Morgan Stanley
  • Wealth Management
  • Jan 5, 2023

Investing in 2023: A Year to Be Patient and Selective

U.S. equities may disappoint in 2023, but patient investors can find potential income and returns in other markets.

Lisa Shalett Chief Investment Officer, Wealth Management

A grueling bear market, touched off by decades-high inflation and an aggressive Federal Reserve response, made 2022 one of the most challenging years for investment returns in the last half century.

Can investors expect something different in 2023? 

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Don’t hold your breath for a durable recovery in U.S. equities in the year ahead. Instead, Morgan Stanley’s Global Investment Committee recommends letting the market pay you to wait for better opportunities farther down the road and looking abroad for potential returns.

Here’s what we’re forecasting for 2023 and three strategies investors can use in the new year:

1. Don’t Expect Much from U.S. Stocks

The multiple bear-market rallies staged by U.S. stocks throughout 2022 suggest many stock investors haven’t embraced the likelihood of higher-for-longer interest rates and a materially slowing economy, even as economic data and Treasury yields continue to sound warnings.

We think U.S. stock investors may be overly optimistic and see two key reasons for concern heading into 2023:  

  • Unattractive valuations: Equity risk premiums—the potential excess returns one can expect for investing in stocks over risk-free bonds—are still relatively low, ranging between 180 and 250 basis points versus a long-term average of more than 350. This tells us that investors are not being appropriately compensated for taking equity risk.
  • Lofty earnings expectations: Consensus 2023 earnings projections for the S&P 500 Index sit around $230, a number that bakes in earnings growth of about 5%. To us, this estimate fails to account for the challenges that companies are likely to face, especially as they start to feel the effect of tighter monetary conditions in earnest. These include lower sales volumes and loss of pricing power, potentially at the same time. We think a more realistic forecast is $195, based on our expectation that the index will retreat another 15% to 20% before recovering through the end of 2023 to a level about flat with today’s.

2. Stay Patient and Collect Income

With both the trajectory of inflation and the overall economic picture still unclear, investors may want to prioritize fixed income in their portfolios. High-quality opportunities currently exist at yields of 4%–6%; overall returns could be higher if the economy slows more or tips into recession.

Two areas to consider:

  • Two-year Treasuries are yielding greater than 4%, while longer-term Treasuries, such as the 10-year and 30-year, are yielding in the high-3% range.
  • Investment-grade corporate bonds are offering more than 5%, which could be a smart choice for investors open to a bit of credit risk while staying focused on higher quality.

There’s also the potential for capital appreciation in fixed income.  A slowing economy could prompt investors to seek out “safe haven” assets, including U.S. Treasuries and other higher-rated bonds, driving prices higher.

3. Look to Emerging Markets

U.S. stocks have long dominated investor allocations, but it may be time to consider selectively owning emerging markets (EM) stocks. A few reasons:

  • EM stocks are trading cheaply relative to their own history and to developed market equities, exhibiting lower cyclically adjusted price-to-earnings ratios.
  • Key headwinds to EM regions are likely to abate. The U.S. dollar, for instance, has come off recent highs and could weaken through 2023, allowing EM economies to benefit.
  • China, which accounts for nearly a third of the MSCI Emerging Markets Index and plays an outsized role in determining investor flows to EM overall, could see economic prospects improve by spring 2023, as the country starts to loosen its zero-COVID controls. Moreover, since it’s not experiencing high inflation or rising interest rates, China has a significant runway for stimulus—a policy lever it will likely pull in 2023 to support the residential housing market. Last, China’s growth prospects could have positive spillover effects for other economies in Asia and Latin America in 2023 in areas like exports and tourism.

All told, we encourage investors to be patient. Uncertainty around the economy and markets remain high, and investors should demand a premium for taking risk. Be open to rebalancing portfolios as inflation and interest rates normalize. 

Connect with your Morgan Stanley Financial Advisor about how our 2023 outlook for the economy and market forces may shape your investment decisions in the year ahead.  

Risk Considerations

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision. 

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Rebalancing does not protect against a loss in declining financial markets.  There may be a potential tax implication with a rebalancing strategy.  Investors should consult with their tax advisor before implementing such a strategy.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.  Technology stocks may be especially volatile.

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.

Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention.

Certain securities referred to in this material may not have been registered under the U.S. Securities Act of 1933, as amended, and, if not, may not be offered or sold absent an exemption therefrom.  Recipients are required to comply with any legal or contractual restrictions on their purchase, holding, and sale, exercise of rights or performance of obligations under any securities/instruments transaction.

The returns on a portfolio consisting primarily of environmental, social, and governance-aware investments (ESG) may be lower or higher than a portfolio that is more diversified or where decisions are based solely on investment considerations. Because ESG criteria exclude some investments, investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria. The companies identified and investment examples are for illustrative purposes only and should not be deemed a recommendation to purchase, hold or sell any securities or investment products. They are intended to demonstrate the approaches taken by managers who focus on ESG criteria in their investment strategy. There can be no guarantee that a client's account will be managed as described herein.

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