According to Goldman Sachs Research, the stock market bear market is predicted to strengthen in 2023 and give way to more optimistic signals later on.
The MSCI All Country World Index of global equities is down nearly 19% this year. While stocks have moved up slightly since the summer, our strategists expect more volatility and declines during this bear market before bottoming out later in 2023. They expect interest rates to peak and economic growth to stabilize before stock prices hold. It goes on.
The fundamentals driving global equity markets have changed dramatically, wrote Peter Oppenheimer, chief global equity strategist and head of macro research in Europe. In the team’s outlook for 2023, they pointed out that, compared to previous years, the cost of capital has risen significantly, impacting the valuations of high-growth companies whose profits are expected to be realized in the future. Earnings of major tech companies fell short of analysts’ expectations.
Higher interest rates and commodity prices have made high quality companies with reliable earnings and cash flows more attractive. “There has been a reversal in the relative fortunes between traditional incumbents and digital entrants in many industries,” our strategists wrote. They prefer companies with high dividends, strong balance sheets and high margins.
At the same time, investors may face a sluggish bear market. According to Goldman Sachs Research, there are two main types: “cyclicals” which are driven by a slowing economy and rising interest rates, and “structural” which are driven by shocks such as an asset bubble or disaster. This downturn is cyclical, typically lasting 26 months and stocks taking 50 months to recover. Stocks typically fall 30% and in these cycles are hit by short rallies before hitting the market floor.
There are several key reasons our strategists believe the stock could fall further. While valuations have fallen this year, it started from a very high peak amid extremely low interest rates. While many stock markets around the world trade at low valuations, US stocks are not.
Part of the difference in valuations is likely explained by better expectations for US economic growth and a stock market with a different mix of companies. But with that in mind, GS Research says it’s hard to justify why the US market is trading in line with the 20-year average. Especially when the margins of large technology companies are under pressure, resulting in job losses and falling investments. And meanwhile, government and corporate bond yields have risen so high that they are becoming competitive alternatives to equities.
Historically, the best times to buy stocks are when economic growth is weak but close to steady. But the expansion outlook is expected to improve later this year, but it hasn’t so far. According to Goldman Sachs Research strategists, “timing is everything.” “A weak economy that keeps getting worse is very different from an economy that gets less bad.”
Goldman Sachs Research has predicted a recession in Europe, while the US narrowly avoided a recession. But even as the world’s largest economy continues to grow, our equity strategists say investors will take a big risk in the high likelihood of a US recession before stocks bottom out. Their base case scenario is that revenues will be flat in 2023.
The spike in interest rates is likely to be bullish for equities. However, our strategists believe bond yields still have room to rise, partly because US policymakers are focused on keeping financial conditions tighter to help contain inflation. It is still unclear how long interest rates will remain high before central banks are ready to lower borrowing costs. Economists at Goldman Sachs do not expect interest rate cuts from the US Federal Reserve in 2023.
Meanwhile, investor positions indicate that the market has yet to bottom out. Some measures have caused investors to become more defensive and recalibrate their portfolios to take less risk, but inflows into equity funds are still strong, especially as US equities bottom out.
A period of “hope” for global stock markets could begin later this year, according to Goldman Sachs Research. This recovery usually starts during recessions, when valuations are rising. Historically, it has been better to invest in stocks just after a trough than just before: the average return over 12 months is higher the month after the trough than the month before. “For this reason, we believe it is too early to position ourselves for a possible transition to a bull market,” Goldman Sachs strategists wrote.