- Some Wall Street observers are worried the S&P 500 is headed for another grim showing in 2023.
- The index suffered its worst loss since 2008 last year amid rising inflation and aggressive Fed policy.
- Here are four lingering headwinds that could drive a big hit to the S&P 500 in 2023.
The S&P 500 could be headed for another dismal year, Wall Street analysts and bankers say, warning that the benchmark stock index still isn’t a safe bet for investors amid a myriad of macro and market headwinds.
The S&P 500 fell 20% in 2022 amid rising inflation and aggressive interest rate increases by the Federal Reserve.
Those are the worst losses investors have seen since the 2008 recession, sparking fears that the market is entering a new era of heightened volatility and anemic returns. BlackRock recently warned investors that old playbooks and approaches can’t be relied on, and to prepare portfolios for a paradigm shift.
Analysts have pointed to four big reasons why the S&P 500 will likely underperform this year.
Morgan Stanley’s chief stock strategist Mike Wilson
1. An earnings recession will ravage stocks
S&P 500 companies are set to report weak earnings this year, with the market is still reeling from the impact of Fed rate hikes in 2022 and cooling inflation set to take a bite out of revenues. Central bankers hiked interest rates a whopping 425-basis-points last year and signaled they will start to ease up on their tightening efforts in 2023. But stocks have already taken a hit, and the full effects of those rate hikes has yet to be felt in the market.
Morgan Stanley’s top stock strategist Mike Wilson estimated that corporate earnings expectations for 2023 were about 20% too high among investors, which means the worst earnings recession since 2008 could hit the market this year. He predicted the S&P 500 would fall 24% in the early half of the year, in line with estimates from Bank of America and Deutsche Bank.
The Fed is rapidly reducing the size of its balance sheet through quantitative tightening.
2. Liquidity is being flushed out of the market
In addition to rate hikes, the Fed is rapidly reducing the size of its balance sheet by around $95 billion a month, a form of monetary tightening that can help reduce asset inflation by taking liquidity out of the market. But that’s a headwind ahead for many asset classes, including stocks, particularly growth and tech stocks that have been boosted by ultra liquid condition and traders desperately seeking higher returns amid the low rate environment.
The central bank has already shaved off $381 billion from its balance sheet since last April, and stocks have plunged as erased most of the gains made during the pandemic period of interest rates near zero and ample cash sloshing around the market.
The liquidity runoff is the “elephant in the room,” Morgan Stanley said, predicting that continued tightening could cause the S&P 500 to drop another 15% by March. Bank of America has predicted a milder decline of 7%.
The S&P 500 is overcrowded, according to Bank of America’s chief stock strategist.
REUTERS/Dario Cantatore/NYSE Euronext
3. The S&P 500 is a crowded trade
Too many investors are huddled in the S&P 500 – and that’s going to make any bouts of volatility even worse as traders move to sell en masse when trouble hits, according to Bank of America’s top stock strategist Savita Subramanian.
“The problem is everyone is using muscle memory to go back into what they think of as the safest equity market, which is the S&P 500. Trouble is, if everybody is in the S&P 500, and they’re all selling at the same time, the S&P isn’t really that safe,” Subramanian said in a recent interview with Bloomberg.
She urged investors to exit crowded areas of the market, like tech, and to bet on energy and small cap stocks.
John Hussman, the market veteran who called the dot-com bust.
YouTube / John Mauldin
4. Stocks are still overvalued
Stocks in the S&P 500 are still overvalued despite the steep sell-off of last year, according to market veteran John Hussman, who warned that the index could see negative returns over the next decade.
Hussman, who called the burst the dot-com bubble in 2000, noted that his favorite valuation measure in the S&P 500 was at a similar level to where it was at the peak of the dot-com era. That indicator has the best track record out of any measure to predicting long-run returns for the stock index, Hussman warned, who thinks the S&P 500 still has more room to fall.
“Notice how little impact the 2022 market decline to-date has had on valuations,” he said. “Though recent market losses have removed the most extreme speculative froth, our most reliable valuation measures remain near their 1929 and 2000 extremes.”
He warned that the S&P 500 could fall another 60% on a “very long, interesting trip to nowhere,” which would bring the index close to 1,500. He estimated the S&P 500 would see an average return of -6% over the next 10-12 years.