The MTC Investment Team presents the 2023 Market outlook:
- The Great Reset – Jason Ritzenthaler, CFA, CTFA
- Fixed Income Update – Kate Braddock, CFA
- Equity Market Outlook – Jonnathan De Jesus CFA, CIPM
- Economic Outlook – Chris Morgan, CFA, CFP®, CAP
- Earnings Update – Katie Cihal, CFA, CPA
- Geo-Political Update – Sharon Giuffre, CFA, CAP
Equity Market Outlook – Jonnathan De Jesus CFA, CIPM
It’s that time of year again, time to dust off our crystal ball and peek into 2023’s stock market! We joked last year about 2022 sounding like 2020 too–in some ways it might have been nice to have the same returns in the U.S. Equity market. Instead, 2022 was a year with persistent declines in prices across most major Equity investments and above-average volatility, as measured by the CBOE Volatility Index. Despite the unpredictability of the future, we believe there are a few notable themes from 2022 that will continue into 2023 and that will impact Equity returns.
Valuations – Stock market valuations refer to the price of stocks in relation to financial measures of fundamental value. The Price-to-Earnings (P/E) is one of the most common measures of valuation in the stock market. We use the P/E ratio as a proxy for investor expectations of future growth. Increases in the P/E ratio suggest that investors expect elevated levels of future growth and are willing to pay a high price for the future growth of the company. Decreases in the P/E ratio suggest that investors expect slower future growth and are not willing to pay a high price for the future growth of the stock. The P/E ratio in the US, as measured by the P/E ratio of the S&P 500 Index on Bloomberg, fell in 2022. The P/E ratio is now closer to the long-term historical average. In 2023, we expect the P/E ratio of the S&P 500 Index to remain within historical norms as investors continue to adjust their required returns on investments (ROI). Throughout 2023, as it was in 2022, valuations will be impacted by the decisions of the Federal Reserve’s Federal Open Market Committee (FOMC). The FOMC raised the Fed Funds Rate (FFR) from 0.23% at the start of 2022 to 4.50% at the end of 2022. This decision also impacted the rates on long-term U.S. Treasury bonds, as those rates rose as well. As long-term U.S. Treasury Bond rates rose, the required ROI of investors increased. We believe the combination of a higher ROI and increased volatility explains why valuations fell in 2022. In 2023, we expect investor ROI and volatility to remain within historical norms, in line with our expectations for the P/E ratio of the S&P 500 Index.
Sector – Sectors refer to groups of companies that are classified based on the type of business they are in or the products and services they offer. One of the most common sector classification methodologies is that which is utilized in the Standard & Poor’s 500 Composite Stock® Index (“S&P 500®”). Comparing the relative performance of sectors helps investors see trends developing within the Equity market.
In 2022, we saw some extremes in the relative performance of a few sectors. The total return of the Energy sector in 2022 was 64.17% while the total return of the Consumer Discretionary and Communication Services sectors were -36.27% and -37.63% respectively1. The average total return in 2022 for the remaining sectors was -10.50%. When we look at some of the members of the Energy sector, we see that Exxon Mobile and Chevron make up approximately 42% of the sector, as measured by the ETF XLE on 09/30/20222. Both firms benefited from the higher energy costs throughout the world. The significant members of the Consumer Discretionary sector, Amazon and Tesla, make up approximately 44% of the sector, as measured by the ETF XLY on 09/30/20222. The significant members of the Communication Services sector, Meta and Google, make up approximately 29% of the sector, as measured by the ETF XLC on 9/30/20222. We believe that one of the main reasons for the extremes in relative sector performance in 2022 is attributable to the performance of Value stocks relative to Growth stocks.
Value vs Growth – Value stocks are investments that investors believe are underpriced relative to their future growth and pay higher dividends. Growth stocks are investments that investors believe deserve a high price for their current earnings as investors expect the investments to have above-average growth in the future and pay low to no dividends. In 2022, S&P 500 Value stocks significantly outperformed S&P 500 Growth stocks. Value stocks, as measured by our holding VTV, had a total return of -2.07% in 20221. Growth stocks, as measured by our holding VUG, had a total return of -33.15% in 20221. Growth stocks, like META (-64.22%), Amazon (-49.62%), and Tesla (-65.03%), struggled in 2022 as the general rise in interest rates reduced the fair value of their expected growth in future cash flows1. Value stocks, like Exxon Mobile (80.26%) and Chevron (58.48%), performed better than Growth stocks as their fair value was not as dependent on their expected growth in future cash flows1. While we do not expect interest rates to rise in 2023 at the same rate that they rose in 2022, we do expect Value stocks to outperform Growth stocks in 2023. The Equity investments in our models are built to benefit from the expected outperformance of Value stocks since our models have more Value exposure relative to Growth exposure.
While forecasting the future is not an exact science, we do believe that considering a range of factors helps give us a sense of how we can best be prepared. In 2023 we will continue to diversify portfolios and focus on fewer, smarter decisions.
External Sources: Bloomberg1, State Street2, ETF Factsheet3
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