Stock Market Forecast 2023: Challenges Abound For Dow Jones, But Stock Pickers Can Shine

The stock market is coming off a punishing year that brought eye-watering losses for investors. As we head into 2023, uncertainty hangs in the air.


With factors including Federal Reserve interest-rate tightening, the Russia-Ukraine war and recession fears, you can expect choppy trading in the stock market forecast for 2023.

Yet this period of uncertainty offers opportunity. One of the rules of Wall Street is there is always a bull market somewhere. Clever stock pickers hold a chance to outperform in a meaningful way as the overall market toils.

Most stock market forecasts for 2023 see moderate improvement. UBS targets a year-end 2023 S&P 500 at 3900 and KKR sees it at 4150. CFRA expects a 2.9% gain, which would put the S&P over 3900. It closed the year around 3840.

With so much uncertainty about the new year, a cautious outlook seems prudent. Long-term trends and investing norms are shifting. Investors must watch carefully for sector changes and make smart stock picks.

Some analysts see value stocks outpacing growth stocks, as big tech stocks continue to seek new footing. Other experts’ 2023 stock market predictions call for strength in infrastructure stocks and opportunities to profit from mergers and acquisitions.

Will The Market Recover In 2023?

S&P 500 annual performance chartInvestors suffered a beatdown in 2022, with all three major indexes making their biggest declines since the 2008 financial crisis. The Dow Jones Industrial Average fared the best, down 8.8% thanks to its relative underexposure to badly beaten technology stocks. The tech-heavy Nasdaq composite endured an ugly fall of more than 33%, while the S&P 500 sank 19.5%.

The year was even more challenging for growth stock investors. The Innovator IBD 50 ETF slumped around 50%, while the IBD Sector Leaders  plummeted a devastating 60%. In 2022, the “big is beautiful” theme was underlined by the IBD Big Cap 20 falling less than 7%.

The whippy action caused the IBD stock market outlook to switch from “confirmed uptrend” to “uptrend under pressure” and to “correction” several times in 2022. Investors who followed IBD’s principles could have limited their losses in comparison to the indexes by following sell rules and paying close attention to the current market outlook to avoid overexposure.

Factors Driving Heavy Pullbacks

A number of factors drove the heavy pullbacks. Inflation and the Russian invasion of Ukraine dealt a devastating one-two blow for equity markets. The Federal Reserve then pivoted from its stance that inflation was transitory and began aggressively raising rates in an attempt to tame prices. These efforts now appear to be bearing fruit, but only after hammering markets lower.

Even is bad year, dozens of stocks more than doubled. Here’s the list.

“Investors are not going to be sad to close the books on 2022, with as difficult a year as it’s been for both equities and fixed income,” said Wells Fargo Investment Institute President Darrell Cronk. “In fact, it’s probably been the most difficult year from a rate of returns standpoint for both those major asset classes in 15-plus years.”

David Ryan, a former hedge fund manager and protege of IBD founder William J. O’Neil, says the widespread carnage has been tough on retail investors and professionals alike.

“It’s probably (been) one of the most difficult markets for most people, especially if you are in the buy-and-hold crowd. There weren’t too many places to hide,” Ryan said.

“So many people are geared toward the 60% in equities, 40% in bonds portfolio, and bonds didn’t really offset the drop in equities as bonds also lost,” he noted. “That combination was a double-whammy for most people.”

Why Is The Stock Market Falling?

Yet there is an argument that the bear market was a necessary evil.

Jenny Harrington, CEO of Gilman Hill Asset Management, believes the 2022 stock market was an important period of normalization for asset valuations.

“When I reflect back, I kind of love 2022,” Harrington said.

“Excesses that never made sense and made me feel like a crazy person are starting to make sense,” she said. “The price of cryptocurrency didn’t make sense, people paying crazy amounts of money for non-fungible tokens didn’t make sense.”

Harrington thinks prices of high-octane “nosebleed valuation” growth stocks had become “totally unhinged.”

“All of those were rationalized. The other thing that was rationalized was the divergence between growth and value stocks, or international and U.S.,” she said. “But these divergences kept getting wider and wider over the past five years until they were way in excess of anything rational in any historical averages.”

Recession Risks In 2023 Stock Market Forecast

A key economic question for the stock market forecast for 2023 is whether the U.S. will enter a recession as the Federal Reserve tries to cool inflation.

At the December Fed meeting, the central bank signaled it would raise its funds rate to a range as high as 5% to 5.25% in 2023.

One key issue is the strength of the labor market. It has held up despite rising rates, and wages have ticked higher even as they fail to keep pace with the overall cost of living.

Wells Fargo’s Cronk points out other factors at play along with the fastest interest rate hikes since 1981.

“It’s also quantitative tightening, the shrinking the balance sheet,” he said. “It’s the trade-weighted U.S. dollar up 12% to 15%, which tightens financial conditions. And it’s the M2 money supply growth dropping from a run rate of 27% during the pandemic down to now negative.”

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Recession In 2023 Could Hit Dow Jones

Cronk believes the economy will go into a recession in the first half of the year. He thinks it would probably end in late summer or early fall.

“But remember, capital markets will be looking nine to 12 months in advance. So we think some of your best buying opportunities or trough levels are likely to come in the first half of (2023). So keep your dry powder ready and be ready to position.”

CFRA Chief Investment Strategist Sam Stovall said the stock market will have a “challenging” first half of the year, as the economy likely succumbs to a “long anticipated, but mild, recession.”

“Whenever we have had inflation above 6% since World War II, we’ve always had a bear market with a recession, and bear markets with recessions traditionally last longer and fall farther than those not associated with recessions,” Stovall said.

Some experts, such as Charles Schwab Chief Investment Strategist Liz Ann Sonders, believe we are already in a “rolling recession” where only certain sectors of the economy are affected at a time.

Stock Market Forecast 2023: Indexes Could Test Lows

Many investors have gotten used to speedy stock market recoveries, which were helped along with generous support from the Federal Reserve. But with the Fed still striking a hawkish tone, a period of market consolidation could be in the cards.

B. Riley Financial Chief Market Strategist Art Hogan says the average correction for a shallow recession is 30% to 35%.

“The market is a forward-pricing mechanism. … It’s a possibility that a good chunk of that bad news has already been priced in,” he said. “Oftentimes by the time the NBER (National Bureau of Economic Research) declares a recession, the market has already moved on and starts moving higher.”

He thinks it is “not impossible” that the market will make new lows but it will take something new to make that happen, such as the Russia-Ukraine conflict escalating or the reopening of China causing an unexpected spike in inflation. This is not his base case for 2023. Rather, he believes a couple tests of the lows could take place.

Wells Fargo’s Cronk says equities could establish a “durable bottom” in the first half of the year before moving higher in the second half as a new market cycle emerges.

But investors would be wise to remember the words of legendary stock picker Sir John Templeton: “Whenever you get a wild excess on the upside, the following correction doesn’t just go back to normal; it almost always falls way below normal.”

2023 Stock Market Predictions For Earnings

With broad belt-tightening, corporate revenue is expected to decline. This both increases the chance of a recession and pressures company earnings.

S&P 500 Consensus Estimates 2023
Sector Earnings Revenue
All S&P 500 companies 5.30% 3.30%
Consumer discretionary 35.80 6.90
Industrials 13.80 4.60
Financials 13.80 8.70
Communication services 10.10 4.40
Utilities 6.80 2.00
Consumer staples 4.20 3.40
Information technology 4.20 3.80
Real estate 2.70 4.70
Health care -3.40 2.80
Materials -8.90 -2.60
Energy -13.10 -7.50
Source: FactSet

Firms could be hit by a double whammy. As sales growth falls, labor and other expenses could remain elevated, pressuring profit margins.

Despite this, the consensus analyst estimate from FactSet currently is for a net profit margin of 12.3% for the S&P 500 in 2023. That would be above the estimated net margin of 12% for 2022 and also higher than the 10-year average annual net profit margin of 10.3%.

But downward revisions are possible, if not likely. As Wall Street analysts cut estimates, stocks could face more downward pressure.

“On Sept. 30, the fourth quarter of this year and the first two quarters of next year were all expected to be positive. Now the fourth quarter of this year and the second quarter of next year are expected to be negative and the first quarter of next year is only expected to be up by 1%,” CFRA’s Stovall said. “This says to me that estimates have been coming down pretty dramatically and we could be heading to an earnings recession, which typically coincides with an economic recession.”

Light is at the end of the tunnel, though. Stock prices look forward and will get a boost if earnings start to rebound toward the end of 2023.

2022 Performance Of Value Stocks Vs. Growth Stocks

Dramatic valuation compression has hit stocks in 2022, but growth stocks took an especially big toll.

SPDR Portfolio S&P 500 Growth ETF (SPYG) has plummeted more than 30% in 2022. This is much worse than the benchmark S&P 500 index.

Value stocks outperformed, with the SPDR Portfolio S&P 500 Value ETF (SPYV) down about 9%.

This trend is seen continuing in 2023, even as the line between value and growth stocks become less distinct with the sharp pullback in growth.

“Value has been performing well this year and I think that’s going to continue, that theme of value stocks,” Ryan said. “There are value indexes on the market and they have been outperforming growth by a large margin. I think that is going to continue, especially in the technology sector. Those super-large-cap tech stocks, I think, are going to have a long time of underperformance. Most of those have been in the growth area.”

2023 Stock Market Forecast For Growth Vs. Value

Gilman Hill’s Harrington warns, though, of dangers in focusing too much on the value space.

“In the same way the pendulum swung too far away from value and into growth, I think it will swing too far in the other direction, though I think there is a little bit of a runway,” she said. “What we’re seeing, which I think is going to continue into 2023, is that investors are flocking to certainty. They are looking for certainty of return and certainty of cash flow.”

She sees parallels between current market conditions and those of the post-dot-com bubble at the turn of the century. She believes growth at a reasonable price (GARP) investing will once again become popular. This was the style made famous by famed Fidelity Magellan Fund manager Peter Lynch.

“Back then, people started talking about the blurred lines between value and growth. I think that’s exactly where we are right now,” Harrington said. “For the past five to 10 years, especially over the past five, there have been two very distinct categories between value and growth. GARP gives managers the ability to have no rigid boundaries, and I think that is where we are at right now.”

2023 Stock Market Forecast For M&A Action

One impact of the current difficult economic environment is a change in merger and acquisition activity. Companies seen as disrupters could get gobbled up by bigger, wealthier players.

“There’s enough disrupters out there that they are either going to make it, and over the next 24 months be in a much better place, or there is a company that is going to look at them and say it’s going to be cheaper to buy them now, and a lot of these companies are going to get taken out,” B. Riley’s Hogan said. “I think we’re going to have some massive M&A activity in 2023.”

He cited the recent move by Adobe (ADBE) to snap up Figma in a deal valued at around $20 billion. The move saw Adobe flex its muscles to take out one of its biggest rivals in digital design.

Cronk believes merger and acquisition activity will likely contract during a recession. But he expects the decline in deal activity to be short-lived, with the pace picking up as the economy pulls out of recession.

One way investors can take advantage of M&A activity is through merger arbitrage. This occurs when you buy stock before an expected M&A transaction takes place. The risk here is that you can be left with painful losses if a deal falls apart.

Should You Invest In The Stock Market In 2023?

Harrington emphasizes the importance for investors not to return to old strategies in the hope of squeezing out performance.

“As I look at it across the broad landscape, many portfolio managers still have their portfolios positioned for the playbook of the past 10 years, and that’s dead,” Harrington said. “You’re not going to make it back the way you lost it. This is really important. If you lost it in Coinbase (COIN), you’re not making it back in Coinbase. If you lost it in Tesla (TSLA), you’re not making it back in Tesla.”

She also says investors must manage their expectations in what figures to be a challenging 2023.

“You’re not likely to see 16% annualized returns for the next several years,” she said. “If you go chasing waterfalls, you’re likely to have a pretty painful experience.”

This echoes the experience of IBD founder O’Neil. In his book “How To Make Money In Stocks,” he writes that “only one of every eight leaders in a bull market reasserts itself as a leader in the next bull market.”

What Should Stock Investors Do In 2023?

A new bull market brings a fresh crop of leaders. But until clarity emerges from the 2023 stock market forecast, it’s shrewd, active investors who are quick on their feet that will enjoy the best returns.

“There will be opportunities, but I think you are going to have to be a much better stock picker,” said Ryan, a three-time U.S. Investing Champion. “Active management will be rewarded much more than just indexing to the major indexes.”

Ryan sees room for outperformance if investors concentrate in areas that are thriving despite the challenging broader action.

“I would continue to look at stocks that trade on the NYSE and I would avoid the large-cap tech stocks,” he said. “It’ll be more of these industrial companies, cyclical names.”

Gilman Hill’s Harrington shares Ryan’s viewpoint that 2023 could be a time for stock pickers to outperform the indexes.

“For the past decade, all you had to do was be in the market to make money. I think those days are over. You cannot just be in the market. You need to be purposeful and more thoughtful,” she said.

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Stock Market Predictions 2023: Active Vs. Passive Investing

“It might be a time for active management. If you are investing for the next 50 years, ETFs are still fine. But the rising tide will not raise all ships for the next few years.”

She sees wide divergences at the company level within sectors, which means investors must be shrewd and pick stocks with the right qualities. At the moment, she favors small-cap and midcap stocks as they are “wildly undervalued” compared to their historical averages.

Ryan believes infrastructure companies like Fluor (FLR) and United Rentals (URI) are names that might do well next year. He also thinks Caterpillar (CAT), Deere (DE) and Terex (TEX) could outperform.

Nevertheless, he says investors should be careful not to get overexposed in a choppy market.

“If it’s going to be a challenging market like 2022, they should have some cash so that when we do get pullbacks, they can invest in some of those stronger companies pulling back,” Ryan said. Investors must decide on their risk profile and how much cash they should hold at different times.

“I’m putting more emphasis on the technical aspects of the stocks that are doing well,” Ryan added. “I do want to see earnings, but you are not going to get the huge growth rates that you might have had in past years.”

Which Stocks Will Do Well In 2023?

From a sector perspective, what is the 2023 stock market forecast? CFRA’s Stovall finds some early signs of a rotation in leadership. Consumer discretionary, technology and industrials are areas investors should consider. He also thinks lightening up on defensive areas such as consumer staples, utilities and materials makes sense.

“The four best-performing sectors and the 10 best-performing sectors on the way down on average never beat the market 12 months after the market bottoms,” he said.

Hogan believes investors should utilize a barbell approach. One end should focus on things people “need rather than want,” at least for the first couple quarters of 2023. These include energy, reasonably priced staples and health care stocks.

For the other end, he suggests focusing on well-priced growth companies with balance sheet liquidity, strong free cash flow, a solid and defensible leadership role in their sector, and a significant contraction in their P/E multiple.

Cronk urges investors to be tactical next year.

“Stay defensive during the early part of the year, then you’re going to have to pivot to more cyclical areas and probably stay away from or underweight more defensive type areas,” he said. “As you get out into the second quarter of the year, we would start saying you want to be underweight utilities, staples, maybe health care.”

2023 Stock Market Forecast For Energy Stocks

One key question in 2023 is whether the energy sector can outperform once again. Energy stocks have been the biggest winners in 2022, with the Vanguard Energy Index Fund ETF (VDE) up about 45%.

Ryan thinks a period of consolidation may ensue given the powerful gains seen in 2022. Cronk, however, believes energy is still in the early innings of a super-bull-market that will last about 10 years.

“If investors have missed the last two or two-and-a-half to three years of good energy equity returns and good commodity returns, I would use this recession and any dip in those prices to add to places in the portfolio because we think you have multiple years ahead of you of decent returns there,” he said. “It really is a supply and demand story. Supply continues to be constrained globally, and as global demand becomes higher, there’s not enough commodities and energy to supply the globe’s needs.”

Stovall also believes energy stocks can make further gains.

“Even though energy has done so well, they are trading at a 47% discount to their average (price-earnings ratio) since 2000,” he said.

Stock Market Outlook For Consumer Stocks

Gilman Hill’s Harrington also sees an opportunity in the consumer space given the fact some stocks have lost as much as 70% of their value.

“Clearly the consumer is going to weaken to some degree, but we need to remember that wages are still increasing. Not at the same rate of growth as they were, but they are still growing,” she said. “People are making more money and the U.S. consumer is indomitable. Many of the consumer-oriented stocks have overpriced the weakness of the consumer.”

She says the stocks were walloped not just on worries about the weakening consumer but also on inventory and supply chain concerns.

“I actually think the consumer stocks could do quite well because many of them have priced in an Armageddon scenario for the consumer,” she said. “But we’re Americans and we like to disgustingly overspend. By their nature, Americans are quite resilient in their spending.”

Please follow Michael Larkin on Twitter at @IBD_MLarkin for more analysis of growth stocks.


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