Financial Industry Insights from Advisors Asset Management


Bottom Line Up Front

2022 has been one of the worst years for the market in decades. This has been an echo of the COVID-19 pandemic and the fiscal stimulus response. Two years ago, the market was difficult because the economy was too bad due to government-mandated shutdowns. Now, the market has been difficult because the economy is too good due to the recovery and too much government stimulus causing inflation which has forced the Federal Reserve (Fed) to aggressively raise interest rates.

While we never like a bad market, they do happen, and we would much prefer them as a reaction to an underlying good economy than a bad one. We expect the market to be volatile during the first quarter of 2023 as the Fed tries to find the “goldilocks” level for interest rates and then hold them steady for the remainder of the year. We believe that will cause the economy to move to a mild recession in which the slowdown caused by the Fed changes the trajectory of inflation but is mitigated by strong employment, savings and fairly intact consumer demand.

Historically, the market tends to recover several months before the economy does. Therefore, we expect a bumpy first quarter, a mild recession in the second and third quarters, with the market recovering in the latter half of the year.


In April 2022 we indicated that the markets would stop getting worse and begin to recover when certain conditions were met.

Those conditions are our four “P’s”: Peace in Ukraine, the determination of reaching peak inflation, the indication of a pause in the interest rate hike cycle, and the patience necessary to get past the elections.

Fortunately, the elections are over; we now have a divided government, which historically is positive for markets. It appears that peak headline inflation was in July at 9.1% and core peaked at 6.6% in September. Indeed, the last reading for the month of November was 7.1% for headline and 6.0% for core. These are positive developments. This in turn has led the Fed to now make a move toward pause by lowering the rate at which they hike rates from 75 basis points earlier to 50 basis points on December 14.

The war in the Ukraine continues, but to paraphrase the famous Meatloaf song, “3 out of 4 ain’t bad.” The S&P 500 has recovered 10% from its most recent October low. This does not mean things are all clear. We expect several more months of continued volatility as the markets adjust to a new, higher level of sustained interest rates and their effect on demand and earnings.

Effect of Fed Tightening on Inflation

The graph above helps demonstrate the 4–6-month lag effect of the contraction in the economy caused by the increase in interest rates. The Fed raised interest rates and inflation kept rising for several months before the effect of higher interest rates took hold.

At this point, we have probably yet to see the full effect of about half of the current rate hike cycle.

The Good News

All the turmoil and the Fed’s decision to raise interest rates aggressively has significantly impacted the nature of the fixed income market.

During the first part of the year, bonds were severely impacted, and the Aggregate Bond Market index fell 16% in the first half of the year as bond prices moved inversely to interest rates.

This is the first time in 15 years that there has been a 4% 2-year Treasury bond. This is significant because it allows us the potential to earn an acceptable yield while we wait for the economy and markets to return to a more stabilized situation.

The Economy

The key thing to remember is we have a volatile market because the Fed is raising interest rates because the economy was doing too well, and inflation was getting out of hand. The trend is now moving to lower inflation, not higher. We have ways to go, and we expect inflation to continue to fall during 2023.

We believe the economy will probably slip into a mild recession, but we think we will be coming out of it before we know we are really in it. The fundamental issue is that wage growth has occurred and there are still more jobs than there are workers which provides a strong base as we go through adjustment.

It takes the Fed two days to analyze and comment on interest rate policy and the financial markets take a minute to reflect the decision. Unfortunately, businesses and consumers do not react that fast and may take months to alter their spending and investment decisions. No one told the consumer, “Don’t fight the Fed.” The consumer is teaching the Fed about patience.

Changes in interest rates tend to affect the economy with up to a six-month lag. To that end we are just seeing the effect of the hikes in June. People have to catch up to the policy. We think the Fed will stop soon and then pauses for a while to let the consumer and business reaction catch up. We think the pause runs until the end of the 2023.

So What?

In this transitional environment it is important to maintain both patience and perspective. We are focusing on:

  1. There is once again an interest rate, and depending upon the investment objective, it may be possible to earn higher interest rates for the next year or two. It is not exciting, but we think it is meaningful.

  2. The market will continue to be volatile; this creates the potential for opportunity in equities, but it is clearly a stock picker’s market. Earnings will likely affect stock price and we think dividends will be back in vogue.

  3. Recoveries take place over time, not overnight. The COVID stimulus recovery of 2021 was an anomaly, and this recovery is likely to take a bit longer. The markets hate uncertainty. As the Fed reaches its terminal rate (the rate at which they quit raising rates), corporate America and households can then reasonably predict the interest rates they will pay. That allows everyone to plan and progress.

In short, we are closer to the end of this cycle than the beginning.


We expect:

  • The Fed to end its tightening cycle in the first quarter of next year.
  • The Fed to hold fast at that point until 2024.
  • A mild recession in 2023 with a recovery in 2024.
  • Fixed income positions can take advantage of higher interest rates.
  • Equities to be volatile but offer good opportunities in companies that are both inflation and recession resistant.

Across this backdrop — barring significant miscalculation by the Fed or a major change in the global risk environment — 2023 will most likely be a positive year for the markets.

CRN: 2023-0110-10563 R

The opinions and views of this commentary are that of Pence Capital Management and are not necessarily that of Advisors Asset Management.  

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit


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