How likely is a return to a bull market this year and how will investors know when start putting their money back into equities?
There appears to be a general presumption that 2022 was the bad year for global stock markets and this year will mark the start of the recovery. The consensus seems to run along the lines of “sure, the first few months of 2023 might be tough but we’ll be back on track by autumn “.
Equities did endure a torrid 2022 with Wall Street’s broad-based benchmark index the S&P 500 down 19.4% for the year, wiping roughly $8 trillion off the market capitalisation of its constituent members. With growth companies, particularly in the tech sector, among the worst affected by the 2022 sell-off, the tech-heavy Nasdaq index did even worse, down 33.1% for the year, while the Dow Jones Industrial average also declined by 8.9%.
Ten of the S&P 500’s 11 sectors were down over 2022 with only the energy sector doing well to rise by a phenomenal 58%. High energy costs were, however, conversely one of the main reasons for declines across every other sector.
In the UK, the benchmark FTSE 100 actually closed 2022 0.9% up on where it finished the previous year. However, huge gains for energy companies, miners and the defence company BAE (up 55%) masked declines across almost every other sector. The midcap FTSE 250, which didn’t have a handful of huge energy, commodities and defence companies with big gains to compensate for carnage elsewhere, fell by nearly 20%.
Almost every single significant stock market in the world suffered heavy losses last year (India’s Sensex was an exception, gaining 4.4% but still recording its worst return in 6 years), and the MSCI World index finished the year down 17.73%.
Overall, 2022 was the worst year for equities since the international financial crisis struck in 2008. But does that necessarily mean 2023 will end with stock markets in the black? Since the end of the Second World War, the average bear market has lasted 11 months and we’ve now passed that milestone. The 12 months that follow the bottom of a bear market also average returns of 20%.
In that context, it’s understandable that investors, and even analysts, are confident that 2023 will prove a good one. It’s historically unusual for two consecutive calendar years to result in stock market losses.
But it has happened. The S&P 500 has recorded losses across back-to-back years four times in the near century since the end of WWII. Given the combination of inflation running at 40-year highs, interest rates rising quickly, the likelihood of a global recession gripping most developed economies over the months ahead and a major war on European soil that could still escalate, is it a stretch to image 2022 and 2023 could become the fifth such instance?
Let’s look at the arguments for and against stock markets ending 2023 ahead of where they closed last year’s annus horribilis.
Why a 2023 stock market recovery is not a nailed-on certainty
Ahead of the start of the current bear market which took hold in November 2021, stock markets looked especially expensive. It’s not unusual for long bull markets to conclude with a melt-up as investors who have forgotten previous bear markets, or never experienced them, get over excited and push valuations beyond reasonable levels. But the 2020-2021 melt-up which followed a sharp but very brief sell-off at the beginning of the Covid-19 pandemic was especially euphoric.
The chart of the Nasdaq above shows that the only previous melt-up to have ever come even close to what happened between late March 2020 and November 2021 was that which preceded the bursting of the dotcom bubble in 2000. And this was much bigger, fuelled by well over a decade of record low interest rates and money printing by central banks, which reached a crescendo over the pandemic.
The result was a lot of companies that looked hugely expensive. And while a lot of the hot air has been taken out of valuations over the past year, there are plenty of sectors and companies that still don’t look good value against historical averages. Especially if earnings take a battering during a coming recession of unknown severity.
The last time valuations had become so detached from reality as they were in late 2021 was 1999 before the dotcom bubble burst. 1999 was also the last time the S&P 500 showed the same kind of volatility as last year which included 16 Fridays on which the index finished over 1% down on the previous week and 15 when it finished at least 1% higher.
After the bursting of that bubble, it was seven years before the S&P 500 had recovered its losses and reaching the bottom took a while too — the S&P’s 49% slide to its low point took two-and-a-half years. We’re still about a year and a half and 30% of decline off those levels.
However, at the peak of the dotcom bubble, US stocks reached Barclays Cape ratio 47 but only reached 39 before the current sell-off started and is now at 29 after 2022 valuation drops. That, though, is still above the ratio of 25 ahead of the 2008 financial crisis which saw the S&P drop 38%. And it is way above the long-running average level of 16. Stock markets don’t look cheap yet.
If the U.S. avoids recession, or it is short-lived and not especially severe, markets could respond positively. Other potential catalysts for a return to a bull market could be some kind of end to the war in Ukraine or smooth re-opening of China’s economy leading to a quick return to strong growth.
Experts are uniquely divided in their predictions for 2023
The open-ended unpredictability of what 2023 might bring is reflected in the particularly divergent forecasts of analysts at the end of last year. A Reuters poll of 41 predictions taken at the end of November indicated an average expectation for the S&P 500 to finish 2023 up 3% from its level then, or around 10% up from where it finished the year. However, many of the individual forecasts were up or down 20% from that average.
There is also a fair chance that stock markets could stage a recovery this year even if the global economy does not. In 2008 Warren Buffet wrote to Berkshire Hathaway shareholders to say he expected economic headwinds would continue into 2009, but that he couldn’t predict how the market would react.
“We’re certain, for example, that the economy will be in shambles throughout 2009 — and, for that matter, probably well beyond,” he said. “But that conclusion does not tell us whether the stock market will rise or fall.”
He added:
“Neither Charlie Munger, my partner in running Berkshire, nor I can predict the winning and losing years in advance.”
The best way to invest in 2023 will be to ignore 2023
As of January 2023, it would neither be a big surprise if stock markets finished the year down 20% nor up 20%. Investors may be more optimistically or pessimistically inclined in their opinions of how long the current bull market might persist and how severe it could be.
But amid such particular uncertainty, only the most self-confident would expose their portfolio to the kind of swing stacking it heavily in favour of the bull or bear scenario could result in if ultimately mistaken. If one thing looks more likely than most at present, it’s that stock markets could move significantly this year. The bigger question is if it will be up or down.
