This past weekend, I played one of my favorite holiday songs on the stereo: Happy Xmas (War Is Over). Released in 1971 by John Lennon and Yoko Ono, it’s a protest anthem against the Vietnam War that has since become a Christmas standard.

The song’s refrain is: “WAR IS OVER! If You Want It. Happy Christmas.” John and Yoko also rented billboards in major cities around the world that conveyed those words.

Fast forward to Christmas 2022. Is the inflation war over? Perhaps…if we want it. Below, I explain why consumer and business expectations about inflation play crucial roles in whether prices go up or down.

I also examine how inflation and interest rates are likely to pan out in 2023, with advice on ways to profit from these macrotrends in the new year.

Read This Story: Six New Year’s Resolutions for Investors

The U.S. Bureau of Labor Statistics (BLS) reported this month that the consumer price index (CPI) in November increased 7.1% over last year and 0.1% over the month. The consensus estimate had called for prices to increase at 7.3% annually and 0.3% on a monthly basis.

On a “core” basis, which removes the volatile food and energy components, prices rose 6.0% year-over-year and 0.2% over the month. Consensus estimates had called for a 6.1% annual increase and 0.3% monthly increase in the core CPI reading.

The good news on the CPI was underscored by the latest producer price index (PPI). The BLS reported this month that the PPI climbed 7.4% in November versus a year earlier. That’s down from the revised 8.1% gain reported for October.

Removing food and energy prices from the PPI reading, prices rose 6.2% for the year ending in November, down from the revised 6.8% increase the previous month. The consensus had called for only a 5.9% increase.

Because the PPI measures wholesale price changes before they reach consumers, many analysts view the PPI as an earlier predictor of inflation than the more popularly followed consumer price index (CPI).

In November, Goldman Sachs (NYSE: GS) forecast a “significant” decline in inflation in 2023. This month, JPMorgan (NYSE: JPM) wrote: “We continue to believe that the underlying trend for inflation is moderating.”

During much of this year, I was a member of the “inflation is transitory” school of thought. This viewpoint was premature, as inflation lingered longer and higher than expected. But inflation is (finally!) coming down.

Inflation has been the result of one-time shocks to the system, i.e. supply disruptions caused by the pandemic and the Russia-Ukraine war. But those shocks are getting sorted out.

Consider shipping rates, which soared during the onset of COVID and have been a major contributing factor to inflation. In September 2021, the global freight rate index reached a record price of $10,400. As of this writing, the index has plummeted to about $2,100. The index takes the sum of all freight data and calculates the average cost of transportation.

During the pandemic, consumers responded to inflation by eschewing inflation-prone services (such as restaurant dining) and buying physical goods instead. The sudden clamor for tangible products caused bottlenecks at shipping ports, but this demand has since cooled and the global transportation infrastructure is returning to normal.

Remember in the run-up to the November midterm elections, when the high cost of gasoline was a fierce political issue? Not anymore.

The average national price of regular gasoline in the U.S. hovers at $3.13 per gallon (as of December 28). That price is about 20 cents per gallon lower than it was 12 months ago and far below this year’s high of $5.00/gal in June. More than half the gas pumps in the U.S. are at $2.92/gal or lower.

The decline in gasoline prices has been driven by less worldwide energy demand, which has driven oil prices lower. The Biden administration’s release of crude oil from the Strategic Petroleum Reserve also has reduced pain at the pump.

Another major component of inflation has been the rising cost of housing, but here too, the pandemic caused freakish imbalances in supply. As COVID becomes less of a concern in the U.S., the housing sector is returning to equilibrium and costs (especially for renters) already are declining.

Regardless, the Federal Reserve is trying to maintain its credibility by staying hawkish. The Fed’s tightening cycle will eventually ease, but interest rate hikes won’t stop altogether in 2023. The latest projections by the Federal Open Market Committee (FOMC) indicate further rate hikes for 2023 before easing in 2024 and beyond (see chart).

To be sure, the jobs market remains hot, and wages have been rising. However, these are lagging indicators. Unemployment data scheduled for release in January 2023 will give us a better picture as to whether the Fed’s aggressive tightening is finally curbing the labor market.

My hunch is that we’ll see higher interest rates reflected in the latest batch of jobs numbers, an outcome that would be disinflationary.

Negative housing report tanks stocks…

Bear market rallies are common, and we’ve seen our share in 2022, but with the last trading week of the year soon coming to an end, the S&P 500 is on track for its worst year since 2008. Yes, we’re getting good news on inflation, but it hasn’t been sufficient to deter the Fed from removing liquidity from the markets, pushing up Treasury yields.

U.S. stocks closed mixed on Tuesday, and Asian equities soared, after China said it would relax COVID restrictions and open its borders in January.

We got negative news on the economy Wednesday, when the National Association of Realtors reported that U.S. pending home sales dropped 4% in November for the sixth straight monthly decline. The monthly reading represented the second lowest in 20 years. The Fed’s goal of squeezing the economy is working…perhaps too well, by Wall Street’s reckoning.

On Wednesday, the main U.S. stock market indices closed sharply lower as follows:

• DJIA: -1.10%
• S&P 500: -1.20%
• NASDAQ: -1.35%
• Russell 2000: -1.57%

The benchmark 10-year Treasury yield rose to surpass 3.88%. West Texas Intermediate crude oil fell more than 1% on recession fears to drop below $79 per barrel.

All 11 S&P 500 sectors finished in the red Wednesday, and they’re also lower for the week and the month of December. Progress on inflation doesn’t change the fact that the stock market is rounding out a dismal 2022.

Inflation: a state of mind…

Expectations influence the path of inflation. If consumers and businesses expect higher inflation down the road, they act accordingly, which in turn makes higher inflation a self-fulling prophecy. The converse is true, so it’s not surprising that as inflation expectations decline, retail spending has been picking up.

Consumer spending has been brisk this holiday shopping season (between Nov. 1 and Dec. 24), jumping 7.6% year-over-year, in defiance of current inflation levels. Shoppers are starting to think that prices, and the economy, will stabilize.

The New York Fed’s latest Survey of Consumer Expectations, released this month, indicates that respondents in November expected one-year inflation to run at a 5.2% pace in 2023, down 0.7 percentage point from the October reading. That’s the lowest level for that reading since August 2021.

New data released this month by the Atlanta Fed also point to lower inflation expectations among businesses.

If the trends I’ve just described continue to unfold in the coming months, the stock market probably will rebound. And as the bear market eases, certain sectors will outperform. The time to gain exposure to these sectors is now.

For guidance, our analysts have compiled a special report of seven predictions for 2023. Our report pinpoints specific investment opportunities that are poised to reap exceptional profits from these predictions.

The product of painstaking research, our report steers you toward quality, under-the-radar picks in a range of industries, including biotechnology, electric vehicles, cannabis, and more. To download your free copy, click here.

John Persinos is the editorial director of Investing Daily.

To subscribe to John’s video channel, click this icon: