Stock market investors experienced a tough year in 2022 as the sell-off across sectors weighed heavily on shareholder sentiment. While the S&P 500 is down 20% from all-time highs, the tech-heavy Nasdaq Composite index fell more than 33% in 2022.
Let’s see what investors can expect from the S&P 500 in 2023.
Is a market recovery on the cards?
Given historical data, the stock market has staged a recovery in subsequent years after a drawdown of 10% or more. In case quantitative tightening measures result in lower inflation numbers, consumer demand should accelerate in the second half of 2023.
The Federal Reserve lowered interest rates soon after the markets crashed back in 2008. A lower interest rate environment acted as a tailwind for growth stocks as the cost of debt was minimal.
So, you could easily fund expansion plans as well as highly accretive acquisitions. Between 2009 and 2021, growth stocks easily outpaced value stocks.
But interest rates rose rapidly in the last year and have spiked to 4.3%. Investors are now worried about macroeconomic challenges ranging from inflation to supply chain disruptions driving valuations of companies across multiple sectors lower.
In 2022, value stocks outperformed growth stocks by a wide margin as shareholders gravitated towards companies with healthier balance sheets, predictable cash flows, and reasonable multiples.
There is a good chance for value stocks to keep outpacing growth stocks in 2023 as the Federal Reserve is focused on keeping inflation in check even if it results in an economic recession.
Alternatively, if the Fed pauses rate hikes and treasury yields stabilize, growth stocks may once again gain pace in the coming months.
Which sectors will perform well in 2023?
In the last year, higher commodity prices, as well as the Russian invasion of Ukraine, ensured the energy sector was the best-performing one. Oil and gas companies managed to generate record earnings and benefit from lofty oil prices in 2022.
Alternatively, the threat of an upcoming recession meant bank stocks were under the pump in 2022. Investors expect delinquency rates to surge and demand for mortgage, consumer, and corporate loans to plummet in the near term. Additionally, lower investment banking transactions should drive commission and related fees toward multi-year lows.
Apart from energy, the three top-performing sectors in 2022 were utilities, healthcare, and consumer staples. Each of these sectors is defensive in nature and recession-resistant. Most of the companies in these sectors enjoy pricing power and stable demand across market cycles.
As the U.S. economy is expected to head into a mild recession in Q1 and Q2 of 2023, investors should expect defensive stocks to hold much better in comparison to broader markets. But cyclical stocks such as banking may rebound in the second half as the economy limps towards a recovery.
In such a scenario, it makes sense to bet on sectors levered to economic growth and moderating inflation, such as industrials and consumer discretionary. Basically, you need to maintain a diversified portfolio of defensive and growth stocks as we head into 2023.
The final takeaway
There are a few headwinds impacting stock markets in 2023, suggesting the S&P 500 will remain volatile in the next two quarters. But we have seen that time spent in the market is a much better strategy than timing the markets.