Investors often ask what to expect in the coming year. We constantly look at the economy and financial markets to determine what we believe will happen next to manage risk and maximize returns in client accounts. Making a forecast of market returns in the next 12 months is very difficult. In fact, financial market returns are strange in that you can generally make a more accurate forecast of the long-term outcome than the short-term.
In those terms, we believe the 10-year average return of approximately 10.5% for the equity market should still be achievable over the coming 10 years. However, as equity markets often do, we expect them to provide volatility in the short term.
Over the past 12-plus months, we have mentioned market valuations, especially the notorious price-to-earnings (P/E) ratio. Entering 2022, the P/E ratio of the S&P 500 was slightly below 25, meaning investors, on average, were willing to pay almost $25 for every dollar of earnings on their investments. That was down from a 12-month high of approximately 32 times hit in March of 2021 but well above the long-term average of about 17 times.
With prices so high to begin 2022, it shouldn’t be a surprise that with a little bit of economic worry, prices of the average stock within the S&P 500 Index fell by over 18% last year. Even after dropping so much, we believe their valuation to begin 2023 is still a bit high at approximately 18.77 times, especially given the Federal Reserve’s continued fight to beat down inflation in our domestic economy.
To fight inflation, central banks generally increase interest rates to slow economic demand. Raising rates has been shown to work in this effort, but it also has another effect—driving asset values lower, especially those with cash flows assumed to be achieved further into the future. Companies with a solid track record of providing investors with cash, generally called value stocks, don’t suffer as much but still lose value during these times. Their counterparts, so-called growth stocks with the bigger prospects for future growth, don’t fare so well. In 2022 value stocks lost 5.25%, including their dividends, while growth stocks lost over 29%.
Given the Federal Reserve is still expected to raise interest rates for the next few months and valuations are not as cheap as you might expect after the big loss in 2022, we believe the market is likely to continue its rocky path for a few months. We wouldn’t be surprised to see the market return to its pre-COVID peak, approximately 13.5% lower than the 2022 year-end value, or lower, before we get the current economic grief behind us. For that reason, we continue to recommend an overweight in value and an underweight in growth companies.
However, we believe fixed-income markets that lost approximately 13% in 2022 should be much more stable in 2023. Considering this, we believe investors with a long-term perspective will be best to continue averaging into current positions and adding new companies to their portfolios when they identify an opportunity.
Finally, the 2021 high prices of your favorite growth stock will likely not be achieved anytime soon. The COVID Bubble attained in 2021 was unsustainable and should have been avoided.
If you have questions on how to begin shifting your asset allocation for retirement, the experts at Henssler Financial will be glad to help:
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This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
