Written by:  Mutsumi Kagawa (Chief Global Strategist, Economic Research Institute of Rakuten Securities)

(30/12/2022)

1. Global stocks performance was bad in 2022 but...

The global stock markets in 2022 decline due to the Ukraine war, rising inflation and concerns about an economic slowdown attributed to rapid monetary tightening by major central banks. Growth stocks with relatively high PERs (high-growth stocks such as high-tech stocks) were adversely impacted by rising interest rates, as investors’ risk tolerance declined. Chart 1 reflects the rate of change in 1 calendar year of world stocks (MSCI World Stock Index) over the last 20 years. World stocks rate of returns in 2022 is likely to be -20.3% (as of December 28), the lowest record since 2008 (-42.1%). Interest rate hikes continued in Europe and US in December. Stock prices were pushed down by the worsening economic outlook and concerns over the spread of the Covid19 in China. However, looking only at global stocks over the past 20 years, the year after the calendar year’s return was negative, it recorded a positive return, and there was no “2 consecutive years of decline”. For example, stock prices fell sharply in 2008 due to the financial crisis (bankruptcy of Lehman Brothers), but the following year (2009), world stock prices turned positive with +27.0% even though the economy was sluggish. In fact, the stock price adjustment of about 20% in 2022 should have factored in the economic slowdown and economic recession that will be a cause for concern in the future.  For 2023, the FRB is expected to stop raising interest rates in the first half of the year (pivot = policy change), and the market is looking at an economic recovery in 2024, with interest rate cuts in the second half of 2023 and the economy bottoming out. Global stocks, especially in the US, are likely to recover in the second half of 2023.

2. The global economy will bottom out in 2023 and recover in 2024

The global economy is expected to decline in 2023. According to the SEP (latest economic and interest rate outlook) released by the FRB on December 14, the US real GDP growth rate is revised downward to +0.5% in 2023, and the unemployment rate is expected rise to 4.6% (from 3.7% in November) due to the cumulative effect of monetary tightening. Chart 2 shows actual real GDP growth rates by country (region) and average market forecasts (average forecasts by private economists: Bloomberg data). According to this, it is forecasted to enter a “mild recession” where the world’s real growth rate is expected to decelerate from +3.0% in 2022 to +2.1% in 2023, while the US’s real growth rate is expected to decelerate from +1.9% in 2022 to +0.9% in 2023. In addition, the growth rate of the EU (European Union) is expected to drop to negative (-0.1%) in 2023. On the other hand, China is expected to recover from +3.0% in 2022 to +4.9% in 2023. The focus is on the outlook for 2024, where global markets will gradually recover. The world (+2.9%), US (+1.3%), China (+5.0%) and EU (+1.4%) are expected to recover from 2023.

I believe the change in the FRB’s rate hike outlook will be key for US stocks. Chart 3 shows the trajectory of the policy rate (FF rate) priced in by the futures market. There is a strong view that the FRB will continue to raise interest rates until the first half of 2023. After raising the policy interest rate to the terminal interest rate of around 5%, it will maintain at that level before cuts in the interest rate during the second half of 2023. The SEP economic outlook presented at the FOMC (US Federal Open Market Committee) on December 14 affirmed the cautious view on the economy. FRB is expected to show consideration for the economy next year. It is assumed that the downward pressure on stock prices due to monetary policy will not increase in the second half of 2023.

3. Check out the earnings forecasts for 2023 and 2024

Chart 4 shows the year-on-year changes in forecasted PERs (price-earnings ratio) and forecasted EPSs (earnings per share/market forecast average) for the calendar year in the descending order of the year-to-date changes of the stock index by sector (industry) in the US market. Looking back at this year’s year-to-date changes by sector, we can see that “energy” was the sole winner at +56.3%.

However, looking at the forecasted EPS growth rate for 2023 and 2024 based on the stock index by sector, energy earnings are expected to decline in 2023 and 2024. On the other hand, IT (Information Technology), consumer goods & services and capital goods & services are expected to post double-digit earnings growth in 2023 and 2024. Based on the S&P 500 index (the entire market), the profit growth rate is expected to slow from +13.6% in 2022 to +6.7% in 2023, but it is expected to recover to +9.6% in 2024. From this perspective, the S&P 500 index-based 2023 forecasted PER of 16.2x and 2024 forecasted PER of 14.8x are undervalued (as of December 28). For the time being, investor sentiment is deteriorating due to the FRB’s hawkish stance and fears of an economic slowdown. Thus, the volatile movements may continue until the first half of 2023. However, I expect stocks will recover in the second half of 2023, when interest rates stabilize, the economy is bottoming out, and earnings are gradually improving from the second half of 2023 to 2024. US stocks account for about 60% of the market capitalization weight (ratio) of the MSCI World Stock Index. If US stocks turn positive in 2023, I foresee risk appetite to pick up globally (even if there are strengths and weaknesses depending on the market).