Tue. Jan 31st, 2023

Investing in 2023: A Year to Be Patient and Selective

U.S. equities may disappoint in 2023, but patient investors can find potential income and returns in other markets.

Lisa Shalett Chief Investment Officer, Wealth Management

A grueling bear market, touched off by decades-high inflation and an aggressive Federal Reserve response, made 2022 one of the most challenging years for investment returns in the last half century.

Can investors expect something different in 2023? 
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Don’t hold your breath for a durable recovery in U.S. equities in the year ahead. Instead, Morgan Stanley’s Global Investment Committee recommends letting the market pay you to wait for better opportunities farther down the road and looking abroad for potential returns.

Here’s what we’re forecasting for 2023 and three strategies investors can use in the new year:

1. Don’t Expect Much from U.S. Stocks

The multiple bear-market rallies staged by U.S. stocks throughout 2022 suggest many stock investors haven’t embraced the likelihood of higher-for-longer interest rates and a materially slowing economy, even as economic data and Treasury yields continue to sound warnings.

We think U.S. stock investors may be overly optimistic and see two key reasons for concern heading into 2023:  

  • Unattractive valuations: Equity risk premiums—the potential excess returns one can expect for investing in stocks over risk-free bonds—are still relatively low, ranging between 180 and 250 basis points versus a long-term average of more than 350. This tells us that investors are not being appropriately compensated for taking equity risk.
  • Lofty earnings expectations: Consensus 2023 earnings projections for the S&P 500 Index sit around $230, a number that bakes in earnings growth of about 5%. To us, this estimate fails to account for the challenges that companies are likely to face, especially as they start to feel the effect of tighter monetary conditions in earnest. These include lower sales volumes and loss of pricing power, potentially at the same time. We think a more realistic forecast is $195, based on our expectation that the index will retreat another 15% to 20% before recovering through the end of 2023 to a level about flat with today’s.

2. Stay Patient and Collect Income

With both the trajectory of inflation and the overall economic picture still unclear, investors may want to prioritize fixed income in their portfolios. High-quality opportunities currently exist at yields of 4%–6%; overall returns could be higher if the economy slows more or tips into recession.

Two areas to consider:

  • Two-year Treasuries are yielding greater than 4%, while longer-term Treasuries, such as the 10-year and 30-year, are yielding in the high-3% range.
  • Investment-grade corporate bonds are offering more than 5%, which could be a smart choice for investors open to a bit of credit risk while staying focused on higher quality.

There’s also the potential for capital appreciation in fixed income.  A slowing economy could prompt investors to seek out “safe haven” assets, including U.S. Treasuries and other higher-rated bonds, driving prices higher.
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3. Look to Emerging Markets

U.S. stocks have long dominated investor allocations, but it may be time to consider selectively owning emerging markets (EM) stocks. A few reasons:

  • EM stocks are trading cheaply relative to their own history and to developed market equities, exhibiting lower cyclically adjusted price-to-earnings ratios.
  • Key headwinds to EM regions are likely to abate. The U.S. dollar, for instance, has come off recent highs and could weaken through 2023, allowing EM economies to benefit.
  • China, which accounts for nearly a third of the MSCI Emerging Markets Index and plays an outsized role in determining investor flows to EM overall, could see economic prospects improve by spring 2023, as the country starts to loosen its zero-COVID controls. Moreover, since it’s not experiencing high inflation or rising interest rates, China has a significant runway for stimulus—a policy lever it will likely pull in 2023 to support the residential housing market. Last, China’s growth prospects could have positive spillover effects for other economies in Asia and Latin America in 2023 in areas like exports and tourism.

All told, we encourage investors to be patient. Uncertainty around the economy and markets remain high, and investors should demand a premium for taking risk. Be open to rebalancing portfolios as inflation and interest rates normalize. 

Connect with your Morgan Stanley Financial Advisor about how our 2023 outlook for the economy and market forces may shape your investment decisions in the year ahead.

SOURCE https://www.morganstanley.com/ideas/investment-outlook-2023-year-patient-selective

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