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Here's What Could Happen to the Stock Market in 2023: The Good and the Bad

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Investors everywhere are scratching their heads, trying to figure out where the market will be headed in 2023. Inflation has finally started to subside, but now the question is how badly the economy will be hit after the aggressive hikes in Federal Reserve interest rate. This year?

Will there be a recession in 2023? If so, how severe will this recession be? Is unemployment about to skyrocket? What impact will the unwinding of the Fed’s balance sheet have on the markets? Or are the worries overblown and the Fed about to engineer a soft landing for the economy, in which inflation continues to fall and unemployment rises only modestly?

Anyone can guess right now, but here’s what could happen to the market in 2023: the good case scenario, the base case scenario and the worst case scenario.

Person looking at computer screens.

Image source: Getty Images.

How bad could things get?

How investors and analysts predict the future price of S&P500, a benchmark for the entire market, is similar to how they would predict the price of an individual stock. They try to calculate the combined earnings per share (EPS) of all S&P 500 companies and then assign an earnings multiple for it to trade.

For example, at the start of this month, the median EPS price target for the S&P 500 in 2023 was $232.53. Currently, the S&P 500 is trading slightly below 20 times earnings, which is within the range it has been on average. So if this EPS consensus holds, one would assume that the S&P 500 would be trading at 4,650 next year, which would be excellent given what is happening.

However, many experts such as analysts from Barclays Think EPS estimates like $232.53 and even multiples are overly bullish right now. Venu Krishna, head of US equity strategy at Barclays, said in October:

Ultimately, earnings estimates remain too high, in our view, for us to have them. a recession or not. A recession will simply speed up the review cycle and get us to the hard way sooner. We think the earnings disappointment is likely to drive down the next leg up for equities.

At the time, Barclays estimated S&P 500 EPS at $210 in 2023, but assigned a lower earnings multiple. As inflation has begun to subside, Krishna has warned investors to “be careful what you wish for… Lower inflation will be bad for earnings” and has actually bolstered earnings more recently.

Barclays has assigned a target of 3,675 for the S&P 500 next year, which is below current levels. The S&P 500 has only fallen occasionally in consecutive years, so that wouldn’t be good.

The base case

About a month ago, analysts at Morgan Stanley The market is expected to end the year at around 3,900, which is similar to where it is today. However, Morgan Stanley expects the road to be bumpy.

The bank’s analysts have revised their EPS estimates for the S&P 500 to $195 next year, bringing them to 3,900, assuming a 20 times earnings multiple. Still, analysts expect a tough year of earnings to hit markets in the first half of 2023, taking the S&P 500 into the low 3,000 range.

But then the team expects 2024 to be a much better year for earnings, allowing investors to reverse course in time to take the market back to 3,900 so they see an end point. boring but lots of volatility and excitement in between.

The bullish case: the S&P 500 rises to 4,800

I don’t think any analyst really expected this to happen where we are today, but there is a way, according to Nicholas Colas, co-founder of DataTrek Research.

Colas reminds investors that it is above all a question of evaluating future profits. Assuming a 17x or 18x forward earnings multiple in 2024, analysts should expect the S&P 500 to generate EPS between $267 and $282 per share. This means that market earnings are expected to increase by 23% over the next two years. Most of that is likely to happen in 2024.

So how could this play out? Well, Colas said that if a recession hits next year, S&P 500 companies should hold their earnings better than expected and see modest earnings growth next year. Then the Fed should stop raising rates next year, which could very well happen, and start cutting rates, which the Fed hasn’t indicated at this point, leading to economic growth and growth much larger profits in 2024.

The big problem here, according to Colas, is that he doesn’t see the S&P 500 hitting 4,800 without a recession, because without it he doesn’t think companies will cut costs any further, which is needed to establish better earnings growth. earnings in 2024. I would also point out that a recession would make the Fed more likely to cut rates next year.

In the current state of affairs

While there is still a lot of uncertainty in the environment, I don’t expect to see a repeat of the Great Recession next year as things stand.

When you look at the strong labor market, where consumer loan losses are compared to pre-pandemic levels, and their savings, many consumers are starting from a position of strength, although it There are certainly pockets of the population that have started to see their savings dwindle rapidly. In addition, the housing market appears to be in much better shape today than ten years ago.

Right now, I expect consumption to slow and prices to stabilize further, which could hurt earnings. But I wouldn’t expect a serious recessionwhich is a double-edged sword, because even if it’s better for the economy, it might not incentivize the Fed to cut rates or create enough earnings growth to push the S&P 500 deeper into the 4,000.

That’s why I currently share Morgan Stanley’s view that the S&P 500 should end next year around current levels and potentially sneak into the 4,000s.

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Bram Berkowitz has no position in the stocks mentioned. The Motley Fool recommends Barclays Plc. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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