2022 was a pretty dismal year for equity markets.
Having kicked January off at all-time highs, stock valuations rapidly went south as inflation precipitated a round of interest rate increases, the likes of which hadn’t been seen in decades.
On top of that, the outbreak of war in Ukraine contributed to an economic outlook that was far from certain.
The one thing that did appear certain was that much of the world would be in recession in 2023.
According to an IMF analysis, about a third of the global economy would fall into contractionary mode and for the rest of the world, ‘it would feel like recession’.
The S&P 500 index of US stocks ended the year nearly 20% below where it started 2022. The Nasdaq index of mainly tech shares had shed about a third of its value by year end – and that was with a bounce towards the end of the year.
The omens were not looking good for the new year.
But a wave of New year cheer appeared to sweep over market traders and analysts as 2023 kicked off.
A steady decline in the rate of price increases and accompanying expectations around more muted future interest rate hikes unleashed a few bulls into the trading arena.
They were further emboldened by the swift reopening of the Chinese economy as it abandoned its strict Covid-19 restrictions.
The positive sentiment was reinforced somewhat by some better-than-expected results from companies that started to report for the full year in January – particularly in the much-battered tech sphere.
The Nasdaq recorded its best opening month of a year in over two decades with a gain of over 11% in January alone.
The S&P 500 was up 6% – its best January in four years – with analysts hailing the stellar start to the year as a harbinger of things to come.
It didn’t last long.
As February rolled around, and the dust began to settle on earnings season, analysts were questioning whether the rally could be sustained.
Goldman Sachs told clients in a note that January was likely to be as good as it gets for stock markets this year.
“Even avoiding recession, earnings are unlikely to grow substantially in 2023,” its chief US equity strategist David Kostin wrote.
He pointed out that the markets were already pricing in a soft landing for the US economy and that valuations were still expensive.
More importantly, he pointed out, growth would be constrained by further interest rate hikes.
A new reality appeared to dawn on traders and investors in February. Despite the solid start to the year, all the main US indexes posted losses for the month.
While the S&P and Nasdaq remained in positive territory for the year by the end of February, the Dow Jones was down around 1.5%.
Interest rate conundrum
The rate trajectory is the nub of the issue for markets right now.
There was an assumption – probably premature – that rate hikes were going to taper off rapidly in 2023 and that the US Federal Reserve (and maybe even other Central Banks) could be forced to reverse course and cut rates later in the year.
That view appeared to take hold despite warnings to the contrary from the regulators themselves.
“Central Banks and the markets haven’t been on the same page. Up until a few weeks ago, markets were pricing in one more rate hike from the Federal Reserve two rate cuts later this year,” Craig Erlam, Senior Equity Analyst with OANDA explained.
“The data we’ve seen since has seen that shift quite dramatically to three rates hikes and no cuts,” he added.
The data he’s referring to is a host of indicators pointing to the US economy being in better shape than had been believed as we came into 2023, including the jobs figures and retail sales.
And then there’s the inflation data which is showing signs of ‘stickiness’, or – in other words – an unwillingness to fall back towards the 2% target favoured by Central Banks.
That leaves the timing of future moves highly uncertain with investors now staring down the barrel of potentially multiple future rate increases that could have the effect of slowing the economy and compressing stock valuation multiples even further.
“We all want to see resilience in the economy but if that leads to much higher interest rates, which are already now very high, that resilience won’t last long and hopes of a soft landing will quickly fade,” Craig Erlam said.
Aidan Donnelly, Head of Equities with stockbroker Davy, broadly agrees on the rates outlook.
“The net easing over the course of 2023 has completely vanished, and now year-end policy rates are priced higher than the peak in January,” he points out.
“The question is how long equity markets can continue to believe they have the upper hand on the Fed before Powell et al come off the ropes and plant one on the chin,” he added.
For now, the game of chicken between markets and Central Banks continues with growing indications that traders may be the ones who have to back down.
A bout of volatility has taken hold in the fixed income markets in recent weeks too.
The expected tapering of rate hikes saw investors rushing into bonds, prompting a record-breaking rally in that asset class in the opening weeks of the year.
However, that too shows signs of fizzling out as mounting evidence of persistent inflation prompt a reassessment of the interest rate path ahead, which State Street Global Advisors referred to as a ‘reality check’.
As with the bond selloff that took hold in the last year or so, emerging market bonds and lower grade corporate debt have been bearing the brunt of the selling this time around.
Continued upwards pressure on interest rates puts riskier segments in difficulty, leading investors to demand higher yields to hold higher risk assets.
Europe’s time to shine?
Stocks in Europe have had multiple false dawns in recent years.
Successive rallies followed by dramatic pullbacks has seen indexes registering relatively modest overall gains.
By contrast, in the US – even with last year’s dismal performance – the S&P 500 index is up 50% in the last five years.
However, some are now asking if Europe’s moment in the sun has finally arrived from a stock market perspective.
The Euro Stoxx 600 Index is up around 20% since October, helped along by a milder than expected winter and the rapid reopening of China’s economy, boosting demand for cars and other goods.
Add to that the higher interest rate environment which has been a boon to the region’s banks.
Financials account for around 16% of the STOXX 600 index. In the US, under-pressure tech companies make up over a third of the S&P 500 index, giving Europe’s markets the edge right now.
The STOXX 600 has added nearly 7.5% in 2023, more than double the 3.4% gain in the S&P 500, according to data from Refinitiv.
“In a market that prefers value-style investments in a high interest-rate environment, that clearly works in Europe’s favour,” Edward Stanford, Head of European Equity Strategy at HSBC said.
Is it a good time to buy?
This is the question not only for those who trade on the open market from day to day but for anyone who has got a pension or indeed anyone considering investing a lump sum in a fund that tracks a market index.
The adage that’s attributed to Warren Buffet is to be ‘greedy when others are fearful and fearful when others are greedy’.
The businessman and financier Nathan Rotschild is believed to have put it more bluntly – ‘buy when there’s blood on the streets’.
The difficulty is knowing when fear has peaked. There’s always the risk – and indeed a distinct possibility – that you buy only to see your investment falling further.
It’s nigh on impossible to call the bottom of any market cycle. Generally, though, a fall in stock valuations can be interpreted as a buying opportunity.
In a recent review of the global markets, Irish Life Investment Managers concluded that the selloff on markets in 2022 presented opportunities for investors who can look through potential short-term volatility.
It added that 2023 offered an ‘attractive entry point for investors with longer-term horizons’.
While acknowledging some risks in relation to company margins and earnings, ILIM sees the potential for higher returns over the next 5 to 10 years with the strongest potential for returns coming from emerging markets, it added.
All of which is good advice from a timing perspective. If putting capital aside to invest, make sure it’s money that doesn’t need to be accessed in an emergency.
Over the medium to long term, past performance has shown that a balanced and diversified portfolio of shares delivers good returns that surpasses that available from just placing the money on deposit.
2023 could be a good starting point, but it’s unlikely to be a knockout year for stock valuations.