We’re laying out our expectations for outcomes in the year ahead, making some bold predictions, and sharing insights on what dislocations we foresee in the markets.
Have you ever heard financial markets referred to as ’toppy’? Toppy markets are ones that have reached an unsustainable peak, climbing high and then slinking backward. It’s an appropriate description for the current equity markets. They are not priced with an accurate level of risk factored in, especially as the Federal Reserve (Fed) continues to tighten, an approach that will have significant impacts on corporate earnings and unemployment rates. The market could climb even higher from current levels but eventually, asset prices will come down to meet the reality of asset values.
Though 2022 was a down year for US equities, we believe that 2023 will generate positive returns for investors. The picture is mixed across sectors and heavily dependent on the Fed. As already noted, when and where they decide to pivot on increasing interest rates will have repercussions across all markets. In addition, it’s still too soon to say for certain to what extent they can rein in inflation.
Healthcare, technology, consumer staples, and infrastructure stocks all present promising opportunities. The winners in these tough times will be those companies that pay dividends, maintain earnings growth, and have the pricing power to defend their margins.
These are the themes we expect to dominate the financial news cycles over the next 11 months:
Inflation: We expect inflation will continue to run high in 2023. The Feds’ aggressive rate hikes will rein it in but at a slower rate. We anticipate that inflation will remain over 4% for an extended period of time.
Federal Reserve: The sledgehammer? The Fed has not minced words about the forceful stance they intend to take to combat rampant inflation. If inflation is stubborn and remains high, the Fed will have to change tactics. They’ll want to minimize the risk of causing extensive damage to a fragile economy. The big unknown is, at what point do they pivot on interest rates?
High Volatility: The market will be undergoing some serious repricing as risk levels are re-assessed. This is likely to bring a significant amount of volatility back to the exchanges. Buckle up for this volatility.
Slow Growth: We expect GDP in most of the western world to be flat and perform below expectations. Emerging markets are likely to grow and may even avoid a recessionary scenario.
Weak Dollar: The US dollar has been enjoying an upward streak for most of 2022, and we expect that it will weaken this year. Should the European economies continue to deteriorate, however, the dollar may retain its strength.
While our assessment might sound somewhat pessimistic, try to remember that markets lead the economy. We do expect the financial landscape to hit its nadir, or lowest point, sometime this year, but there’s good news as well. The markets will be looking forward, and they will begin to rise in anticipation of better times ahead. Ultimately, our forecast for 2023 is a drop – followed by a pop – with an overall up year for US equities.
Amidst all this, we will continue to seek out any dislocations that we can use to our advantage. Two major trends stand out here. One is that stocks are currently overvalued at their current level of earnings. 2023 earnings are expected to be lower, and this will put pressure on stock prices.
The other is that the valuations of small-cap companies have fallen significantly. Some of these companies are innovators in their field and will come out of the downturn even stronger. In general, they are undervalued across the board and will lead the broader market during the recovery phase.
