The fear of inflation waned in the back half of 2022 while the fear of recession and a big drop in earnings grew. Worries about corporate profits are still very real, but so far earnings have held up well enough to support 2023 equity gains. With almost three quarters of the S&P 500 companies reporting through February 9th, sales have grown 5.37% while earnings have fallen 2.68%. Analysts lowered their figures before the quarter started allowing sales and earnings to surprise 1.30% and 1.82%, respectively. The “whisper numbers” were likely worse. Margin compression has happened, but profits have held up better than feared. The bears’ forecast of an imminent collapse in profits has been delayed for at least another quarter. Additionally, management forecasts have been cautious, but good enough increasing the likelihood of so-so year for earnings in 2023 after a phenomenal increase in 2022. Equity markets can digest flat or slightly negative earnings. This is probably incorporated in current stock prices. NPP does not think that a significant decline in earnings is priced into the market. Decent earnings coupled with cautious but not terrible management should allow stocks to hold a good portion of year-to-date gains.
This is not to say that earnings were the only factor leading to robust equity returns so far in 2023. Interest rates have declined materially year-to-date thanks to economic reports indicating slowing inflation. The benchmark ten-year Treasury fell from 3.87% at the end of 2022 to 3.68% on February 9th despite the recent backup in rates. Falling interest rates and slowing growth are usually positive for some of the market’s biggest sectors including information technology, communication services and consumer discretionary.
Several technical factors also contributed to the bright start to the year. A cessation of tax loss selling likely helped push equities higher. Many of 2022’s biggest losers have outperformed broader indices in 2023. More importantly, the end of the second year of a President’s term to the middle of the third year is almost always a good time to own equities. Whether this is due to substantive reasons or has just become a self-fulfilling prophecy is unknown, but it is a consistent market trend. Presidential cycles tend to fade after the second quarter. This year may be no different, but for now NPP thinks investors would be wise to avoid falling into the pessimistic side of the bulls versus bears argument. A deep recession seems unlikely, though we think a shallow one is likely later in 2023 or 2024.
We were positive on equities and financial assets when the year started. We still are but think a little more caution is warranted. The recent rally has front-loaded returns, but the case for a continuation of the 2022 bear market depends on much weaker earnings. NPP does not see this happening and we expect positive equity returns for the remainder of 2023.