Time in the market vs timing the market

For the first time in nearly three years, prices fell on a monthly basis. Consumer prices declined 0.1% MoM1, resulting in a YoY2 inflation figure of 6.5% in December 2022. On the other hand, we saw January 2023 nonfarm payrolls coming in strongly at 517,000 new jobs, exceeding expectations of 188,000.

After a series of supersized rate hikes, the US Federal Reserve (the Fed) raised its federal funds rate by an expected 25bps3 to 4.75% in February 2023. The Fed left the language about "ongoing increases in the target range" in place, but Fed Chair Jerome Powell turned rather dovish saying the “disinflation process has started” in his press conference.

Has the stock market bottomed?

The big reset in rates spared no major asset class as we saw a distinct investment style change with growth underperforming value. Energy, Financials, Healthcare outperformed, while Tech and Consumer Discretionary underperformed in 2022.

From oversold conditions, with help from positive seasonality effects, the S&P 500 Index staged a rebound in Q4 2022 after touching a fresh 52-week low of 3491 in October 2022.

After a highly volatile and challenging year, many investors are eager to see an end to the bear market, wondering “has the stock market bottomed”?

Waiting for the pivot

To answer this question, investors, as well as policymakers and economists are all trying to forecast what lies ahead for the economy in 2023, with the key debate on Fed pivot timing.

A Fed pivot would be a very important positive catalyst for markets, but unfortunately, there is no perfect leading indicator. Our house view maintains a 5% terminal federal funds rate forecast, which implies just one more 25bps3 rate hike upcoming in March 2023, and then pausing until a pivot in 2024.

Interestingly, what the Fed says is often more important than what they do. So, what could a pivot sound like? The Fed saying “Job done on inflation for now, time to focus on economic growth”?

This too shall pass

Central banks dominated 2022, but would become less of a focus in 2023. On the back of recessionary concerns, the next hurdle the market has to overcome is earnings.

In our view, the worst of inflation is likely over us, but not earnings drawdowns, for which we could potentially see further mean-reversion to earnings declines during recessionary periods (see chart 1). That said, this is largely a reflection to economic slowdowns due to the series of rate hikes, which is more transitory (ie. macro driven) than structural.

As the old adage goes, “it's not about timing the market, but time in the market”. We believe 2023 will be a year to navigate the landing path, but as we may have experienced before, a landing can be bumpy. 

Earnings to come into focus

We are currently in the midst of the US Q4 2022 reporting season. 68.3% of the S&P 500's market cap has reported, with earnings beating estimates by +1.5%, and 63% of companies topping projections as of 3 February 2023 (see chart 2).

Earnings forecast downgrades started in June 2022, three months after the Fed’s first rate hike since 2018. Consensus 2023 EPS1 growth declined from 10% to 2% over the past few months, suggesting that earnings normalisation is underway.

Going forward, China’s pent-up demand post easing of restrictions could provide support to the global economic cycle, notwithstanding potential upward inflationary pressure the China reopening could bring alongside.

Moving on from “Hurricane” to “Mild Recession”

Most of the US banks managed to beat expectations for Q4 2022 results, though estimates had come down significantly in recent weeks and there was still a mixed picture within the numbers.

We saw strength in net interest income and consumers continued to spend on credit cards. However, the banks collectively provisioned US$2.8 billion in Q4 2022 to cover potential loan losses, and the deal-making environment was weak.

Despite this, the banks were importantly less bearish on the economy than some had expected. Most of them talked about a “mild recession”, and the previously heavily-bearish JP Morgan CEO Jamie Dimon said in relation to his earlier “economic hurricane” comment: “I shouldn't have ever used the word ‘hurricane’2.”

The market’s positive reaction to the results and the prospect of a “mild recession” also suggests the shares may have already discounted plenty of negativity.

Finding the right balance between growth and profitability

The tech megacaps generally reported mixed Q4 2022 earnings and guidance. However, we are notably encouraged by the change in culture to be more conscious about cost and capex3 growth, where management spoke about being more efficient and removing excess, while still continuing to invest.

With the days of growth at all costs behind us, the tech space is seeing secular growth slowing down. Slowing secular growth would mean greater exposure to macro headwinds and competitive forces.

Though, on a more positive note, the current starting point for tech megacaps is much more favorable than a year ago as valuations have come off from elevated levels, suggesting a reset in expectations.

We believe the tech megacaps’ healthy balance sheets should allow them to navigate the challenging microenvironment better than peers, while their core businesses would lead to an eventual recovery.