The stock market’s brutal year leaves Wall Street with little confidence in an upturn

(Bloomberg) — A brutal year for US stocks is drawing to a close, and Wall Street has little confidence that the outlook will improve any time soon.

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After charting a recovery since October on speculation that the Federal Reserve is nearing the end of its most aggressive rate hikes in decades, stock prices have fallen over the past two weeks amid renewed concerns that tighter monetary policy will hurt economic growth in the region. will slow down in the first half of 2011. next year. The S&P 500 lost almost 20% this year. Price-sensitive growth stocks have been hit even harder, sending the Nasdaq 100 down more than 30%.

“We are heading for a recession, but it will be a story of two halves next year, one that will likely improve in the stock market in the second half,” said Sam Stovall, chief investment strategist at CFRA. He expects the S&P 500 to retest its October lows in the first half of 2023, but to end next year at around 4,575, up nearly 19% from Friday’s close.

The main question facing Wall Street now is how close the Fed is to ending its rate hikes — a moment that has historically produced double-digit returns for stocks.

According to Luca Paolini, chief strategist at Pictet Asset Management, tighter financial conditions threaten to shift investors’ attention next year from inflation to the risks of an economic slowdown. He is bearish on US equities over the next three to six months, looking at three key factors that could end the bear market: a trough in corporate earnings, a steeper bond yield curve and cheaper valuations in the most sensitive stocks. cycles in the economy.

“We are still in a bear market,” said Paolini. “A spike in inflation is evident, but we expect equities to be weak next year. The fall in inflation can be slow and painful – certainly not strong enough for central banks to move from tightening to easing. Therefore, we do not expect interest rate cuts next year. I am much more concerned about growth than inflation in 2023.”

While the S&P 500 has priced in at least a modest earnings recession, higher borrowing costs and continued economic uncertainty are likely to dampen potential equity gains over the next year, according to Bloomberg Intelligence’s fair value model.

When the bottom will come, however, is a fierce debate. And there is a risk that earnings estimates are still too optimistic. Brokerage analysts’ aggregated target of 4,498 for the S&P 500 for the next 12 months assumes earnings will rise 4.3% — markedly higher than the BI model of a 2% implied decline.

Another sign of pessimism: This year’s thrashing has turned Wall Street strategists into bears for the first time in at least two decades, with the average analyst forecast predicting a fall in the S&P 500 in 2023. a contrary signal for equities and that the overly bearish sentiment points to a market bottom.

In addition, the recent cooling of inflation gives cause for optimism. According to Jim Paulsen, chief investment strategist at The Leuthold Group, since 1950 the S&P 500 has averaged total returns of 13% over the 12 months following the 13 major inflation spikes. And in the 10 instances where the index rose during the year after a significant inflation spike, the S&P 500 continued to return an average total return of 22% the following year, according to data from the company.

While U.S. stocks are likely to start recovering sometime in 2023, it could take more than two years for the S&P 500 to hit its January high again, according to BI. The Fed’s need to keep rates high in the face of still high inflation could weigh on earnings and keep average annual returns for the S&P 500 at 5.7% over the next three years, compared to 12.7% from 2010 to 2019, according to Gina Martin Adams, BI’s chief equity strategist.

Seema Shah, chief global strategist at Principal Asset Management, expects next year to continue to be particularly challenging for technology stocks, whose high valuations are being dragged down as borrowing costs rise.

“Sure, next year will be challenging, but it will be an opportunity for equity investors,” said Shah, who expects the US economy to enter a recession in the second half of 2023. “The Fed is unlikely to respond to an economic downturn with some relief. While this year has been about valuation compression, next year will be about earnings decline, so we expect further losses in the stock market.”

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