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Even after bouncing off their October lows, stocks were down big in 2022 – and market watchers expect more of the same in 2023, at least at the start. With the Federal Reserve set to continue raising interest rates and the U.S. economy yet to start a much-expected recession, investors are sitting on a lot of uncertainty, and that should fuel volatility in 2023, say experts.
“Two-in-three economists are forecasting a recession in 2023, yet corporate earnings estimates haven’t come down to reflect that,” says Greg McBride, CFA, chief financial analyst, Bankrate. “If the economy continues to slow and quarterly earnings calls in January reveal a dour outlook for the year, corporate earnings estimates will be marked down and the market could have a renewed tumble.”
While the market as a whole may tumble in 2023, some sectors may be poised to outperform amid a downturn. Higher rates have hurt growth stocks, but many value stocks have performed well, or at least not nearly as poorly. And that’s one area to watch in 2023, say experts.
Here’s what investors should expect in 2023 – and how they should invest to thrive in 2023, according to market analysts.
Keep watching interest rates – and look for signs of a recession
A key area for investors to watch in 2023 is interest rates, as the Federal Reserve has indicated that it may slow or stop rate hikes, likely in the first few months – a marked shift in policy.
“The tightening of monetary policies will dictate the course of the market, which again will be dependent on how fast inflation cools in the coming year,” says Kunal Sawhney, CEO of Kalkine Group, an independent provider of stock research.
The year 2022 saw an unprecedented pace of rate hikes to combat multi-decade highs in inflation. While the Fed funds rate began 2022 at a target range of 0 – 0.25 percent, it closed the year at 4.25 – 4.5 percent, after seven consecutive Fed rate hikes, including a period of four straight meetings where the central bank boosted rates 75 basis points. In addition, the Fed has rapidly drained liquidity from the financial system by running off its bond portfolio.
Those moves have led to falling stock and bond markets, so investors looking for the turn in markets need to keep a close eye on the Fed.
“2021 was a bull market driven by Fed liquidity. 2022 was a bear market driven by Fed liquidity,” says David Keller, chief market strategist at StockCharts.com. “‘Don’t fight the Fed’ will continue to be good advice in 2023, with the first half of the year likely weaker based on the Fed’s ongoing efforts to fight inflation.”
That rapid rise in interest rates has led many analysts to expect a recession in 2023.
“There is an ongoing obsession with the word recession that’s floating across the minds of investors today,” says Dan Raju, CEO of Tradier, a brokerage platform. “The Fed’s obsession with recession will likely result in more interest rate hikes in the first quarter of 2023, which means that we are going to have continued volatility in the financial markets.”
So as long as inflation remains elevated, expect the Fed to continue raising interest rates. Only when we see a turn in the Fed’s posture may the market start to see a bottom, say experts.
Beyond the Fed and rising rates, Raju also points to broader geopolitical concerns, such as events in Ukraine, and weakening economic data in China.
“Retail investors must remember there’s still a lot of uncertainty out there right now,” he says.
Which types of stocks could outperform in 2023?
Despite the decline in markets in 2022, investors are looking ahead, and many see a relatively attractive climate if investors can think long term rather than be caught up in the moment. Individual pockets of the market could do well despite the larger economic malaise and could set up investors, as opposed to short-term traders, for years to come.
But until the Fed relents on raising interest rates, it could be more of what drove 2022’s market.
“This year saw growth stocks, tech stocks, and cryptocurrencies take a beating,” says Sawhney. He expects 2023 to “progress on a similar path until recovery begins.”
It’s important to not let the financial media and short-term news distract you from the long-term opportunities, says Josh Answers, host of the Trading Fraternity channel on YouTube. “Look at fundamentals and stick with what you know and have researched,” he says. “The news outlets are always late to the party, so do your homework and anticipate moves in the market.”
And with the economy weakening, it could be a good time to stay away from retail and leisure companies, which are sensitive to economic cycles, says Mina Tadrus, CEO of Tadrus Capital, a high-frequency-trading hedge fund. “The pandemic has already had a significant impact on these sectors, and a potential recession could further hurt their performance,” he says.
Here are a few areas where investors could see opportunities in the year ahead.
“Maybe the market has further to fall and maybe it doesn’t, but the prolonged sale on quality assets is irresistible,” says McBride.
And the focus here is on quality companies, those which might not only survive a recession but actually thrive, by extending their competitive advantages. In contrast, weaker or heavily indebted companies may falter as economic conditions worsen.
“Stay focused on long-term strategies that seek to capitalize on innovative and growing businesses that are aiding the digital transformation of all enterprises,” says Gerry Frigon, president and CFO, Taylor Frigon Capital Management.
Value stocks are another notable area that should outperform, as they have during rising rates or during a falling market.
“Investors are so used to growth stocks outperforming value, but 2022 provided a strong lesson on which stocks and sectors tend to thrive in a rising interest rate environment,” says Keller.
He expects bond yields to continue to rise from here, meaning that value stocks could continue to outperform.
“We don’t feel that the 10-year Treasury yield has seen its peak yet for the cycle, and that should lead to ongoing strength in value stocks over growth stocks,” says Keller. “Investors have not seen this sort of environment for decades.”
Tech stocks have been some of the hardest-hit stocks in the market, with even bellwethers such as Amazon down more than 50 percent from its all-time highs. The tech-heavy Nasdaq is down more than 30 percent from its 52-week high, and its most significant components such as Apple and Microsoft have fallen well below their yearly high watermarks. But such declines provide opportunities moving forward.
“Software is likely to fare well once the rate hikes have subsided and the long-anticipated ‘recession’ either happens or not,” says Frigon. “One is hard-pressed to find a space that has better growth currently, or in the future than in that space.”
Keller agrees: “If and when a market bottom emerges in the first half of 2023, we’d be looking to technology as a fantastic long-term opportunity, given the heavy drawdowns since late 2021.”
Tadrus also thinks tech stocks may do well in 2023, after having been a long-term winner over the last decade. He also thinks healthcare and utilities may perform well, because they “tend to be relatively stable and are less vulnerable to economic downturns.”
Small-cap stocks are usually some of the first stocks to be hit when investors catch a whiff of recession. Their smaller size and lower financial wherewithal make them a riskier proposition, compared to large-caps. But it’s important to look at opportunities here carefully since small stocks have the potential to grow at higher rates and deliver better returns for investors.
“Most investors are letting the pessimism of the moment get in the way of recognizing excellent value that exists in many small to midsize companies,” says Frigon.
Picking a few good small-caps could lead to outsize returns for years to come.
How should investors navigate a potentially rocky 2023?
Many investors see the first six or nine months of the year – and a concurrent recession – as a slow period that sets up investors for better returns later in the year.
“We feel that going into the fall, the stage will be set for a strong recovery from the 2022-2023 cyclical bear market,” says Keller.
But even if that stock recovery slips into 2024, a down market simply provides more time for long-term investors to make their investments at lower prices.
“Most experienced investors find opportunities to build wealth for the long term during bear markets,” says Raju.
Here’s how experts say to navigate the market in 2023.
Think long term
Investors must look past the doom and gloom of today and realize that today’s lower prices are likely to be seen as good bargains in just a few years.
“This is a great time to be investing as valuations have come down to more reasonable levels,” says McBride.
While the market may be rocky in the short term, even over the entire course of 2023, investors who are thinking three to five years out should be amply rewarded over time.
Go slow and steady
“The best way to invest in this type of market is with a small sum of money,” says Josh Answers.
Fortunes are built over time, so investors should stay disciplined. For many investors, this discipline involves adding money to the market regularly using a process called dollar-cost averaging, which helps you avoid the risk of putting all your chips on the table at the wrong time.
“The stock market has been down 15-20 percent for months on end, so for investors who are dollar-cost averaging, you’re continuing to effectively buy $1 bills for 80-85 cents,” says McBride.
By investing regularly, you can avoid buying at too high a price but you also keep your focus on adding to your investments when they’re lower, setting up better returns for years to come.
“Many people are scared right now due to the volatility, but that shouldn’t scare you if you are investing small and frequently,” says Josh Answers. “Slowly and frequently, one time a month, has kept us alive in this market.”
You can’t get the market’s long-term returns unless you remain invested, but that’s exactly what is toughest to do when stocks have fallen. Nevertheless, it’s vital to stay invested.
“You want to remain fully invested and maintain your regular investments because at some point this market will begin to rebound and that tends to happen when the headlines are still pretty ugly,” says McBride. “You want to be on the train, and not on the platform, when it pulls out of the station.”
One way to help you stay invested is to take a passive investing approach, helping to take your emotions out of the game. Set up your account to buy stock or index funds on a regular basis and then don’t even look at the market.
“As a proponent of set-and-forget passive investing strategies, fears of bubbles and recessions do not cause alarm,” says James Beckett, a financial coach and writer for the personal finance website TinyHigh.com. “Market-timing simply is not part of the passive-investing philosophy.”
Many market watchers are expecting 2023 to be a rough time, with plenty of volatility. But whether it ends up being easier or tougher, investors have some proven long-term investing strategies that can help them weather that market. And even if 2023 ends up being another tough year for investors, it likely sets up a stronger rebound for the following year, meaning now is the perfect time to get even more invested at lower prices in anticipation of the bounce back.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.