So far, 2023 has confounded economists, humbled forecasters, and rewarded investors. Despite a rapid rise in interest rates, the U.S. economy continues to grow. Inflation has fallen\u2014if not quite to desired levels\u2014and stocks have entered a bull market, with the
\n S&P 500
\n gaining 17% year to date and the
\n Nasdaq Composite
\n up more than 30%.<\/p>\n
Neither the economy\u2019s resilience nor the market\u2019s strength seemed obvious, or even likely, at the end of 2022, a year that saw the Federal Reserve raise interest rates by more than four percentage points to combat soaring inflation, and the S&P 500 fall by 19%. Yet, the skies have been mostly sunny this year over Wall Street and Main Street alike, and the forecast for fall is more of the same, although with a bit more haze.<\/p>\n
Wall Street\u2019s top strategists are divided on the near-term outlook for stocks, which depends in large part on the economy\u2019s future course\u2014and the Fed. The most bullish case for financial markets is the Goldilocks case, or \u201cjust right\u201d conditions, including an orderly retreat in inflation and a steady economy that keeps consumers spending and enables corporate profit growth.<\/p>\n
For the optimists, a recession this year is no longer in the cards. \u201cEverything has been pushed out from a macroeconomic perspective,\u201d says Anders Persson, chief investment officer of global fixed income at Nuveen. \u201cThe economy is holding up better than expected. The consumer is stronger than expected.\u201d<\/p>\n
If inflation continues to slow, as it did in the past year, that would mean the Federal Reserve\u2019s job is nearly done. A likely end to rising interest rates would be good news for stocks, paving the way for this year\u2019s narrow, tech-focused rally to broaden. It would also allow bond prices to appreciate some. (Bond prices move inversely to yields.)<\/p>\n
\u201cWe\u2019re going to have a pretty good economy going into next year,\u201d says Ed Yardeni, president of Yardeni Research. \u201cThe stock market is already looking into 2024 and discounting a better year, with less hysteria over an imminent recession.\u201d<\/p>\n
With continued disinflation, \u201cthe Fed\u2019s next move [for interest rates] might very well be lower,\u201d he says.<\/p>\n
The bearish case also rests on a good economy\u2014too good, that is. Recent data suggest that economic growth is accelerating, which implies stickier inflation than many had hoped. As a consequence, the Fed might need to tighten monetary policy further to restore price stability, rather than loosening it next year, the pessimists say.<\/p>\n
\u201cMy guess\u2014and I emphasize the word \u2018guess\u2019\u2014is that the economy will be stronger than people think,\u201d says Richard Bernstein, CEO and chief investment officer of Richard Bernstein Advisors. \u201cThat will force the Fed to continue to raise rates.\u201d<\/p>\n
Another worry is that the central bank will go overboard in attempting to vanquish inflation, raising interest rates to a level that pushes the economy into a recession. In that case, bond yields would rise, profit growth would diminish, and equity valuations would fall. Excessive tightening is \u201cour No. 1 concern right now,\u201d Persson says.<\/p>\n
Worse, fiscal and monetary policy both could be hampered in ways that might prolong a potential downturn. \u201cThe Fed can\u2019t really cut rates as aggressively as it has historically, given the inflation problem,\u201d says Mike Wilson, CIO and chief U.S. equity strategist at The economy and the markets also could chart a middle course as 2023 segues into \u201924, wherein the economy stagnates but doesn\u2019t crash; inflation diminishes but remains above the Fed\u2019s 2% target; and markets trade sideways for a while, as they have done for much of the summer. This seems the most likely course to Gargi Chaudhuri, head of iShares investment strategy for the Americas at \u201cModeration is the key word for the fall, both for the economy and inflation,\u201d says Chaudhuri. \u201cThere are data points that suggest the potential for extreme moves on either side\u2014an extreme recession or a sudden jump in growth\u2014but I expect things will simply continue to moderate.\u201d<\/p>\n As has been the case for the past few years, the Fed\u2019s actions\u2014or lack thereof\u2014will heavily influence investors\u2019 behavior. Fed Chair Jerome Powell is loath to repeat the monetary-policy mistakes of the 1970s, when Fed officials gave up their inflation fight too quickly, allowing price growth to reaccelerate. That necessitated another, even more aggressive tightening cycle, which took the federal-funds rate up to 20% in 1980.<\/p>\n Today\u2019s fed-funds target range of 5.25% to 5.50% is far below that historic peak. But it is far above the near-zero rates that prevailed through much of the Covid pandemic. In Wall Street parlance, rates are likely to stay \u201chigher for longer\u201d as the Fed maintains its vigilance.<\/p>\n Most of the market strategists and chief investment officers whom Barron\u2019s<\/em> canvassed don\u2019t expect the Fed to lift rates again in the current cycle, while a few are penciling in just one more quarter-percentage-point increase by year end.\u00a0<\/p>\n Pricing in the futures market assigns roughly 50\/50 odds to another rate hike before year end, according to the CME FedWatch Tool.<\/p>\n That\u2019s the \u201chigher\u201d part. How much \u201clonger\u201d the benchmark rate will remain at today\u2019s level is an open question, as Powell strongly suggested in his Jackson Hole speech on Aug. 25.<\/p>\n Much will depend on the course of inflation. If price growth continues to trend lower, monetary policy will tighten without the Fed\u2019s further intervention, as the real rate of interest\u2014the nominal rate minus the inflation rate\u2014will rise. Even in the absence of a recession, the central bank might choose to cut interest rates in a falling-inflation scenario to maintain its policy stance at a consistently restrictive level, as laid out by New York Fed president John Williams in recent remarks.<\/p>\n Bond yields could decline modestly by year end, should investors see continued progress in taming inflation\u2014and should the Fed indicate it has finished raising rates. Persson expects the A harder economic landing in 2024, with more rate cuts, could result in an even bigger rally in Treasury prices, although a recession would hamper stocks.<\/p>\n Persson notes that bond prices historically have risen during the first three months after the Fed has finished raising rates in a cycle. In the meantime, he\u2019s more excited about the fat yields on offer these days. \u201cThe vast majority of fixed-income returns come from the income generation,\u201d he says. \u201cNot very much ultimately comes from capital appreciation, [which requires] timing the market.\u201d<\/p>\n Less-risky securities such as U.S. Treasuries represent good value today, with attractive yields that investors can clip while the bonds mature. Persson stresses the importance of diversification across different categories of fixed income, given the uncertain rate outlook. Nuveen Strategic Income (ticker: FCBYX), holds corporate bonds, government debt, mortgage-backed securities, and more, he notes. The fund has an effective duration of 5.3 years, an average credit rating of triple-B-minus, and a yield of 5.9%.<\/p>\n Bernstein\u2019s firm has a neutral-duration allocation to Treasuries, with holdings in both short- and long-term securities.\u00a0<\/p>\n Chaudhuri prefers the belly of the Treasury yield curve, the focus of Ten-year Treasury inflation-protected securities, or TIPS, sport their highest payout in 15 years: a 2% real yield. TIPS will outperform nominal bonds if inflation reignites. \u201cI like to call them Totally Irreplaceable Portfolio Solutions,\u201d Chaudhuri says. \u201cOwning a 2% real rate in your portfolio is an incredible opportunity for investors.\u201d<\/p>\n Falling inflation might be good for bond prices and stock market multiples, but it is a potential headwind to earnings growth, Morgan Stanley\u2019s Wilson says. It will mean less pricing power and tighter profit margins for more companies. That\u2019s just what Wilson forecasts; he expects S&P 500 companies to earn $185 this year, well below industry analysts\u2019 consensus estimate of $220.<\/p>\n Wilson recommends overweight positions in healthcare and utilities. Healthcare stocks are \u201cquality defensives,\u201d he says, with relatively cheap valuations. The companies have decent growth and balance sheets, and little cyclical exposure. Utilities are defensive, as well, and tend to be the last sector to stumble in a market downturn. The Wilson is bearish on pricey technology and consumer discretionary stocks, and expects the S&P 500 to decline this fall, given the stocks\u2019 large combined weighting in the index. He has a year-end target of 3900, implying a drop of more than 10% from recent levels.<\/p>\n Christopher Harvey, Later this year, however, he expects bond yields to fall again and stocks to rebound, led by the biggest companies on the market. Harvey looks for the S&P 500 to trade in a range of 4200 to 4600 for the rest of the year, and end 2023 at 4420.\u00a0<\/p>\n Harvey expects to see growing concern about the economic outlook for 2024 as the fall progresses. That\u2019s a negative for cyclical stocks\u2019 earnings but could prompt the market to price in Fed cuts next year, bringing down bond yields and helping growth stocks. The result might be a buy-what-you-know rush back into the market\u2019s biggest, most successful, and theoretically most stable companies.<\/p>\n \u201cFor the top 50 companies in the The market\u2019s largest tech stocks have rallied this year on growing investor enthusiasm for AI technology and applications.<\/p>\n Yardeni has a year-end target of 4600 for the S&P 500, and likewise expects megacap stocks to lead. \u201cIt\u2019s pretty hard to knock those stocks down,\u201d he says. \u201cEvery time they take a dive, it turns out to be a buying opportunity. People are consistently willing to pay a high multiple for those stocks.\u201d<\/p>\n Bernstein takes the opposite view, noting that stocks such as Bernstein expects investors to pare their megacap holdings and redeploy the proceeds into other corners of the market this fall. \u201cI don\u2019t believe that there are seven growth stories in the entire world,\u201d he says. \u201cThat is such a bearish view of the U.S. economy [and] the global economy. It does, however, make me excited about all the other overlooked opportunities out there.\u201d<\/p>\n Specifically, he has been increasing his firm\u2019s exposure to small-cap stocks, as he expects inflation to stay above 2% on an annualized basis, providing a tailwind to earnings growth. Small-cap indexes have a greater weighting than large-cap indexes in economically cyclical companies, and cheaper valuations than large-caps, characteristics that will give them the upper hand, he says.<\/p>\n Harvey likes mid-cap growth stocks, which also sport relatively cheap valuations and solid growth prospects and are positioned positively from a technical perspective. The risk\/reward ratio is in the group\u2019s favor, he says, with the potential for price\/earnings multiples to expand and fundamentals to improve. More merger-and-acquisition activity would also favor midsize growth stocks, he says. The BlackRock\u2019s Chaudhuri assesses stocks through a factor lens, stressing quality characteristics that include strong balance sheets and stable earnings growth. Quality stocks, thus defined, could win in multiple macro and market environments, if not lead the market, she says. Chaudhuri recommends the The S&P 500 isn\u2019t grossly overvalued today, at 19 times estimated earnings for the coming year, but nor is it pricing in an adverse economic outcome. It is expensive relative to bonds: Yields on U.S. Treasuries are above their October 2022 highs, back when the index was around 3600 points.<\/p>\n \u201cTypically, this is the way it is when we\u2019re late in the cycle,\u201d Wilson says. \u201cIn the absence of hard evidence, people\u2019s views are dictated by price action. The fact that [stocks have] rallied so much has emboldened the view that a soft landing is more likely.\u201d<\/p>\n Recent price action suggests that stocks will preserve most of their gains for the year, although the market might not trade much higher. Next year will bring fresh challenges\u2014it\u2019s an election year, after all\u2014and the bill may come due for the economy after nearly two years of rate hikes.<\/p>\n Stick with quality stocks and a diversified bond portfolio, and look for bargains in cheaper parts of the market. Enjoy what\u2019s left of the sunshine, while it lasts.<\/p>\n Write to Nicholas Jasinski at nicholas.jasinski@barrons.com<\/p>\n<\/p><\/div>\n
\n Morgan Stanley.<\/span>
\n \u201cOn the fiscal side, it is already unprecedented to have a federal deficit of 8% [of GDP] when the unemployment rate is at 3.5%.\u201d<\/p>\n
\n BlackRock,<\/span>
\n and she isn\u2019t alone.\u00a0<\/p>\n
\n 10-year U.S. Treasury note
\n yield to finish 2023 with a yield between 3.75% and 4.00%, down by as much as half a percentage point from recent levels.<\/p>\n
\n iShares 3-7 Year Treasury Bond
\n exchange-traded fund (IEI). It has an effective duration of 4.4 years and yields 4.3%.<\/p>\n
\n Health Care Select Sector SPDR
\n ETF (XLV) and the
\n Utilities Select Sector SPDR
\n ETF (XLU) are investment plays on these sectors.<\/p>\n
\n Wells Fargo\u2019s<\/span>
\n head of equity strategy, thinks stocks may hit a rough patch in the near term. Bond yields could rise more in the coming weeks as Fed expectations continue to shift, he says. Plus, September historically has been a seasonally weaker period for the stock market.\u00a0<\/p>\n
\n Russell 1000,<\/span>
\n you\u2019re paying only a 10% premium [over the rest of the index] for better earnings, stable growth, relatively low risk, and stronger balance sheets\u2014and with an artificial-intelligence kicker,\u201d Harvey says. \u201cFor an extra 10%, that\u2019s an attractive list of things to have.\u201d<\/p>\n
\n Nvidia
\n (NVDA),
\n Meta Platforms
\n (META),
\n Tesla
\n (TSLA), and
\n Amazon.com
\n (AMZN) each are up at least 60% year to date. Just seven stocks have contributed about 70% of the S&P 500\u2019s rise in 2023.<\/p>\n
\n Vanguard Mid-Cap Growth
\n ETF (VOT) provides exposure to the group.<\/p>\n
\n iShares MSCI USA Quality Factor
\n ETF (QUAL), which counts Nvidia,
\n Apple
\n (AAPL),
\n Visa
\n (V),
\n Nike
\n (NKE), and
\n ConocoPhillips
\n (COP) among its top holdings. The fund has returned 22% this year.<\/p>\n