What is the outlook for the stock market in 2023?

Earnings Season Is Wrapping Up. Why 2023 Earnings Forecasts Might Have Farther to Fall.

Nov. 9, 2022 3:00 am ET

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The expectation broadly on Wall Street has been that 2023 earnings forecasts would drop after third-quarter results were in, as economic demand is expected only to weaken further. Now, the third-quarter earnings season is largely done, and yet analysts are still likely to lower their estimates even more from here. 

About 90% of the S&P 500 market capitalization have reported third-quarter earnings, and expectations for 2023 profits have also already dropped. Actual third-quarter per-share earnings results for S&P 500 companies, in aggregate, have beaten analysts’ expectations by about 3%, according to Credit Suisse.

10 Top Stock Market Predictions for 2023

In October 2021, I gave a stark warning to investors.

No one rings a bell at the top of the market… America, however, does have someone who looks like a bell-ringer: Fed Chair Jerome Powell. And last Friday, he made his intentions clear: ‘I do think it’s time to taper.’ – Moonshot Investor, Oct. 27

By December, I would urge investors to sell their meme coins and then get out of crypto the following May. Bitcoin (BTC-USD) is still down 35% from that call.

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That’s because some economic cycles are straightforward to forecast.

High inflation? You can be sure central banks will raise interest rates to slow the pace. Unemployment out of control? Vote-hungry legislators will be pushing stimulus bills before you can finish this sentence.

In other words, most developed economies follow a boom-bust cycle as predictable as tides going in and out. Cryptocurrencies, bonds and other rate-sensitive assets tend to follow suit.

Meanwhile, predicting the movement of individual stocks is a far more challenging task. My No. 2 stock pick for 2022 doubled within two months, while my No. 1 pick dropped 60%. Unlike the economic tides that rise and fall, individual companies can surge to dominance…

…or disappear off the face of the earth.

It’s the difference between predicting the average tide for a day (i.e., economic cycles) or the size of each wave (i.e., individual stocks).

10 Top Stock Market Predictions for 2023

Nevertheless, picking stocks and predicting markets go hand in hand. No amount of macroeconomic insight is helpful to investors unless it helps us understand what we should do next. And fortunately, 2023 is shaping up to become a year where predictable macroeconomic forces are back in the driver’s seat.

Prediction 1: An Aggressive Fed Gets Inflation Under Control

Rising rates will likely trigger a recession this year, according to data models by the Conference Board, a non-partisan think tank. They now predict a 96% likelihood of a U.S. recession within the next 12 months.

That’s oddly good news for inflation hawks. In every recession until the 2020 Covid-19 pandemic, economic slowdowns have been linked with softening demand and lower prices. The pattern was only broken in 2020 when massive fiscal stimulus offset the severe downturn caused by pandemic-induced lockdowns.

A graph of US consumer price inflation history

Source: Chart by InvestorPlace

In 2023, a recession will help bring inflation back under control.

Demand for goods is already slipping. Henry Hub gas prices – a key indicator of industrial production – dropped from their $8.81 record in August to $7.88 in September. And on the consumer side, prices of big-ticket items are also showing weakness. The Manheim used vehicle value index is now down 13% from the start of the year, while housing transactions have slowed.

Most importantly, the U.S. government has avoided the temptation of unleashing fiscal stimulus. Last week, President Joe Biden quietly scaled back significant portions of student debt relief. And high gas prices have been met with increased drilling permits and attempted Middle East diplomacy rather than the energy subsidies the U.K. and E.U. have pursued. The White House has briefly put the practicalities of inflation ahead of ideology for now.

Several structural issues will remain through 2023. Cutbacks in OPEC+ production threaten to keep oil prices aloft. A severe housing shortage should keep real estate tight. But naysayers of the Fed aren’t giving Jerome Powell or the White House enough credit — with both monetary and fiscal policy temporarily working in the same direction, 2023 will be the year inflation gets back under control.

Prediction 2: The Dow Jones Hobbles Back Above 33,000

Signs are also emerging that America will escape a prolonged recession in 2023. On Friday, the Labor Department revealed that unemployment had fallen to 3.5%, a strong signal of economic health. And job openings remain relatively high – a factor that has helped keep the “shadow” U.S. unemployment rate relatively stable.

A graph of shadow us unemployment rate through October 2022

Source: Chart by InvestorPlace

“Companies suffering from worker shortages have little fat to trim,” notes the Economist. “This resilience is to be welcomed. It implies that a recession, if one arrives, is likely to be mild.” A strong dollar will only help buffer the U.S. economy against significant declines.

That will likely keep the Dow Jones Index (DJIA) in positive territory next year. The median company in the Dow Jones now trades for 18.8x price-to-earnings (P/E), a significant discount to its 5-year average of 21.8x. That suggests the Dow Jones could reach 35,650 if markets return to normal.

But I’m tempering my expectations, at least for now. Of the 30 companies in the Dow Jones, only 17 will increase earnings per share (EPS) by more than inflation, according to Wall Street analysts. And the big winners in the index – including Chevron (NYSE:CVX) and Disney (NYSE:DIS) — will unlikely repeat their strong performance beyond 2023.

The U.S. also risks major supply-side shocks. On Monday, the Biden administration implemented sweeping new restrictions on chip exports to China – a move designed to slow Chinese development of advanced technologies. The action came less than a month after the White House reaffirmed the President Donald Trump-era tariffs on its economic rival.

These trade barriers could trigger tit-for-tat restrictions, particularly in high-value tech exports like solar panels and electronics. China could also restrict U.S. sales of anything from Apple iPhones to Nike shoes.

Barring such escalation, 2023 will likely shape up as a year where low-volatility firms inch higher and the U.S. sidesteps a significant recession.

Prediction 3: Hypergrowth Stocks Soar

All this creates a “goldilocks” situation for high-growth stocks. The slowing pace of rate hikes, coupled with a relatively mild recession, means that demand for higher-risk assets will rise sooner than expected.

History creates room for optimism. According to a study by CFRA Research, the S&P 500 typically rises 17% in the 12 months after a recession, compared to a 1% loss in the year before. Post-recession periods turn out to be some of the best moments to buy.

The rebound effect is particularly notable with cyclical companies, a sector of high-beta stocks. A study by Fidelity found that shares in the consumer discretionary sector bested the average stock market by 12% in early cycle recoveries since 1962 with a 100% hit rate.

Today, investors can find these opportunities in higher-risk startups like Desktop Metal (NYSE:DM) and Ginkgo Bioworks (NYSE:DNA) that trade near their liquidation value. Markets currently value Desktop Metal’s equity at $800 million, only 40% higher than the value of its ExOne acquisition in 2021. The value of DM’s patents and assets is likely worth over $1 billion, a fact that Wall Street analysts highlight with their $3.76 price target.

Ginkgo’s upside is even higher, given the company’s intellectual property (IP) in synthetic biology. Shares have a 145% upside, according to Wall Street.

In 2023, these companies will spring back to their intrinsic values as the Fed slows the pace of rate hikes.

Prediction 4: Finance Stocks Surprise to the Upside

In July, I recommended Charles Schwab (NYSE:SCHW), a “sleeper stock quietly beating Robinhood.”

“At first glance, Charles Schwab might seem like an ordinary brokerage business… Instead, Charles Schwab makes the [Profit & Protection buy] list because it’s quietly become one of America’s largest and best-run banks… Rising interest rates will boost Schwab’s revenue without causing additional costs.”

Shares have since risen 16%, outperforming the S&P 500 by over a fifth.

In 2023, shares of financial companies will continue to rise. Banks earn income from net interest margin (NIM), and rising rates tend to increase the spread. For every 1% that rates rise, Schwab will earn around 6.2% more in NIMs.

Operationally leveraged firms will gain even more. At online bank startup SoFi Technologies (NASDAQ:SOFI), each additional NIM dollar raises operating income by $2.33 because of the fintech’s relatively high fixed costs.

That’s good news for investors in firms like SoFi. The company has little direct exposure to mortgages and a stock price that now borders on its liquidation value. The San Francisco-based firm trades at a price-to-book of less than 1, giving it potential 5X upside.

A graph of sofi technologies price-to-book value through October 2022

Source: Chart by InvestorPlace

It won’t be a smooth ride. Investment banks like Goldman Sachs (NYSE:GS) will see earnings drop by around 43% as deals dry up, according to consensus estimates. And slowing economies are generally bad news for banks, which depend on the strength of their underlying economy.

But for investors with higher risk appetite, finance stocks like SoFi and Charles Schwab will surprise to the upside in 2023

Prediction 5: Lithium Stocks Dominate

In January, analysts at Goldman Sachs warned that lithium supply could triple by 2025. The oversupply, it forecast, would cause prices to crater to $11,000.

Less than a year later, such predictions have been upended. In August, California moved to ban the sale of gas-powered vehicles by 2035. Many states like Massachusetts, which link their emission standards to the Golden State’s, will automatically follow suit.

These regulations have turned supply-demand forecasts on their head. The International Energy Agency now projects demand by 2025 will be 25% higher from announced EV pledges. By 2030, that gap could widen to almost 60%. Lithium now trades at record highs.

Several companies stand to gain. Of the blue-chip players, established firms like Sociedad Quimica y Minera de Chile (NYSE:SQM), the world’s largest supplier of lithium, will benefit from high prices. Analysts are already calling for earnings per share (EPS) to top $13.3 in 2023, up from $2.05 in 2021.

On the other end, startups like Lithium Americas (NYSE:LAC) could see even more significant gains. These companies have multiple projects under development and trade at a significant discount for regulatory uncertainty. LAC’s Nevada-based Thacker Pass project has been in legal limbo for years, despite receiving mining permits from both the Trump and Biden administrations. A severe lithium metal shortage will pressure state governments to concede on mining restrictions. Stocks like Lithium Americas could rise 200%.

Prediction 6: Ethereum Crushes the Competition

In 2021, I predicted that Ethereum (ETH-USD) would dominate the tokenization space.

It’s hard to know which tokens will win. In the carbon credit space, CO2, UPCO2 and MintCarbon are all competing for the same prize, but all three could wind up losing anyway.

However, I can tell you one cryptocurrency that’s sure to be a winner:

Ethereum.

The ‘picks and shovels’ play of tokenization now supports 97% of all NFT transactions, according to Cointelegraph Research…. As we look towards 2022, Ethereum will continue to succeed.

Fast forward a year, and Ethereum has indeed maintained its lead in tokenization. The world’s second-largest cryptocurrency has waved off competition from Solana (SOL-USD) and Flow (FLOW-USD); 75% of NFT transactions remain on the Ethereum blockchain. And in mid-September, the cryptocurrency pulled off a switch to a Proof of Stake protocol with zero downtime. Ethereum transactions now use 99% less energy than they once did.

ETH will likely widen its lead in 2023 as funding for rival blockchains dwindle. The value of the Solana Foundation’s approximately 95 million SOL has dropped from an astonishing $24.6 billion in 2021 to $3.1 billion today. And once-promising upstarts like Immutable X (IMX-USD) have failed to live up to their initial hype, starving them of additional fundraising potential.

Ethereum isn’t immune to the 2022 crypto winter, either. Weekly NFT sales are down almost 75% from the start of the year, according to The Block. And ETH prices are down 65% year to date. But as the crypto shakeout of 2018 demonstrated, dominant players tend to extend their lead during market drawdowns. 2023 will look no different.

Prediction 7: Investors Wait Too Long to Buy

Finally, stocks typically bottom out around two months before the end of rate-hike cycles, according to data going back to the 1980s. That pattern suggests that markets will bottom out in Q4 2022, since rates will likely peak in early 2023.

Many retail investors, however, will miss jumping back in. According to surveys by the American Association of Individual Investors (AAII), negative sentiment hit 61% in September, its highest reading since the 2009 financial crisis. A separate study by VandaTrack found that investors are now less willing to buy the dip after the stock market’s recent underperformance.

That means many investors will miss out on once-in-a-decade deals. 42 U.S-listed companies now trade with negative enterprise values, despite having positive free cash flow. Add in all money-losing companies, and 391 American firms receive the dubious award of having enough cash to take themselves private, according to data from Thomson Reuters.

2023 will be a phenomenal year for many of these companies… and many investors stand to miss out.

Conclusion: 3 Bonus Predictions to Watch

Rising rates and protectionist economic policy create predictable patterns that markets have seen since the 1950s.

Real estate prices sag. Rising mortgage rates and poor affordability will dent home prices in 2023, as they did in the 1991 and 2008 recessions.

Semiconductor stocks struggle. Sector insiders have been ringing alarm bells over oversupply since July. Protectionist policy will worsen the glut for American firms.

Staples and healthcare stocks underperform. Like in 2002 and other post-recession years, low-beta stocks tend to do worse than their riskier counterparts.

Together, that means traditionally “safe” investments will lag.

In their place, hypergrowth stocks and riskier plays will steal the show. And though we might not know exactly which stock (or wave) will succeed, it’s becoming clear that the entire tide is ready to come back in.

Tom Yeung is a market analyst and portfolio manager of the Omnia Portfolio, the highest-tier subscription at InvestorPlace. He is the former editor of Tom Yeung’s Profit & Protection, a free e-letter about investing to profit in good times and protecting gains during the bad.

Tom Yeung is a market analyst and portfolio manager of the Omnia Portfolio, the highest-tier subscription at InvestorPlace. He is the former editor of Tom Yeung’s Profit & Protection, a free e-letter about investing to profit in good times and protecting gains during the bad.

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