As a very painful market year exits, Wall Street’s strategists expect 2023 will end on a much better note —even if the path there continues to be highly volatile. 2022 was a horrible year for many investors in both equities and fixed income, and one of only six years in the last 45 where the S & P 500 saw a double-digit decline . Both asset classes were volatile and sharply lower, and bonds literally turned in their worst performance ever . The tried-and-true 60/40 investment strategy , where one of those asset classes is expected to hedge the losses in the other, failed miserably. Even cash lost value, as inflation flared. “We still see a positive year next year, one that’s probably going to be accompanied by a lot of volatility in the early months,” said Jeff Kleintop, chief global investment strategist at Charles Schwab. Kleintop said the market will be concerned about recession, China’s reopening, and how quickly the world’s central banks are going to stop raising interest rates. “All those forces are going to be pushing and pulling on the market at least in the first few months of next year and that could mean a bumpy ride for investors,” he said. Kleintop and other strategists expect stocks could end the year higher. “Those concerns should recede by mid-year, and over the latter part of the year, which I think has become consensus, things look a lot brighter and the markets look better,” he said. As for fixed income, interest rates could continue to edge higher, but they should come down in the back half of the year, as inflation fades, according to Rick Rieder, BlackRock’s chief investment officer of global fixed income. Yields move opposite bond prices. “I think the back half of the year will be great for fixed income and good for equities,” he said. In that declining interest rate environment, markets should be helped by “the realization that the economy is not falling off the cliff a la 2008,” he added. The ‘R’ word Recession is one of the top worries for investors, and there is not much agreement on when it will start, how long it will last or how deep it will be. But there is a clear sense on Wall Street that a recession is on its way, as the Federal Reserve continues to raise interest rates. “Recession at this point appears very likely. To me, the debate is going to be is it a mild one or a deeper recession. Ironically, I think if the recession takes place earlier, it has a chance of being milder,” said Jimmy Chang, chief investment officer at Rockefeller Global Family Office. “Because if it happens later means additional Fed rate hikes. I think the Fed will likely be overtightening the economy into this recession.” Chang said a recession could be mild, since consumers are in good shape and the banking system is strong and well regulated. “The job market is still very tight and hopefully companies won’t let go of people aggressively,” he said. Investors are waiting for an inflection point in the job market, since a big jump in unemployment could be a catalyst for the Fed to pause its interest rate hiking or even start to cut rates. “At this point, the labor market is slowing at a remarkably slow pace,” said Ethan Harris, head of global economic research at Bank of America. “I think it’s highly uncertain, but sometime in the next three to six months, the labor market will start to weaken a lot. What triggers this shift is a change of psychology. Up until now, people are still getting hired, there’s tons of job openings. At some point, people start to question the sustainability of the expansion. They start to cancel job openings. … The economy is being held up by duct tape and bailing wire.” The economy should start to actually lose jobs by the summer, he said. “Some time between March and June, I would expect that the economy shows clear signs of recession. The economy is in pretty good health other than the inflation problem,” said Harris. “You don’t have a massive credit bubble.” For the stock market, strategists expect the economic downturn will slam corporate earnings and that could help drive stocks to a new low early in the year. “The market never makes a bottom before the start of the recession,” Chang said. “That will mean the new low for the cycle is still ahead of us. … At some point, the Fed will blink and reverse policy and that will mark a bottom.” The S & P 500 ended 2022, down 19.4% at 3,839.50, its worst performance since 2008. “Our target is 4,150 for the end of 2023. For me, the upside case being 4,600 and the downside case being 2,450,” said Julian Emanuel, head of equity, derivative and quantitative research at Evercore ISI. The extreme low does not have a high probability of being reached, but it could be if there is a steep earnings decline of 15%, which is normal in a large recession, he said. In that scenario, the market prices stocks at 13 times earnings, which is consistent with valuations in a capitulation, he said. Emanuel said he favors value stocks and companies that were beaten down by year-end tax selling, but still have good earnings outlooks. On his list are Schlumberger, Snowflake , Kroger and Etsy. “We continue to think value works. Energy is the only sector that is pricing in a recession in the U.S.,” said Emanuel. The SPDR S & P Oil & Gas Exploration & Production Fund and the S & P Select Energy Sector SPDR Fund are two ETFs that reflect the S & P energy sector . “It’s very clear the action in the oil market is pricing in a China re-entry again so for us, energy continues to look attractive,” said Emanuel. China reopening: Risk or reward? China’s swift elimination of Covid-19 restrictions this month and the reopening of its economy could indeed boost oil prices, but it could also be a double-edged sword for the world economy and a big factor for markets in 2023. Rockefeller’s Chang said the next few months will be challenging for China. “This quick switch from zero-Covid to this quick ripping the Band-Aid off to full herd immunity is a big shock to the system,” he said. “I think there will be a cyclical rebound starting in the second quarter next year. In March, they have the National Party Congress. … I think the next few months could be pretty volatile so that could create a trading opportunity.” A rebounding China should help other economies and companies that do business there, but it could also create other problems, Kleintop said. “How fast does China reopen? Of course, it’s difficult to discern. It’s moving along pretty quickly despite the obvious rise in hospitalizations,” he said. There’s understandable initial euphoria about the reopening, but it could drive up the costs of goods and commodities, according to Kleintop. “There are a number of companies that are going to benefit from China’s 1.4 billion consumers,” he said. “I do think it’s going to be an inflationary force. … I think that will be a disappointment for markets that have really gotten their heads around the idea that inflation is coming down. The idea that we’ve seen the peak and it could be coming down could really be spoiled by the reopening of China.” Russia and central bank wildcards Russia’s invasion of Ukraine created havoc in markets in 2022 and added to commodity inflation. The invasion also created an energy crisis in Europe, and that remains a risk for 2023 since Russia was Europe’s biggest oil and gas provider. Europe’s energy problem is not solved, and strategists say while it may have enough gas in storage for this winter, it could be challenging as Europe tries to replenish its stores for the next one. For the whole world, another oil spike or period of prolonged high prices would be another weight on the economy. Energy strategists expect higher prices, but they expect the world should have sufficient supplies. The world’s central banks pose another major risk for markets. The Federal Reserve and others, like the Bank of England, European Central Bank and even the Bank of Japan, have been tightening policy to fight inflation. Rising interest rates have forced a readjustment of market valuations, and that will continue as rates keep rising. The Federal Reserve’s forecast points to a high target rate of between 5% and 5.25% in 2023. The Fed has raised its fed funds target range to 4.25% to 4.5%, after starting at zero to 0.25% in March. The Fed’s forecast also includes rate cuts in 2024. CNBC Pro’s guide to investing in 2023 Energy funds were among the biggest ETF winners in 2022 — but not exclusively These ETF strategies can help investors navigate a murky 2023 for markets Wall Street’s biggest investors are all but sure of a recession next year. Here’s where they are hiding out Oil expected to stay volatile in 2023, but the price could depend on China reopening Strategists see a major risk to the economy and markets if the Fed tightens too much before stopping because of the lagged effect of its policies. BlackRock’s Rieder said a big issue for the U.S. economy could be the real estate market if the Fed overtightens. The Fed’s forecast suggests two or three more interest rate hikes in the first half of the year. Rieder said commercial real estate is already under duress. In the residential market, mortgage rates have risen to more than 7% for 30-year mortgages, and as a result, home sales have plummeted. Pending home sales fell 37.8% in November on a year-on-year basis. “The one swing factor is: do you really bludgeon the hiring dynamic, the spending dynamic, the net worth dynamic, the leverage in real estate. That’s the place I have the closest lens on,” Rieder said. “While I think 2008 is not a relevant comparison, to the extent the Fed chooses to overtighten, then it becomes something at least to look at because of the focus on the housing market and real estate broadly — commercial and residential,” he said. “For the U.S., that is the big wild card.” Optimism about 2023’s second half Barring a deeper recession or new exogenous event, strategists are fairly uniform in their view that the second half of 2023 will be better than the first half of the year and certainly better than this year for both stocks and bonds. “I think that returns on fixed income could be quite good. I think it’s going to be two-staged. We have to follow the Fed to higher rates … and then I think growth is slowing, inflation is coming down,” said Rieder. So rates could rise before heading lower in the second half, and that environment will be better for stocks. If there’s a recession, he expects it to be shallow. Rieder said 2023 is going to a banner year for fixed income, and “not so much because it’s going to be rates rallying so much,” he said. “It’s just the carry is so darn attractive.” The carry is the difference between the yield on a bond and the cost of holding that instrument. “I think rates still have some upside,” said Rieder. He said the 10-year Treasury yield could get up to a little over 4% before heading lower. He said he favors high-quality bonds with durations of five years or less.
