Today in the podcast, our thoughts on the 2023 outlook for the US equity market.
to know: First, our year-end:
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Now, the details.
s no change to our year-end:
• Our 4,100 target represents a gain of 3% from Monday’s close. It’s the median of five different models encompassing analysis on the economy, valuations, sentiment, politics, and stocks vs. bonds. Our most optimistic test puts the index at 4,600, our “bull case” if our “base case” of 4,100 is too conservative.
% real GDP throughout:
o The two big things contributing to the downshift in our 2023 EPS forecast are: (1) weaker GDP assumptions than our last update, and, (2) our new interest expense model, which increased our expectations for the bite that this will take out of earnings.
o The $199 puts us even farther below consensus which is still tracking at $231.
Takeaway #2: We continue to anticipate choppy conditions in US equities over the next few quarters.
• We continue to see stocks as caught in a tug of war between the bulls and the bears.
• On the bullish side, our sentiment work is constructive (net bullishness was still below -10% in the latest AAII survey, normally accompanied by a 15% 12 month forward return in the stock market), … and our valuation model also implies that moderating inflation and slightly lower interest rates can support some modest P/E expansion into the low 20’s on a trailing basis. Both of those help push up price target up.
• On the flip side, the Fed is still a problem. The S&P 500 is typically down one month before final hikes, which our economics team expects to happen in March.
is also trading on the:
• Other challenges include a limping economy (stocks are typically flat when full year real GDP is in the 0-2% range), the diminished appeal of stocks relative to bonds (which was also a problem as 2011 and 2018 began, as seen in our dividend yield test and earnings yield gap analysis), and the need for sell-side earnings estimates to come down.
• On earnings, there are a couple interesting data points to keep in mind as we ponder what further estimate cuts mean for stocks.
o First, stocks already trading like a major hit to EPS growth is coming.
nd for all the talk about how:
o And third, we’d keep a close eye on the rate of upward EPS estimate revisions for individual companies in the S&P 500. Typically, the stock market bottoms 3 to 6 months before the rate of upward revisions turns positive again.
Takeaway #3: In terms of higher-level positioning, we prefer US equities over non-US equities, Value over Growth, and Small Cap over Large Cap.
• On US/non-US, fundamentals favor the US …recession odds are lower, and the US outperforms when recessions occur… …but valuations are stretched as we suspect once a bottom is firmly in place non-US equities will assume leadership again.
• On Growth/Value, balance sheets look better for Value the stronger Dollar is worse for Growth, and recessions usually usher in big sticky leadership shifts but Growth is higher quality and tends to outperform when GDP is weak.
o We’d keep an eye on 10 year yields as declines tend to favor Growth stocks.
o Valuations are also worth watching, as they are starting to turn attractive for Growth again but just barely.
• Our highest higher level conviction call is Small Cap over Large Cap.
o We upgraded Small Cap to overweight back in July. Small Caps have actually been outperforming Large Caps since mid-May. We were early on this call and see more room to run.
o There are four things we really like about Small Caps right now –
• First, valuations still look attractive, in both absolute and relative terms vs. Large Caps,
• Second, Small Caps are more domestic, meaning the stronger US dollar is less of a headwind,
• Third, Small Caps have a better earnings profile than Large Caps right now with better trends on earnings revisions and margins seen at the moment, and
• Fourth, Small Caps already appear to be baking in a recession – Small Cap performance is already baking in a spike in jobless claims and a plunge in ISM to typical troughs.
That’s all for now, thanks for listening, and be sure to reach out to your RBC representative with any questions.
