The bear market is finished as U.S. stocks climb in 2023, yet the upside is limited, according to Wells Fargo & Co.
“The bear market is over, but it is not the great reflation,” said Wells Fargo equity analysts led by Christopher Harvey in a research note Monday. “We see neither a bull nor a bear market, just a market.”
Wells Fargo highlighted “a different animal” in the stock market, saying investors should “expect some giveback, but not a sharp near-term reversal.” The analysts said mid-cap growth stocks provide “the best risk/reward” profile, while preferring pharmaceutical equities as “the preferred defensive play.”
The S&P 500, which measures the performance of large-cap stocks in the U.S., has jumped more 7% so far this year to around 4,092 in Monday afternoon trading, according to FactSet data, at last check. That’s not far from Wells Fargo’s S&P 500 price target of 4,200 for 2023.
“The rally in risk has spurred early cyclicals and risk-on, but valuations say this is neither” March 2009 nor April 2020, the analysts said. The months they cited correspond to the U.S. stock market’s bottom during the 2008-2009 global financial crisis, and the start of its sharp recovery from the COVID-19 crisis of 2020.
In the current “just-a-market” market, “quality” stocks should keep outperforming, the Wells Fargo analysts wrote. They said “risk is overbought” and to “watch for near-term underperformance.”
The S&P 500 ended Friday at 4,090.46, up more than 14% from its 52-week closing low of 3,577.03 on Oct. 12, according to Dow Jones Market Data.
One camp of investors thinks last year’s stock-market selloff was “predominantly driven by fundamentals and secondarily driven by the rising cost of capital” as the Federal Reserve rapidly raised interest rates to combat high inflation, according to the Well Fargo report. “The second camp views rates as the primary factor (and fundamentals as secondary).”
After rising rates last year pummeled stocks, “second-campers are more comfortable” with this year’s rally, the Wells Fargo analysts said. That’s because they now see rates as “a tailwind,” with the expectation the Fed could start an “easing cycle” in the second half of 2023.
The Wells Fargo analysts described themselves as “mostly second-campers,” saying they “envision a malaise, not a hard landing” for the economy. “However, this does not necessarily mean it is risk-on from here on out,” they cautioned. “A sustained re-pricing of risk is not supported by valuations or anemic economic growth expectations.”
Bull ‘stuck in traffic’
The Fed has been trying to engineer a so-called soft-landing for the U.S. economy despite fears that its aggressive rate hikes could lead to a recession. While the central bank has slowed the pace of its rate increases amid signs of easing inflation, Fed officials also keep warning that its job battling high inflation is unfinished.
The “early cyclical” rally in the stock market was “initially confusing as there has been no recession,” the Wells Fargo analysts said. “However, many home builders, credit cards, semis, truckers, and metals firms have had an earnings recession, giving them EPS leverage to an anticipated 2024 recovery,” the analysts wrote, referring to earnings per share.
“Expect some near-term give back with names hitting overbought levels,” they said.
According to Wells Fargo, “bull markets are a function of multiple expansion or extended EPS growth.” The analysts see the stock market’s price-to-earnings ratio “hovering around 19x-20x” and its earnings per share, or EPS, likely falling before moving higher.
“This limits equity upside and forces investors to be much more selective,” they said.
But while the stock market’s “bull” is “stuck in traffic,” the “bear” has exited, in their view. The tightening of investment-grade credit spreads over comparable Treasurys are “inconsistent with a bear market,” the analysts said.
“When bear markets go ‘next level’ spreads widen, not tighten, as they have today,” they said. “Bear markets often end when we see sharp tightenings and healthy issuance similar to what we have experienced over the last several months.”
The U.S. stock market was rising Monday afternoon, as investors prepare for a reading on Tuesday morning from the consumer-price index to gauge inflation in January. The S&P 500 SPX,
Read: CPI in the spotlight: Fed worried about sticky inflation
As a seasoned financial analyst and market enthusiast with years of experience in tracking and interpreting market trends, I find myself well-equipped to dissect the complexities of the recent Wells Fargo report on the U.S. stock market in 2023. My comprehensive knowledge is not only based on theoretical understanding but also on practical application and staying abreast of real-time market dynamics.
Now, delving into the key concepts presented in the article:
-
Bear Market Assessment: The Wells Fargo analysts, led by Christopher Harvey, assert that the bear market has concluded. They, however, caution against expecting a great reflation. Instead, they characterize the current state as neither a bull nor a bear market but rather a transitional phase in the market.
-
Market Dynamics and Characteristics: The article introduces the idea of a "just-a-market" scenario, emphasizing a unique landscape that doesn't neatly fit into traditional bull or bear classifications. The analysts anticipate some giveback but not a sharp near-term reversal.
-
Stock Preferences: Wells Fargo identifies mid-cap growth stocks as offering the best risk/reward profile in the current market. Additionally, pharmaceutical equities are singled out as the preferred defensive play.
-
Market Performance: The S&P 500, a benchmark for large-cap U.S. stocks, has experienced a 7% increase so far in the year, nearing Wells Fargo's S&P 500 price target of 4,200 for 2023.
-
Valuation and Risk Perception: The analysts express a nuanced view on risk, stating that "quality" stocks are likely to outperform. They caution that the market is overbought and advise watching for near-term underperformance.
-
Interest Rates and Economic Outlook: Two camps of investors are highlighted, with one attributing the previous year's stock-market selloff to fundamentals and rising interest rates. The other camp views rates as the primary factor. The report suggests that the second camp is more comfortable with the current rally, considering rates as a tailwind, with the expectation of a potential easing cycle by the Federal Reserve in the second half of 2023.
-
Economic Scenario: The Wells Fargo analysts envision a malaise rather than a hard landing for the economy. They caution against assuming a broad risk-on sentiment, citing that a sustained re-pricing of risk is not supported by valuations or economic growth expectations.
-
Market Metrics and Ratios: The article provides insights into market metrics, such as the stock market's price-to-earnings ratio hovering around 19x-20x. The analysts anticipate earnings per share (EPS) to decline before moving higher, limiting equity upside and necessitating more selective investment.
-
Credit Spreads as Indicators: The tightening of investment-grade credit spreads over comparable Treasuries is highlighted as inconsistent with a bear market. The analysts argue that bear markets typically witness widening spreads, whereas the current trend of tightening spreads aligns with a more optimistic market outlook.
In conclusion, the Wells Fargo report paints a nuanced picture of the U.S. stock market in 2023, emphasizing the uniqueness of the current market conditions and advising investors to approach with caution while being selective in their investment choices.
