Our 2023 base case scenario for equities for development markets is subject to a two-phase development: a) developed equity markets are expected to price adjust based on lower EPS forecasts which will be followed by b) the start of a new long-term growth trend of long duration assets on the back of declining interest rates and inflation.
History to repeat itself!
Based on mean reversion principals, one could expect that markets would auto-recover some of the lost ground; we assume that much of this is done by now.
Historically speaking, there are two exceptions to this: the markets were flattish in the aftermath of the dot-com bubble in 1999, and the same applies to equity performances following the 2007 financial market crisis. Markets started regaining confidence in 2001 respective in 2009. We note that today the economic backdrop is different from the ones in the past. In 2007/2008 the correction was driven by an overleveraged real estate market; in 1999 the bubble was due to an exaggerated valuation of just about any social media stock, an abundance of venture capital, and the frenzy about media related stocks. The whole crashed when the availability of venture capital disappeared. In comparison with the 2021/2022 crises, at the start of the crisis, valuations of tech stocks were high but lower than in 1999/2000 and venture capital actually never disappeared.
According to a chart published by JP Morgan Asset Management, growth stocks do
not appear to be overly cheap as of now. In fact, the chart “MSCI World Growth and Value forward price-to-earnings ratio multiple” suggests that we are at pre-COVID valuation levels. However, value stocks appear to be more reasonably priced when compared to history. While they have corrected less in comparison to growth stocks, they are also back to pre-COVID levels.
As outlined in the base-line scenario, we believe that 12-month forward EPS expectations are too high. In fact, as of now, they have corrected just by about 5% from the peak level. One would expect, given the high rate of inflation, that companies would be suffering more. While we understand that some complementary efficiency programs and other savings help to offset higher input and labor costs, this cost transfer cannot be undertaken endlessly and without any negative impact on corporate revenues over time.
Our baseline scenario anticipates that the 12-month forward EPS estimates will
decline by another 10% to 15% from their present levels. One could argue, since this a widely known fact, that the market has already priced in this correction. Yet, we believe that this is not the case as most analysts have not really adjusted their opinions into a downgrade mode.
At this point of time, we would expect that both the blue and orange lines in chart #2 will find some common support and then bottom out. For this to hold true, earnings growth has to decrease and correct faster!
What about the private consumer?
Households are feeling the squeeze, mostly because of higher energy costs. Consequently, consumer confidence across developed markets is reaching its lowest level in 50 years. At the same time, because of higher interest rates, the cost of housing has become more expensive. Existing home owners have mostly fixed-term loans which in essence means that only first-time buyers will be impacted. Like corporations, private households have swapped to a different spending model and draw upon savings and spend less, but on better quality products.
And is there any good news?
While everybody is focused on concerns, we see opportunities. Good news is rare item these days, but we see:
- China will be ending its zero-COVID strategy in 2023.
- Real interest and inflation will peak in 2023.
- CB will start easing late 2023 beginning 2024.
- The recession will be short lived.
- Spending related to IT will continue to increase in 2023.
- The market is underweight risky assets.
- USD will continue to be relatively strong.
- HY and credit will remain strong and attractive.
- Cyclical stocks are cheap, in particular in Europe.
- Energy stocks to provide decent dividends and more upside.
- Biotechnology to recover from the market downturn.
- Bitcoin will recover some of the lost ground which will provide an opportunity for fearful investors to exit before the big shakeup will take place on the back of reinforced regulation.
Overall, we are not calling the bottom for equity markets: However, we do think that investors who can deal with volatility can start looking at the above opportunities during the 1st quarter of 2023. Most of the bad news is in the price, and investors are psychologically geared negative now.