Stocks are likely to get smacked down in the first half of 2023 before markets improve

Published Mon, Dec 5 202212:34 PM ESTUpdated Mon, Dec 5 20223:11 PM EST

Patti Domm @in/patti-domm-9224884/@pattidomm

The outlook for 2023 is a bit better for stocks, but the first half sounds like it could be downright ugly. Wall Street strategists are unveiling their outlooks for next year. There is somewhat of a shared view that the first half could be particularly rough, with the market possibly testing its October lows. Then there is an anticipated recovery in the second half. Some experts expect the market may not end up much higher than where it is right now by the end of 2023. "We're all saying the same thing," said Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets. "We're going to retest the lows. Earnings are going to come down." Calvasina expects the S & P 500 to end the year at 4,100. "My flat year thesis is kind of consensus. I think the median strategist is around 4,000," she said. "If there's risk, it's to the upside, not the downside after the bad year we've had." The S & P 500 is down about 15% in 2022. Strategists are also looking at a period in which Federal Reserve tightening could tilt the economy into a recession early next year. Views vary on how deep such a downturn could be, and some expect the central bank could still pull off a soft landing. "Our view on risk markets in 2023 consists of two periods: market turmoil and economic decline that will force interest rate cuts, and subsequent economic and asset recovery," wrote JPMorgan's Marko Kolanovic in his outlook. The strategist expects lows to be retested due to what could be a significant decline in earnings as interest rates rise. "We are inclined to think this could happen between now and the end of the first quarter," he noted. Bank of America's chief investment strategist, Michael Hartnett, sees a similar divide for next year. "We stay bearish risk assets in H1, set to turn bullish H2 as narrative shifts from the inflation and rates 'shocks' of '22 to recession and credit 'shocks' in H1 '23," he wrote in his outlook. Jeff Kleintop, Charles Schwab's chief global investment strategist, expects a shallow recession may already have begun. He predicts the first half will be worse for stocks than the back half of the year, with a choppiness similar to the past six months. "We see positive returns for the year, although high volatility continues for the next few months," he said. "You're going to pay a price for a better year next year." A market scenario that rhymes Calvasina said the clues to the coming year might be found in the 2003 period, and how the market behaved at that time. "If you look at the playbook, this is about the time the equity market should take a breather," she said. "The market retreated in December, and it retreated into March when it put in the final bottom." Back in 2003, the market was trading out of the Y2K tech bubble. Now, the market is trading out of the post-pandemic stimulus. "They were both large-cap growth bubbles, pulled forward by spend," she said. "There's a lot of ways the market rhymes with that period." Calvasina said investors could already be anticipating the turbulence of the first half. "Whatever everyone is talking about for the following year, you start to react to in December," she said. Clarity on the economy should also come in the first quarter, and companies could help provide important insight around earnings season. "We need to see how confident companies really are. I think we'll get more flavor of that in the next few months. At that point, we'll have some visibility into 2023," she said. Calvasina said the degree of pessimism about the market is a positive contrarian sign for stocks. "If companies stay calm and don't fire too many people, I see a case for muddling through," she said. "I can see the seeds of the upside. I can also see the seeds of the downside." How to play it Kleintop said he has used a strict rule in 2022 on which stocks to own, and that trend should continue to work next year. "If you look at this year, it's been one mantra," he said. "It's not about sector or countries. It's about quality. Companies that have a lot of cash flow relative to their valuations, and those paying high dividends. Those strategies worked all year." Kleintop said holding quality names will help investors avoid worrying about where the market will bottom or when to shift their strategy. "If you want to be in tech, just buy the highest dividend payers. They've been outperforming," he said. "The other overall theme is international. We've finally started to see international stocks outperform this year." If the dollar begins to weaken, that would also be a tail wind for foreign stocks, he added. Calvasina expects small caps to be an area of outperformance, and she still sees value in energy and financials. "If I could just make one trade, and buy one thing right now, it would be small caps," she said. Traditional tech, like semiconductors and software, are also areas she is looking at, but not internet names. "Everything is trading on the 10-year [ Treasury]. If you do get a move down in yields, you need to have some growth in your back pocket," she said. "Don't buy all of growth. Just be very selective. ... I've been looking selectively at tech names as rebound plays."