The 2022 economic headlines were dominated by inflation at 40-year highs, the Federal Reserve dramatically raising interest rates, the impacts of the war in Ukraine and the bankruptcy of a cryptocurrency exchange. Heading into the new year, WAMC’s Jim Levulis checked in with Hugh Johnson, chairman and chief economist at Hugh Johnson Advisors, about what 2023 might hold.
Johnson: Well, I think 2023 is going to be a very, very exciting year. First of all, when you start the year, most of us, when I say most of us, I'd say the consensus among economists, and I'm certainly in that camp, is that certainly the first half of the year is going to be a very, very difficult period of time. Generally, the expectation, my expectation is that the economy will probably be in a recession in the first and second quarters of 2023, it may be delayed or not start until the second quarter. But I think the economy, which has been very much in the process of slowing through 2022, is going to probably contract in the first quarter and second quarter of 2023, which is going to present a big change number one, contraction. And secondly, it's going to present very big challenges, let's say, for policymakers, such as the Federal Reserve. So hang on everybody. The beginning part of 2023 is likely to be more difficult than a very difficult 2022. And therefore, we have to be sort of braced for a little bit of problems in the first part of 2023. But let's not forget that 2023 has two halves, not just the first half, but the second half. And the second half, in my judgment as a guest is probably going to be a lot better.
Levulis: So I want to pick up on a word you mentioned there, it's been talked about a lot, will it happen, yes or no? And that was recession. You say in 2023, the first half? Yes.
Johnson: Yeah, it's hard for me, quite frankly, to say that there's not going to be a recession. An important variable that we watch very carefully is the index of leading economic indicators. I emphasize the word leading, it's published by the Conference Board, and that index has declined for eight successive months. We're gonna see the November number, we're gonna see it very soon. And the November number is likely to be a decline. And if it is a decline, that'll be nine successive months, it's hard to make the case that will avoid a recession, when you have eight or nine successive monthly declines in the index of leading economic indicators. In addition to that, a lot of talk has been about the yield curve. The yield curve is inverted. Those of us that have watched this historically know that when you get an inversion of the yield curve, it's almost invariably, precedes a recession. So quite frankly, the economy has been in the process of slowing, it seems to be creeping towards a contraction or a recession. And I think we're probably feel the full blow of that contraction or recession in the first two quarters of 2023. So expectations should be changed accordingly.
Levulis: Turning to inflation, that certainly was a key economic factor in 2022. Do you think the worst of inflation is behind us?
Johnson: I sure do. One thing that you can almost count on, when you take a look at financial market history. The stock market declines in anticipation of a contraction or recession in the economy. And the recession is almost always invariably accompanied by a decline in the rate of inflation as the economy recedes or contracts, then the upward pressure on prices gets reduced significantly. We've seen in the last six months of 2022, a decline inch by inch in the year-over-year rate of inflation. It is coming down, it's coming down slowly, but it is coming down. And once you get more than just a slowdown in the economy, something more severe, a little bit of a contraction in the economy, you're likely to see the rate of inflation come down a little bit more steeply or rapidly. So I think that's what's in the cards for the first half of 2023. We'll see the rate of inflation come down. I do think that the high rate of inflation of 8% in 2022 is behind us. That will be the high and we'll see inflation coming down continuously through 2023.
Levulis: Federal Reserve Chair Jerome Powell has said he plans to keep raising the key interest rate until inflation reaches 2%. That federal funds rate currently stands at a range of 4.25% to 4.5%, that's the highest level in 15 years. Looking to that inflation reaching 2%, when do you think that might happen?
Johnson: I wish I knew the answer to that question, Jim. It's a tough question to answer simply because of forecasting the exact number on inflation is difficult at best, let alone trying to achieve it if you're running the Federal Reserve. I don't think it's going to be achieved, or I don't think we're gonna get to 2% in 2023. We may get there in 2024. And everybody that's listening should really take into consideration and it depends on the index you're using to be your inflation index. And very little bit esoteric, but the personal consumption expenditure price index, we may get there. But in the consumer price index, which most of us pay attention, too, I don't think that's in the cards, and certainly not in 2023, maybe 2024. So we're going to have a tough time getting to 2% under the best of circumstances. Chairman Powell and the rest of the members of the Open Market Committee have a real challenge.
Levulis: And why is the Fed’s target 2%?
Johnson: I wish I knew the answer to that question. You know, they want some inflation, but they don't want too much inflation. I agree with that. You don't want prices to be declining, because that sets in motion, a lot of what we call deflationary variables or deflationary process, which could be bad news for the economy, but you don't want it to be too high. It's almost I don't want to say arbitrary, it's not a number that's picked out of the air, there is some rationale behind it. And we come up with 2%. But believe me, if it's 2.5 percent, if that's where they get in 2024, and I think it'll be the earlier part of 2024 is our best case, we get there in the early part 2.5 percent, I think that will be found to be quite acceptable. But don't forget, if you go back to 2023, we're looking at a configuration, which includes at least I think, a configuration which includes our contracting economy and an economy that's contracting, albeit at a very slow of not a very severe pace, but nevertheless, a contraction in the economy, and bit by bit declining rates of inflation. What will the Federal Reserve do? Even if we're not at 2% under those conditions? That's a real question.
Levulis: What are your expectations for a divided Congress, Republicans in control of the House, Democrats in control of the U.S. Senate, in terms of economic policy and impact?
Johnson: Well, I think as you can probably guess my answer is going to be, I don't expect a lot coming out of Congress. And I'm not so sure that's the worst of all possible worlds to have a divided Congress. A lot of things are going to be made easier, I think, for the Democrats and getting certain things such as judges through the U.S. Senate, as long as they have control there. And as long as they get the right votes on the right side, from you know Machin and obviously, that's going to be an issue. But I don't think quite frankly, especially with the House being divided, but divided very closely being a very close call in the House, I don't think you're gonna get a lot of important legislation, tax changes, I don't think it's going to be easy, we'll get some, but we're not going to get a lot of them. And some of the spending increases that we have looking at that we're looking at for fiscal year 2023. It's going to be a struggle or battle every step of the way. That's not the worst of all possible worlds. We need a little stimulus, a little bit of increased spending for the federal government in Washington, but not too much increase in spending for the federal government in Washington. So I think when it's divided, I think that the chances are getting very little in the way of significant legislative change. I just don't think there's going to be much.
Levulis: And now much of 2022’s economic volatility was partially blamed on the war in Ukraine. Do you think that will continue to loom as large in 2023?
Johnson: There are issues like the economy, there are issues like inflation. There are issues like Federal Reserve policy, but there are very big issues throughout the globe. China is a very, very significant issue. What's going to happen when we have a significant even greater outbreak of COVID in China, that's in the cards, how they're going to deal with it, what's going to be the impact on their economy. Ukraine, we're talking about and I'm getting some fairly clear intelligence on the fact that there may be a counter offensive by Russia come sometime in the spring, April, May or June. And that might be significant when they have a lot of the so-called new recruits are trained and are ready to go into combat. So there's a real chance of a counter offensive, or the things could heat up. Things are gonna get difficult for Russia as well, the connection they have to Crimea that may be interrupted, and that's going to put their back against the wall. So I think things in Ukraine are going to actually heat up between now and the end of 2023. And I think we're in for a very long stay there. It is and it will become a very significant issue impacting the global economy, particularly the economy of the West, and for a much longer period of time than anybody expects.
Levulis: Turning to one of the largest economic headlines of this latter half of 2022, there's been a lot made about the bankruptcy of cryptocurrency exchange FTX. What do you make of its impact, or potential impact on the stability of cryptocurrency, or digital currency in general?
Johnson: There's nothing that could have happened that I would not applaud more than the problems with FTX and cryptocurrencies. Look, I think that people who play the crypto business and this is me talking, this isn't a generally accepted view, but it's certainly my view. It said it's purely speculative. And we've gone through a period of speculation. That period of speculation has been characterized by a number of things. Overvaluation, enormous leverage, widespread optimism, unfounded optimism. And that period of speculation is ordinarily followed by distress when prices stopped going up when the speculators begin to have difficulty making their debt service payments. That's certainly happened. We've seen a lot of bankruptcies with regard to companies that are involved in crypto that's very normal in a mania. And then that's followed by very sharp declines in prices, which was also seen, and those sharp declines in prices are very characteristic of a mania and might be accompanied by the emergence of or the revelation of swindles and scandals. And when you talk about FTX, and you talk about the emergence of swindles and scandals or the revelation thereof, we certainly have seen that, and that has made bad matters even worse. And quite frankly, I have seen this as speculation, I have warned that speculation. I've warned that it's not good news for the financial markets in general or for the economy, for that matter. And I think that's all playing itself out. It's a very unfortunate period of speculation, which has had an impact on people's lives.
Levulis: And now the federal government is exploring sort of a government-backed digital currency, other nations also exploring this, is that something you think is a good idea? Doesn't sound like it?
Johnson: Yeah, well, it's not a bad idea in this sense. The most important thing when it comes to currencies, whether we're talking about fiat currencies, whether we're talking about currencies, or whether we're talking about non-currency money supply, it's important for the Federal Reserve or the central bank, wherever the central bank might be, to be able to control or to manage the growth rate of that money supply, or currencies and money. And that's extremely important. So if they can find a way to do that, I don't have any problem with them developing a cryptocurrency or a digital currency. In fact, I think would applaud it and welcome it. But it has to be the case that the Federal Reserve continues to have its control, continuing control over the size of the growth rate of the money supply. Keep in mind that we've had we've had enormous changes in the money supply over the course of the last two or three years. And it's been important that's had an important impact and overwhelming impact on the economy. The Federal Reserve, first of all, lean towards less restraint, increase the size of their balance sheet, increase the money supply enormously in 2020-21 too much so. It introduced a lot of inflation, and now they're contracting or reducing the size of their balance sheet, the money supply, the growth rate in the money supply is coming down. And that's obviously having an impact on the economy and inflation. So the Federal Reserve has to maintain control. So that they can introduce cryptocurrency or digital currency, I would not be against that so long as they maintain or preserve some of their control over the growth rate of the money supply. That's important to monetary policy and to the functioning of our economy.
Levulis: Hugh, I want to turn to Wall Street. We're speaking here late December and the S&P 500 is down about 19% so far this year, 2022. Your advice or thoughts for investors heading into 2023?
Johnson: I'm glad you asked that question. Look, when you look at financial market history back to 1890, you'll notice one thing. First of all, you'll notice that this a bear market. And you mentioned the numbers, the bear market, really it has been a bear market. Has been in some ways very normal, really, quite frankly, the percentage decline, which is more than 19%, which is where we are now. But at one point, it was up at 26.7%. That's about average as bear markets go. The duration of this bear market is almost one year, that's a little bit less not much, than the average of bear markets. The one thing that's missing, however, is bear markets end. And bull markets restart or start again, when the economy is in a recession, or we're having a contraction in the economy and the Federal Reserve or policy makers take their foot off the brake, and investors see that, they know that prospects for the economy and earnings are going to get better, because policymakers are taking their foot off the brake. And that's what's gonna happen in 2023, first quarter, second quarter. And that means we're going to have the foundation or the stage is going to be set for a turn from a bear financial market to a bull financial market. And that's why I say that my guess it all only can be a guess, but it's a good guess, based on an understanding of financial market history is that we'll have a real good second half of 2023. But unfortunately, we're going to struggle or have a difficult first half of 2023. But be patient, we'll get through it. And it'll be followed by good times.
