitely stop the market from collapsing.” The labor market has been in shock, even as the Fed tries to cool it down. Economists expect another 217,500 payrolls to be added in December and the unemployment rate is expected to remain at 3.7%, according to FactSet. The company has announced layoffs, and the trend is expected to pick up in the first quarter. “One metric to watch is the unemployment rate,” said Jimmy Chang, chief investment officer of the Rockefeller Global Family Office. He pointed to the economic rule that a recession has begun when the unemployment rate rises half a percent from the trough. Chang expects the recession to start at the beginning of the year. Other data will also be important in the market’s deliberations about whether a recession is imminent. The housing market already appears to be in recession, with home sales on hold, and retail sales will become important as a measure of consumer health. The next retail sales report is January 18. Wild card As always, there is the potential for geopolitical influence to change the forecast, like the war in Ukraine last year. Analysts expect oil to trade higher than current levels, but do not expect prices to rise as much as last year. However, he did not rule out energy surges in the event of another development. China is not known for oil prices, but also for the global economy. Reopening may be a positive economic force, but it may also generate more inflation due to increased demand for goods and commodities. There are also questions about whether the results of Beijing lifting the Zero-Covid restrictions quickly when there are high numbers of cases. “This is the wild card for 2023,” Chang said. “I think the next few months could be volatile.” Chang expects China’s economy to improve in the coming months, especially with the National Party Congress meeting in March. “The time of economic rebound may start in the second quarter so the market can hope,” he said. “The next few months will be very difficult, but hopefully in the spring, there will be enough immunity to start,” he said. What income? Another event that could create volatility for stocks is fourth quarter earnings season. That started in mid-January, with JPMorgan Chase earnings one of the first major reports on January 13. “Income is expected to start a recession pattern in the fourth quarter,” said Stovall. “Right now it’s down about 3% year-on-year … We’re seeing an income recession that usually coincides with an economic recession.” Stovall said first-quarter results, reported in April, are expected to decline, by 0.3% for S&P 500 companies. The second quarter is expected to decline 2.3%. “There’s never been a bear market down without a noticeable spike in volatility, and it won’t happen in 2022. That’s why the first half could be volatile,” said Julian Emanuel, head of equity, derivatives and quantitative strategy at Evercore ISI. “One thing you know for sure is that income numbers are going to go down.” Emanuel said investors should stick to value stocks, or names that have been beaten up but have better earnings outlooks. He also recommends that investors protect themselves from high volatility in both directions with S&P 500 options. After the worst year for bonds, Bonds produced the worst performance in 2022, surprising when the S&P 500 also fell 19.4% in the worst year since 2008. As global central banks move away from zero and even negative interest rate policies, bond markets are set to rise as a result. Yields move the opposite price. Now bond market strategists see exciting times for bond investors in the coming year, as yields are higher and high-quality bonds can provide relatively safe income compared to volatile equities. “It does not provide the recession-risk type of protection. At the same time, there is only a lot of real value created without taking a lot of risk,” said Greg Peters, PGIM Financial co-chief investment officer. Peters expects to see more money flowing into traditional bond funds “The funny thing about bonds is that the worse it gets, the better it gets. The starting point is to produce things and do things. I think it changes the conversation. It changes the allocation, “. Peters said. “When I went back a year ago, a year and a half ago, people asked me why do I need bonds? It’s different now. Get that kind of yield. Get that kind of income, bonds do what they do. they have to do it again.” The cost is the difference between the bond’s yield and the cost of holding the instrument. Peters said that there is a possibility that the economy can escape the recession and even see a soft landing in 2023. “Peeling everything back, investors have become the central bank led, so liquidity leads when the rate is at zero or negative,” he said. “When rates are higher, there are other risks to the system. Central banks are not there to rescue at the drop of a dime, and actually it is a more natural environment … You will see money in motion finding a way into the bond market.”