2022 will go down in history as one of the worst years for stocks in the last few decades; what will 2023 bring to the markets?
Which Scenario Looks Right to You?
It’s impossible to forecast the near-term path of the markets, but we can try and distinguish trends and upside and downside risks to these trends:
- Base Case: a mild recession in the first half of 2023, which brings down inflation, letting the Fed ease in the second half; the S&P 500 (SPX) rallies 10%-20%.
- Bear Case: the Fed over-tightens, sending the economy into a “hard landing,” sending stocks down for the year.
- Bull Case: the Fed succeeds in bringing down inflation without causing a recession, and stocks rally as they did in 2021.
It would be reasonable to work according to the base-case outlook while hedging against different scenarios that might affect some stocks more than others.
Base Case: Mild Recession Followed by an Upturn
In the base-case scenario, it would be a no-brainer to buy tech stocks. The decades-long trend of technology entering every layer of human life will continue, and tech stocks will likely shine again.
According to Morningstar (NASDAQ: MORN) analysts, large-cap growth stocks are now one of the cheapest segments in the market, having suffered some of the biggest declines. Shares of Meta (NASDAQ: META), Alphabet (NASDAQ: GOOG), Nvidia (NASDAQ: NVDA), Amazon (NASDAQ: AMZN), Microsoft (NASDAQ: MSFT), and Apple (NASDAQ: AAPL) have suffered staggering losses in 2022 and look strongly undervalued. There’s no doubt that many of the Big Tech companies will see their stock performances improve as the economy mends and sentiment picks up, making their current prices look like decent entry points.
Make sure to look beyond the price at the fundamentals, though. After the crazy rally and its bust, investors will be much more skeptical of bombastic growth promises that aren’t underpinned by solid numbers. When optimism returns, it will be much more realistic, at least for a while. So, it’d be a good idea to choose stocks of companies with robust earnings, ample cash, and strong growth prospects.
In addition, have a look at another dirt-cheap equity segment: small caps. These stocks suffer in downturns but tend to outperform when the economy improves. Small-cap P/E ratios have reached their lowest levels in two decades, and the recession looks already priced into their valuations.
To take advantage of this, you might want to have a look at the shares of Sarepta Therapeutics (NASDAQ: SRPT), Shockwave Medical (NASDAQ: SWAV), Lattice Semiconductor (NASDAQ: LSCC), Pure Storage (NYSE: PSTG), Tetra Tech (NASDAQ: TTEK), or WillScot Mobile Mini Holdings (NASDAQ: WSC), as they look promising.
Bear Case: Bad Recession or High Rates for Longer
If you believe that 2023 may turn out to be another “risk-off” year but still want to remain invested, consider picking stocks of companies that don’t depend on cheap funding and are supported by ample cash, strong business models, and dominance in their markets. Dividend-paying companies are preferred; value stocks will likely outperform in this setting. Pay attention to the industries: discretionary products and services take a much bigger hit in recessions than those supplying the necessities.
For example, Kraft Heinz (NASDAQ: KHC) is a leader in the packaged food market. It has substantial pricing power and pays stable dividends, which could help hedge against an economic downturn. Occidental Petroleum (NYSE: OXY) has been a great inflation hedge, trading at a P/E ratio of 5.2. Target (NYSE: TGT) is a dividend king with a strong market cap and solid profitability. Another high-dividend stock is Danaher (NYSE: DHR), a stable, diversified conglomerate. Johnson & Johnson (NYSE: JNJ) has plenty of cash, a high dividend yield, and vast market share. Top this list with Berkshire Hathaway (NYSE: BRK.B), the best-run financial conglomerate in the U.S., and you should be well-equipped for a recession.
Bull Case: No Recession, Markets Rally
If you believe the U.S. economy will avoid a recession, you’d think that one should just buy everything at these prices, right? Well, no: it will take time for another broad “buy-all” rally to emerge; investors will be very selective for a while, putting money only on those companies that have established business models and resilient financials.
Go with the “base-case” portfolio, adding to it some stocks from sectors that benefit from higher growth, basing your choice on reasonable stock pricing and good fundamentals. Considering adding tech and discretionary stocks to the portfolio, such as Sally Beauty (NYSE: SBH), trading at a P/E ratio of 7.5, Century Communities (NYSE: CCS) at 2.8, Green Brick Partners (NYSE: GRBK) at 3.99, Western Digital (NASDAQ: WDC) at 10.5, Stride (NYSE: LRN) at 15.0, Applied Materials (NASDAQ: AMAT) at 12.8, and ON Semiconductor (NASDAQ: ON) at 16.2.
The Takeaway: Just Hold On
Whatever happens in 2023, remember: every bear market has ended with a new bull market. Hedge your portfolio to ride out the turbulence, and don’t lose calm.
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