It’s official, 2022 has been the worst year for the S&P 500 in more than a decade.
The index is on track to close out the year down more than 17%. That’s the S&P 500’s first double-digit percentage annual loss since the Great Recession, when the index slid 38.4% in 2008.
But if you take the long-term view, years like these are aberrations—and they can also be excellent long-term buying opportunities.
To put it into perspective, the S&P 500 hasn’t seen back-to-back down years since the bursting of the dot-com bubble in 2001 and 2002. The index has typically delivered an average annual gain of 9% since 1996.
Unfortunately, the dual headwinds of high inflation and Federal Reserve interest rate hikes won’t be going away in the near term. But if the Fed manages to get inflation under control and navigate a soft landing for the U.S. economy, analysts say 2023 could be a much better year.
2023 Outlook for Stocks
Higher interest rates are bad news for stock prices. They increase the cost of capital, which discourages companies from borrowing and investing to expand their businesses.
The bad news for investors is that earnings growth tends to stagnate. There’s also a negative impact on discounted cash flow valuations, which can hurt high-growth stocks.
Growth Stocks
It’s been a tough year for stock prices across the board in 2022, but rising rates have been particularly hard on growth stocks. In fact, the Vanguard Growth ETF (VUG) has significantly underperformed the S&P 500, generating a -27.8% total return year to date.
Since 2000, growth stocks have outperformed value stocks by a wide margin overall. But growth stocks underperformed value stocks from 2003 to 2007, another period of sharp interest rate increases.
Value Stocks
While growth in stock valuations has tumbled in 2022, value stocks have held up relatively well. In fact, the Vanguard Value ETF (VTV) has generated a total return of just -1.7% year to date.
As far as investors are concerned about market volatility, geopolitical and economic uncertainty, and rising interest rates, they will likely continue to seek relative safety in value stocks.
Thomas Shipp, quantitative equity analyst for LPL Financial, says value stocks will likely continue to outperform until interest rates fall significantly from current levels.
“A slower pace of smaller rate hikes, and ultimately a pause in the hiking cycle, will be headwinds to value’s relative performance,” Shipp says. “But until there is a clear path that inflation is sustainably headed toward the Fed’s 2% long-term target, value has a good chance to outperform growth.”
Shipp notes that LPL’s Strategic & Tactical Asset Allocation Committee continues to tilt toward value from an asset allocation perspective.
Stock Market Sectors
Elevated inflation and rising interest rates have hit some stock market sectors harder than others.
Global energy shortages linked to the Russo-Ukrainian war have helped the energy sector post record gains. The S&P 500 Energy sector is up 70.3% in 2022, and it’s the only market sector that has generated positive year-to-date gains.
In addition, defensive market sectors that have relatively stable earnings outlooks—consumer staples, utilities and health care—are all down less than 6% on the year.
Darren Colananni, wealth management advisor at Centurion Wealth Management, says the S&P 500 may struggle in gaining much traction in 2023 as interest rates remain high. Colananni’s year-end 2023 S&P 500 price target is only 3,700, around 7% below current levels.
Colananni says investors should focus on sectors that have the most projected earnings growth in 2023. In particular, he is bullish on consumer discretionary stocks and industrials.
“For consumer discretionary, we are thinking of companies like Starbucks, McDonald’s, Amazon, and Disney. For industrials, we are thinking of companies like 3M, FedEx, and Waste Management,” Colananni says.
Wells Fargo anticipates a weak economy in the first half of 2023. Samana prefers the earnings power of energy stocks, tech and health care.
“These companies have strong quality and profitability characteristics that should help them weather rising rates and the recession we see in the first half of next year,” he says.
While recession can be a scary word for investors, Wells Fargo sees a light at the end of the tunnel in the second half of 2023. The firm’s year-end S&P 500 price target is 4,300 to 4,500, implying roughly a 10% upside from current levels.
