Because of bludgeoning in 2022, most investors expect stocks to be “dead money” in 2023…
It would not entirely surprise anyone to say that most investors expect equity markets to “churn” in 2023. Basically, most investors believe the “crisis” environment of 2022 is spilling over into 2023. And most just see a litany of headwinds from Fed hikes to economy slowing to EPS contraction to “cash is king” to inflation “takes years to control.”
- so most investors and pundits, including many of the team at Fundstrat believe stocks will go “nowhere” in 2023.
…stocks going nowhere…
BASE CASE: The “maths” for what to expect in 2023, post a “negative return” year (2022)
Question: how common is a “flat” year? Our team calculated the data and it is shown below:
- since 1950, there are 19 instances of a negative S&P 500 return year. In the following year,
- stocks are “flat” (+/- 5%) only 11% of the time (n=2)
- stocks are up >20% 53% of the time (n=10)
- yup, stocks are 5X more likely to rise 20% than be flat
- and more than half of the instances are >20% gains
So, does a “flat year” still make sense?
As shown below, these probabilities are far higher than compared to typical years:
- since 1950, based upon all 73 years
- stocks are “flat” 16% of the time vs 11% post-negative years — BIG DIFFERENCE
- stocks are up >20% 27% of the time vs 53% post-negative years — BIG DIFFERENCE
- see the point? The odds of a >20% gain are double because of the decline in 2022
It is for this reason that we see 2023 as a year of opportunity, and less of crisis. In our view, this is the opposite of consensus.
3 POSSIBLE CATALYSTS: What are the possible catalysts/drivers for a “positive surprise” in 2023
Naturally, the question is what are the possible factors that would enable equities to produce >20% gains in 2023, versus a “flat” year. We believe there are 3 possible catalysts:
- First, we think US inflation undershoots Fed and consensus, by a wide margin in 2023. In fact, we think the December CPI report could see core CPI as low as 0.1% MoM and bring annualized inflation to below 2%. By the way, inflation is also set to collapse in Euro-area as well falling to 2%-range in early 2023. So this is a global “disinflation” underway.
- This would be a “step” function change in the path of inflation versus what the Fed expects. And as a consequence, would arguably set the stage for the Fed to lower the path of forward rates and even change the view regarding “higher for longer.”
- Second, despite what look like “strong” jobs markets, leading indicators already suggest wage gains are set to slow. It is visible even in the Atlanta Fed wage tracker (3M annualized slowing) and in leading surveys, as highlighted by Goldman Sachs Economists.
- Third, equity (VIX) and bond volatility (MOVE) are likely to fall sharply in 2023, in response to a step function downwards in inflation and a consequently less hawkish Fed. Our analysis shows this drop in VIX is a huge influential factor in equity gains.
- If VIX even falls modestly in 2023, the median gain is 22% (see below) with a win-ratio of 83%. This is far higher than equity markets overall. Thus, if the trajectory drop in inflation, along with easing wage gains transpire, we expect equity and credit volatility to drop sharply. As such, this would further support >20% gains.
Core CPI: December Core CPI could come in at +0.10%
On 1/12, the BLS will release Dec CPI and we believe “core inflation” could be as low as +0.10% MoM%. This would represent a massive decline in the pace of inflation and put the 3M annualized (SAAR) rate at ~2%.
- In our view, this would be a massive positive surprise
- Bloomberg consensus shows +0.3% for Core CPI
- The lowest is +0.20%, so +0.10% is half of the lowest figure.
This would also be a positive surprise for the Fed. We have already written previously how we believe the Fed forecasts are already >60bp too high for 2022 inflation.
- And if this December CPI comes in as we expect, would be the “floor dropping” out of their forecast
- Fed voting member Kashkari even wrote earlier this week “it is too soon to definitively declare inflation has peaked”
- So we can see the Fed mindset. Skepticism of improving data.
And Fed’s Bullard is less hawkish, but if our view on inflation is correct, even Bullard will be dovish.
And as we noted earlier, JPMorgan Economists forecast that Euro-area inflation could fall to sub-2% in 1H2023. That is a massive collapse in inflation and would be a dovish development.
And as for wage growth, Goldman Sachs economists see wage inflation falling to about 4% by the end of 2023. That is close to the Fed’s target of 3.5%. And if this tracks true, the Fed reaction is to make a dovish pivot.
STRATEGY: VIX matters far more for 2023 returns than EPS growth
Our data science team compiled the impact on 2023 equity returns from variables:
- S&P 500 post-negative year (2022)
- the varying impacts of
- VIX or volatility
- USD change
- Interest rates
- EPS growth
- All of the 4 above, positive or negative YoY
- Data is based on rolling quarters and summarized below
The surprising math and conclusions are as follows:
- most impactful is VIX
- Post-negative year (rolling LTM)
- if VIX falls, equity gain is 22% (win ratio 83%, n=23)
- if VIX rises, equity lose -23% (win ratio 14%, n=7)
- I mean, this shows this all comes down to the VIX
- EPS growth has little impact
- If EPS growth is negative YoY (likely), median gain +14.8% (win-ratio 70% n=33)
- If EPS growth is positive YoY, median gain is 15.5% (win-ratio is 78%)
- Hardly a sizable bifurcation
As the scatter below highlights, we can see the sizable influence of the VIX. Even in all years, the VIX is a key factor:
- in our view, if inflation falls sharply
- and wage growth slows
- Fed doesn’t have to cut, but this is a dovish development
- we see VIX falling to sub-20
- hence, >20% upside for stocks
And as shown below, EPS growth has a somewhat important correlation, but hardly as strong as VIX changes.
- the difference in median gain is a mere 70bp (positive vs negative) post-negative year
- the importance of EPS growth is stronger in other years
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