Can mega-cap technology stocks make a resurgence? Could higher interest rates be a game changer for European banks? And will 2023 be a breakout year for carbon capture?
Diverging views, whether on a specific stock or the long-term outlook of a whole sector or global region, offer fertile ground for investors interested in generating excess returns, or alpha. Here are seven key themes for 2023 that examine what the market may be missing.
1. Mega-Cap Stocks Come Back in Favor
Up until late 2022, mega-cap technology stocks—whose market capitalizations are multiples more than the $10 billion classification of a large-cap stock—were market darlings, buoyed in part by the soaring popularity of indexing, which typically bases weights on market cap. Changes in the macroeconomic backdrop (i.e., higher inflation and interest rates) and other factors prompted investors to change course. The 10 largest stocks in the S&P 500 at its peak in 2022 lost a combined $4.9 trillion last year.
While the market seems skeptical that mega-cap internet stocks will stage a comeback any time soon, Morgan Stanley Research thinks they could emerge stronger in 2024 and beyond. The wildcard is the incremental return on investment of artificial intelligence and machine learning. “Maintaining or increasing investment intensity while reallocating resources to areas with stronger and more tangible returns will likely position mega-cap internet stocks stronger after 2023,” says U.S. Internet analyst Brian Nowak.
2. Private Markets Primed for Long-Term Growth
Private equity, venture capital, real estate and other private markets have for years benefited from an influx of capital and strong relative performance. Understandably, investors might be wary of what a challenging macroeconomic environment means for private markets, and Morgan Stanley analysts expect relatively moderate near-term growth for this category. Over the long term, however, the $10 trillion private markets industry could grow at 12% compounded annually to $17 trillion in assets over the next five years. “Our long-term outlook is supported by rising allocations, new growth engines and private markets’ strong track record versus public markets,” says Michael Cyprys, who covers Brokers, Asset Managers & Exchanges
3. Carbon Capture Could Have a Breakout Year
Carbon capture—a process that removes or prevents carbon dioxide from entering the atmosphere—will likely play an important role in achieving long-term climate goals.
The consensus view is that carbon capture will take five to 10 years to scale, given high costs and technological uncertainty. However, analysts and strategists think 2023 could be a breakout year for carbon capture and storage. A key impetus: The Inflation Reduction Act, which raises the tax credit from $50 to $85 per ton, has significantly increased the U.S. addressable market for carbon capture.
“Large energy companies, which are already benefitting from strong oil and gas prices, now have an increasingly viable path to profitably decarbonize their own operations and other industries,” says Devin McDermott, Equity Analyst and Commodities Strategist. These initiatives, he adds, can help de-risk long-term cash flows and potentially offset the impact of long-term erosion in oil and gas demand.
4. Higher Rates Are a Game Changer for European Banks
Investors’ decade-long wariness around European banks persists, as the region seems headed for a recession. But while the consensus worries that banks could endure losses on loans, Morgan Stanley banking analysts disagree. “We are firm believers that higher rates are a game changer for the sector, and healthy liquidity levels will translate into slow deposit repricing, and hence further upside,” says Magdalena Stoklosa, an equity analyst covering European banks. Even after building in a “layer of caution” in provisions, banks can continue paying a 10% yield in the form of dividends and buybacks. And, with 20% upside to the sector, which was recently trading at six times 2024 earnings, valuation has plenty of room for adjustment.
5. Europe Sees a Building Boom Spurred by Energy Standards
Typically, construction does only as well as the economy. However, demand for construction materials and products has improved despite weak economic growth, thanks to a strong uptick in energy-efficient construction and remodeling. “We’ve seen a fundamental shift in Europe’s commitment to building energy efficiency over the last three years,” says Cedar Ekblom, an analyst covering European building and construction.
These policies are already directing government budgets and funding packages toward energy-renovation upgrades that should underpin demand—and at a time when related stocks are trading at significant discounts. The companies best positioned to benefit are those that offer products and services aimed at boosting energy efficiency by improving a building’s “envelope,” or the roof, walls and windows of a structure.
6. U.S. Airlines Will Have a Goldilocks Moment
The last three years have brought extreme conditions for U.S. airlines. While the pandemic created a frigid environment in 2020 and 2021, pent-up demand and inflation in 2022 were too hot in the domestic leisure market even while corporate and international travel continued to run cold.
Consequently, the market thinks that industry tailwinds are transitory, while headwinds, such as cost inflation, are permanent. Morgan Stanley analysts have a different view. “More normalized dynamics will create ‘just right’ conditions—leading to better earnings than markets are currently pricing,” says North American transportation analyst Ravi Shanker.
7. Asia Is Positioned for Outperformance in 2023
Investors continue to view China and other Asian markets with a skeptical eye because, among other reasons, they worry that central banks will hike rates and restrain growth.
Morgan Stanley’s outlook for the region is notably different. Strategists think that a combination of easier financial conditions and healthy balance sheets will support domestic demand strength in Asia. China’s reopening should provide an additional boost, driving Asia’s growth outperformance in 2023.
Meanwhile, many Asian markets have been historically cheap. When Morgan Stanley made its initial bullish call on Asian equities late last year, valuations were 40% below their early 2021 peak—marking one of the longest and steepest bear cycles in recent history.
For more Morgan Stanley Research on this year’s “Big Debates,” ask your Morgan Stanley representative or Financial Advisor for the full series of reports, “Big Debates 2023” (Dec 12, 2022).
