Can stocks return to bull market territory this year?

A recovery is coming but it may take a little longer than we would like, financial analysts say

A trader at the New York Stock Exchange. Stock markets started the year with renewed buoyancy, boosting investor sentiment. AFP

Investors began the new year in a much brighter mood than they ended the last one, and a swift stock market rebound reflected their renewed buoyancy.

Share prices picked up along with sentiment, with Wall Street and London climbing by about 5 per cent in the first two weeks of trading, and Europe up a sprightly 7 per cent.

Many are looking forward to the fabled US Federal Reserve “pivot”, when it eventually stops raising interest rates and starts cutting them. They expect this to fire the starting gun on the next bull market.

Any sign that inflation is falling feeds this narrative, so recent news that US consumer prices fell for the sixth month in a row to 6.5 per cent in December triggered investor optimism.

It sent them scrambling to find more good news, including Russian President Vladimir Putin’s stalling invasion of Ukraine, China’s easing of Covid-19 restrictions and evidence of economic growth, well, anywhere.

Investors started 2023 in the mood for seeing the best in any situation, says Chris Beauchamp, chief market analyst at online trading platform IG.

They have even been celebrating weaker economic data, welcoming a slowdown in US payrolls and manufacturing.

“That might seem odd but the general takeaway is weaker data will slow the Fed earlier than expected, or perhaps bring forward the first cut in US rates,” he says.

The UK’s FTSE 100 index neared a record high, Mr Beauchamp says, and continues to outshine the US - as it did last year.

“Things seem to have brightened considerably for the UK economy in the last few months, while signs of weakening inflation in Germany gave European stocks the boost.”

However, in recent days, the mood has darkened following the crash in Goldman Sachs’s stock price, after it posted a brutal 66 per cent drop in fourth-quarter profits, and a 1.1 per cent decline in US retail sales in December, the biggest fall in a year.

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“With the earnings season only just hitting its stride, such weakness in economic data bodes poorly for corporate results,” Mr Beauchamp says.

Suddenly, those bullish end-of-year forecasts of recovery look overdone, which puts retail investors in a tough position.

Is it time to load up on shares while valuations are still low, or do they risk being swept up in another bear market rally?

Much now rests on the coming earnings season, says Axelle Pinon, a member of the investment committee at fund manager Carmignac.

“2022 was not an easy year for equity investors. We witnessed a significant decrease in the valuation of major indices, but shouldn’t be fooled into thinking all stocks are now cheap.”

S&P 500 earnings expectations for the final quarter of 2022 have dropped more than 10 per cent in recent months, but it is the forward-looking commentary that will matter, Ms Pinon says.

“We expect many companies’ earnings to weaken in 2023 as margins become squeezed by tighter financial conditions, higher input costs and lower demand.”

While companies used their pricing power to pass on inflationary costs to customers last year, this should prove harder in 2023, Ms Pinon says.

“Pricing power should wane, leaving companies squeezed between rising labour costs and slowing output prices or demand.”

Only companies with healthy profit margins and relatively low debt are expected to withstand the subsequent margin squeeze, Ms Pinon says. She suggests investors look beyond the overvalued US to China and, to a lesser extent, Japan.

Both are going through major changes that should prove positive, as China reopens and Japan eventually reverses its long-standing monetary policy.

Investors banking on a US technology rally may have to be extra patient, she says, quoting Microsoft chief executive Satya Nadella, who said last week that there would be two more years of pain before a “massive” technology rally.

Higher borrowing costs mean technology companies “can no longer drive long-term growth at the cost of short-term profitability”, Ms Pinon adds.

Luca Paolini, chief strategist at Pictet Asset Management, shares Ms Pinon's view that Asia is the place to be right now as it offers investors respite from weak growth and tighter monetary conditions in the West.

Pictet is starting 2023 with a “tilt” towards Asian and emerging market equities, particularly China, “amid signs that Beijing is seeking to normalise its pandemic policies”.

“Pent-up consumption should be a big boost to the domestic Chinese economy, once it gets past Covid,” Mr Paolini says.

Last year marked the end of an era as years of low inflation and interest rates finally went into reverse, says Andrew Bell, chief executive of the Witan Investment Trust, who also favours China.

“Pent-up demand, a restoration of industrial production and determined government efforts to end the slump in China’s property sector are likely to mean the world’s second-largest economy is the only major centre to pick up speed in 2023, mitigating the weakness elsewhere.”

Pent-up consumption should be a big boost to the domestic Chinese economy, once it gets past Covid

Luca Paolini,
chief strategist at Pictet Asset Management

This should drive global growth, but with a potential downside.

“China’s appetite for commodities may slow the decline in inflation over 2023, prolonging the peak in interest rates,” Mr Bell says.

Investors may have to wait longer than they would like for the Fed pivot but Mr Bell remains optimistic as energy prices wane and the green transition gathers pace.

“We anticipate greater infrastructure investment in sustainable energy sources, both for climate policy reasons and to reduce dependence on hydrocarbons after the price surge in 2022.”

Investors expecting a swift return to the economic and monetary conditions of the past decade will be disappointed, warns Yves Bonzon, group chief investment officer at private Swiss bank Julius Baer.

The Fed will struggle to reduce inflation to its 2 per cent target. Instead, it will “be structurally higher going forward and settle around 3 per cent”.

The road ahead is volatile and there is the added risk that central banks will make a serious policy mistake by tightening too fast and draining the market of liquidity, he says.

The good news is that the worst is now behind us, as this year’s starting position is much more favourable than January 2022, Mr Bonzon says.

So, investors are right to be positive but they simply need to be patient. The recovery is coming but it may take a little longer than we would like. In the meantime, take a look at China.

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