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What could be next for stock markets in 2023?

We look at some of the major themes likely to move markets over the next 12 months, as well as dig into a few sectors we think could be worth paying close attention to.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Sophie Lund-Yates
Equity Analyst

Published on 18 January 2023

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

2022 reminded investors that trying to properly predict the future is impossible. The year was a rollercoaster for markets, filled with one unexpected event after another. Russia’s invasion of Ukraine and the related energy crisis being just two examples. We expect 2023 to have its fair share of ups and downs.

Here we look at some of the major themes likely to move markets over the next 12 months, as well as dig into a few sectors we think could be worth paying close attention to.

This article isn’t personal advice. If you’re not sure if an investment is right for you, ask for advice. Investments and any income from them can rise as well as fall in value, so you could get back less than you invest.

Will inflation be a problem for stock markets in 2023?

The big macroeconomic themes of 2023 will be much the same as last year, so inflation will continue to be a buzzword.

Inflation is the overall rise in prices of goods and services in the economy, and it’s been running wild lately.

Excessive money printing by central banks got the inflationary wheel turning during the pandemic. Worsened by skyrocketing oil prices in 2022, UK inflation soared above 11% for the first time in over 40 years.

With wage increases struggling to keep pace, consumers are being left with less cash in their pockets once essential items like fuel and groceries are paid for. This means there’s little excess cash to spend on things like new clothes, the latest gadgets, or going out for dinner. Retailers in these areas will likely continue to feel the pinch in 2023.

The good news is that inflation could be close to its peak in countries like the US and UK. But as some estimates suggest UK inflation could sit at 5% by the end of 2023, it looks like we’ll still be living with high prices throughout this year.

What does this mean for interest rates and the stock market?

Elevated inflation means interest rates are going to be a main theme this year too. To bring inflation back down, central banks need to take some heat out of the economy. Raising interest rates is one way to do that.

Higher interest rates make borrowing more expensive, meaning all else being equal, there’s less money pumping around the economy. As people spend less, this helps bring inflation down.

In December 2022, the Bank of England (BoE) increased interest rates by 0.5% to 3.5%. But with inflation still running hot at 10.5%, the BoE is expected to continue raising interest rates throughout 2023. Rates are expected to reach 5.25% by the end of the year.

The pace at which interest rates get to the BoE’s target will also affect markets. If interest rates rise faster than expected, the market will likely experience further downward pressure. If interest rates rise more slowly than expected, we might see the market stabilise or even begin to recover.

But there’s a lag between raising rates and falling inflation. That means central banks are walking a tightrope between managing inflation and avoiding a prolonged recession.

Recession fears

Those higher interest rates feed into the risk of recession, because higher rates reduce economic activity. A recession can sometimes be defined as a significant decline in widespread economic activity which lasts more than a few months.

Consensus is that the UK is currently heading into a recession. While both the length and depth of such a recession is anyone’s guess, the BoE expects this recession to last the whole of 2023.

But why does this matter to you?

During a recession, stock prices typically plummet because the economy shrinks and companies struggle to remain profitable. This often leads to companies laying off some of their workforce in a bid to cut expenses. Rising unemployment pushes consumer spending down further, setting off a vicious cycle of economic contraction which often sends markets spiraling downwards.

Markets tend to stay depressed throughout a recession. Since 1950, the average recession has lasted ten months, with the longest lasting 18 months. But not all companies are created equal, and some companies fare better than others.

What does this mean for stocks?

Looking forward, don’t be surprised to see high-profile companies miss their earnings estimates, and recessions officially start in many major economies. That’s likely to result in sharp market movements for some individual companies.

Companies most at risk from this sort of event are those whose valuations are based on sentiment rather than fundamentals. Companies with weak cash flows are vulnerable too. If incoming cash flows can’t keep up with operating costs, sudden downward revaluations could be in store.

In light of this, we think some sectors are better prepared to thrive in current conditions than others.

Banks with more traditional banking operations could benefit from a higher rate environment as it allows them to improve their net interest margin. That’s the difference between what a bank pays out in interest on deposits and what they charge in interest on loans – offering them the chance to make more profit.

However, with consumers under pressure, the quality of banks’ loan books will be under scrutiny. A sharp recession will result in more loan defaults, which will increase impairment charges and hurt profits.

As the cost-of-living crisis is expected to worsen in 2023, consumers will focus their spending on needs, rather than wants. This makes low-cost consumer staples a resilient space. Consumer staples are the kind of thing customers need to buy come rain or shine, rather than the goods they can go without.

The healthcare industry is another potentially resilient space when times get hard. It’s a key area that you simply can’t afford to cut back spending on. This makes it what we call a non-cyclical sector, meaning it’s relatively insulated from economic downturns.

Add to this the ageing population globally, and demand for healthcare services looks set to increase over the long term. As ever though, remember nothing is guaranteed.

What should investors do during tough times?

UK and US markets struggled in 2022 and lots of investors have been left licking their wounds. Some might even question whether it’s worth being in the market at all in 2023, given the negative sentiment about the near future.

While the answer isn’t clear-cut, we always say you should invest with the long term in mind. Here’s why.

Pulling out of the market and waiting for a ‘better’ time to invest is known as trying to ‘time the market’. Attempting to pick the perfect time to invest is an incredibly difficult and risky task. Investors who try this run the risk of being out the market during market rallies, therefore missing out on any exceptional returns.

Traditionally, the best days on the market happen after very difficult times, making them easier to miss if you jumped ship when things got shaky.

The below figure helps to highlight this:

Impact of missing the best 10 days in the UK stock market (2000-2022)

Past performance isn’t a guide to future returns. Source: Lipper IM, from 03/01/2000 to 30/12/2022. Figures based on £10,000 starting investment.

Waiting for the right time to invest?

The chart above shows the impact of missing the best days in the market in the first 22 years of this century. Starting with a £10,000 investment, missing just the best ten days would’ve cost you more than £13,000.

Viewed from another angle, staying fully invested in the market would’ve generated a total return of 175%. If you missed those ten days however, you would’ve returned just 43%. Not a bad payout for sitting back and ignoring the volatility. Remember investments rise and fall in value, so you could get back less than you invest.

These figures should highlight the importance of thinking long term when investing, and staying in the market. Unfortunately, short-term volatility comes part and parcel with investing. While it’s always unsettling to see your investments fall, we’d encourage investors to view a market decline as a potential opportunity.

Whatever happens over the next 12 months, be sure to spread your risk with a diversified portfolio and ignore short-term fads. Stick to your long-term investment goals and remember, it’s a marathon not a sprint.

Also keep in mind, it’s crucial to understand what you’re investing in. If you think you’ve found a resilient sector worth attention, that doesn’t mean all companies within that space have what it takes to thrive.

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