Despite Potential Recession, 2023’s Return is Not Determined

By Tim Courtney, Chief Investment Officer

Predictions of an impending recession are nearly everywhere these days, with many analysts describing it as the “most anticipated recession in history.”¹ But amid the negative sentiment, it’s important to maintain perspective about how the market works. While we shouldn’t enter 2023 wearing rose-colored glasses, the coming year could very well be productive for investors. Here are some key points to consider about market behavior:

• The market is forward-looking. The market focuses on future expectations while adjusting prices with real-time information. The market is not always right about the future as Paul Samuelson noted and joked in 1966 that the market had predicted 9 of the last 5 recessions. But because markets are forward looking, today’s prices are a fair estimate of what assets are worth based on future expectations. If this truly is the most anticipated recession in history, today’s prices should at least partially reflect it.
• Earnings, which fall in recessions, are more volatile than stock prices. Normally headlines focus on prices and price changes. That leads many to think that the prices are the big movers. While prices certainly change, sometimes more than we would like, earnings actually change even more and have a higher volatility than prices.² Investors understand that big changes in S&P 500 earnings (like going negative in 2008 or surging 70% in 2021) won’t persist and that earnings will likely revert back to average growth over time. Most of the value of a company isn’t based on what it will earn in the next year, but what it is expected to earn over the next 5, 10, 20 years or longer.

• Valuations have declined significantly year-to-date. Valuations are much lower now than at the start of 2022,³ and this is true across nearly all broad sectors and across nearly all broad markets in the world. This isn’t to note that in general stocks are cheap today, but that some of the rise in interest rates and risk is reflected in prices. Many value stocks such as energy, material, financial and industrial names, which are the most sensitive to economic cycles and downturns, are already trading at lower valuations than they were several years ago.
• Historical market performance tends to be positive. S. equity markets have generally moved higher in about 70% of all months, quarters and years.⁴ Following down years like this one, markets are positive in about 70% of all subsequent years. Knowing that this year was negative doesn’t give us any additional information about what next year’s return might be like.

We know the odds of a recession have increased going into next year. There are some concerning conditions right now, with inflation rising to the steepest levels in 40 years,⁵ a struggling labor force and high levels of debt. With so many policy, fiscal and economic changes over the last three years, predicting returns for the next year is especially treacherous. Real returns don’t come without risk, and markets are aware of these challenges as well. As always we want to remain diversified and invested in companies that produce the goods and services we use each day. If you have any questions, please contact your Exencial advisor.

Sources:

1. Investor’s Business Daily (5/27/22) — The Federal Reserve’s ‘most anticipated’ recession in history may be coming
2. S&P Dow Jones Indices (12/08/22) – S&P 500 Earnings Report, 1988 – 2022
3. MarketWatch (12/7/22) — S&P 500 Index
4. Investopedia (11/4/22) — January barometer
5. Bloomberg (10/13/22) — Core US inflation rises to 40-year high, securing big Fed hike

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