JPMorgan and Goldman say stock recovery won’t be easy in 2023

(Bloomberg) — Investors ready to turn the page on stocks’ worst year since the global financial crisis should brace for more pain heading into 2023.

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That is the blunt message of top strategists from Morgan Stanley, Goldman Sachs Group Inc. staunchly hawkish.

The second half will mark a recovery once the Federal Reserve stops raising interest rates, they say — but it will likely be a moderate recovery that will still see stocks only moderately higher than they were at the end of 2022.

“The risks that stock markets have struggled with this year are not over and that makes me nervous about the outlook, especially in the first half,” Mislav Matejka, global equity strategist at JPMorgan Chase & Co., said in an interview.

According to the average target of 22 strategists polled by Bloomberg, the S&P 500 will end next year at 4,078 points — about 7% higher than current levels. The most optimistic forecast is a 24% increase, while the bearish view shows an 11% decline. In Europe, a similar study of 14 strategists predicted an average gain of about 5% for the Stoxx 600.

The cautious central case reflects the mountain of challenges from monetary tightening to the war in Ukraine and the energy crisis in Europe. The first of these has already helped quell a recent equity rally.

Even the better news on inflation has a big caveat, as it hasn’t stopped central banks from focusing on getting it under control. Hawking noises from both the Fed and the European Central Bank led to sharp stock falls last week and reminded investors that timing the much-anticipated policy shift won’t be easy.

If that message didn’t get through, the Bank of Japan hammered home on Tuesday with a shocking adjustment to its bond yield policy.

To be sure, consecutive years of decline are rare for US stocks, so after this year’s decline, it’s unlikely they’ll see yearly declines again in 2023. Since 1928, the S&P 500 has fallen only four times in two consecutive years: The Great Depression, World War II, the oil crisis of the 1970s, and the burst of the Internet bubble in the early 2000s.

Read more: After this year’s slump, the S&P 500 faces a historic warning sign

JPMorgan’s team expects the S&P 500 to fall back to 2022 lows before a Fed pivot fuels a second-half rebound that will leave it about 10% higher than current levels. At its low point this year, in October, the index was down 25% to 3,577 points.

Top money managers are also predicting a rocky start to 2023, with earnings shifting into the second half, according to a Bloomberg News survey released this month.

For those with an optimistic view, they can point to the resilience of the US economy, a slower pace of rate hikes and China’s reopening from strict Covid lockdowns.

But despite all that, one of the main consensus among strategists is that stock markets are not yet reflecting a generally bleak economic outlook.

Christian Mueller-Glissmann and Cecilia Mariotti of Goldman Sachs said late last month that their model implied a 39% chance of a US growth slowdown over the next 12 months, but risk assets only priced in an 11% chance.

Morgan Stanley’s Michael Wilson—a stalwart bear ranked No. 1 in this year’s institutional investor survey—sees the S&P 500 drop a whopping 21% more in the first quarter. With a subsequent recovery, the index will end the year at about 3,900 points, representing an increase of about 2% from Monday’s closing price.

Linked to the deteriorating economic outlook are corporate earnings. While earnings in 2022 have held up surprisingly well to runaway inflation, they are expected to crumble next year as pressure on margins mounts and weaker demand brings greater risk of stagflation.

Wilson warned this week that the profit decline could be similar to that seen during the 2008 financial crisis, and that it is not priced into stocks.

A survey by Bank of America Corp. also found that fund managers expect the earnings outlook to worsen next year, leading them to be more positive on bonds compared to equities. Their relative positioning in equities versus fixed income is the lowest since 2009.

“We don’t expect this year’s constructive growth to continue into 2023,” said Dubravko Lakos-Bujas, a strategist at JPMorgan and No. 2 in the Institutional Investor survey. He expects earnings to fall 9% in the US, 10% in the Eurozone and 4% in Japan.

According to Goldman Sachs strategist Sharon Bell, the drop in earnings in Europe may not be as bad as during typical recessions. While previous contractions have sent earnings down about 30%, this time the decline may be limited to 8%, in part due to the boost for luxury and mining companies from China’s easing of Covid lockdowns.

In Asia, Beijing’s shift from its Covid Zero policy has also improved the outlook for equities there.

Morgan Stanley strategists, including Jonathan Garner, remain overweight emerging market equities in the region relative to developed markets, as they are “more confident that a new bull cycle is starting.” The team at Nomura Holdings Inc. meanwhile, said recessions in the West will allow Asia to outperform as equities there offer cheaper valuations and better fundamental prospects.

“2023 is a year where global growth forecasts have taken quite a hit,” said Mehvish Ayub, senior investment strategist at State Street Global Advisors. “It is a continued uncertain outlook with a lot of volatility to navigate. Equities continue to be challenged.”

–With help from Lu Wang and Michael Msika.

(Context updates on S&P 500 annual performance in ninth paragraph)

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