Equities 2023 – What’s the bigger risk?

By Monik Kotecha

There’s no denying that 2022 was a difficult year for equities – but as one US commentator recently pointed out, years in which the S&P was down more than 18%, as it was in 2022, have been followed by years of 20% plus returns, every single time for the past 90 years. This, plus a few other key factors identified by Insync suggest that standing on the sidelines may pose a bigger risk than investing.

As we enter 2023, standing on the sidelines may pose a bigger risk than investing.

Everybody, and their mother, brother, sister, cousin, and uncle is negative on the first half of 2023.

Wealth destruction was the dominant theme of 2022. The global equity market shrank US$15 trillion in market capitalisation, while global bond markets saw US$30 trillion in value wiped out. Virtually every asset class declined. Oil held up better, rising strongly in the first half but correcting as global growth expectations faltered, ending the year flat.

The US dollar was the big winner, which rose 9% year-to-date. Cash, which was considered ‘trash’, gained 1.8%. High inflation, slowing growth and monetary tightening largely characterized the global economy throughout 2022. Rising inflation and slowing growth created stagflation concerns.

But we think the market may surprise on the upside in 2023.

The impact of 2022

There’s no denying that 2022 was a difficult year for equities – but as US senior investment analyst, Luke Lango, from InvestorPlace recently pointed out, years in which the S&P was down more than 18%, as it was in 2022, have been followed by years of 20% plus returns, every single time for the past 90 years.

Either this is the first time in 90 years that stocks don't soar after an awful year or stocks surge by >20% in 2023

Source: InvestorPlace

The sentiment at year-end was very negative, which is a good contrarian indicator. Typically, the average forecast from Wall Street’s top strategists predicts the S&P 500 climbing by about 10%, which is in line with historical averages. This time around, the pros are unusually cautious, with most expecting the S&P to end 2023 lower.

A Bank of America fund manager survey shows fund managers relative positioning of stocks versus bonds is the lowest level since 2009. Fund managers also hold the highest level of cash (5.9%) since the bursting of the technology bubble in 2000/01.

The consensus view is that earnings have further to fall in 2023 and this remains a top investor concern. The market (buyside) tends to look out 6-12 months ahead of sell side analysts, and anticipates any earnings decline in advance of it actually happening.

Earnings have historically bottomed after stocks bottomed. Since 1950, the trough in earnings growth lagged the bottom in the S&P 500 by about 6-7 months. Stock prices tend to inflect upwards before we see improvements in earnings, GDP, and employment. October 2022 may well have marked the lows in stock prices which has already discounted the fall in earnings ahead of sell side analysts.

Looking ahead

As we enter 2023, we think standing on the sidelines may pose a bigger risk than investing. Here’s why.

The US midterm elections were held in November 2022. Historically, the S&P500 has outperformed the market in the 12-month period after a US midterm election with an average return of 16.3%, and not delivered a negative return during this period over the past 60 years.

Inflation may still prove to be transitory

Many argue that inflation will be much stickier than markets currently discount, and that it will take multiple years to restore price stability (2% inflation). However, we continue to believe that the outbreak of inflation is squarely the result of the pandemic shock. As the pandemic-related economic dislocation renormalizes and the Federal Reserve continues to tighten monetary policy, inflation may well eventually fall back to pre-pandemic norms.

An area of additional concern, as a result of the pandemic, has been the reduction in the labour market participation rate. This has the potential to drive sustained increase in wages inflation and lower levels of productivity.

We are today living in the golden age of technology and innovation which we continue to consider to be deflationary for two primary reasons:

1. Technology reduces the demand for labour, which puts downward pressure on wages and employment levels, which in turn reduces demand for goods and services because workers have less money to spend
2. Technological innovation also leads to automation, tools that make workers more efficient, and the elimination of some job roles

So where are the opportunities?

We have found that the long-term cash flows and valuation of companies exposed to megatrends do not change as a result of an increase in interest rates, or a slowdown in the global economy. Megatrends are unstoppable long-term growth trends with profitable industry structures.

Here's just one example.

The 60+ age cohort is set to more than double to 2.1 billion by 2050. This is what we call a demographics megatrend. The fastest ageing group within this cohort is those aged 70-75 and this is where we have identified prime investing opportunities.

As the population ages, so does the incidence of chronic disease. Older people also often suffer from multiple chronic conditions at the same time. The second leading cause of death within those aged 70-75, after heart disease, is cancer.

The demand for companies providing cancer drugs is not reduced by changes in interest rates, inflation, or recession. These factors also do not change the trajectory of ageing populations, nor the increasing demand for solutions for chronic diseases.

Current volatile market conditions provide opportunities to invest in highly profitable businesses benefitting from megatrends at lower prices.