markets & economy  |  june 22, 2023

2023 Midyear Market Outlook: Finding the Signal Through the Noise

Bearish indicators could be flashing misleading signs.

 

Key Insights

  • The global economy avoided recession in the first half. The second half will bring more tests as higher interest rates and tighter liquidity are fully felt.

  • Investors may want to think twice before aggressively jumping into longer-term U.S. bonds. Credit sectors and global ex-U.S. markets offer return potential.

  • Earnings estimates may need to fall further. Still, there are opportunities in U.S. small-cap stocks, mega-cap technology, and global ex-U.S. markets.

Arif Husain, CFA

Head of International Fixed Income and Chief Investment Officer

Justin Thomson

Head of International Equity and Chief Investment Officer

Sébastien Page, CFA

Head of Global Multi‑Asset and Chief Investment Officer

Introduction: Reluctantly Bearish

Moving into the second half of 2023, the balance of economic forces still appears tilted against global capital markets. Sticky inflation, central bank tightening, and financial instability all pose clear risks.

Yet, through late May, economies and markets both showed surprising resilience. Growth remained positive in the major economies (Figure 1), and earnings results came in stronger than expected. Key equity markets posted gains.

Growth Has Slowed but Major Economies Are Not in Recession—Yet

(Fig. 1) Growth in real gross domestic product (GDP), year over year

Line chart of growth in gross domestic product after inflation, where the lines represent year-over-year growth for the U.S., Europe, Japan, and China from December 2018 through March 2023.

As of March 31, 2023.
Sources: Haver Analytics/U.S. Bureau of Economic Analysis, Statistical Office of the European Communities, Cabinet Office of Japan, Japan Ministry of Internal Affairs and Communications, International Monetary Fund.

These results appeared to validate the wisdom of a “reluctantly bearish” approach. Bearish, because the risks are substantial. Reluctant, because excessive pessimism can lead investors to overlook opportunities and miss market recoveries.

It’s an open question whether economies and markets can continue to defy the pessimists in the second half, says Sébastien Page, head of Global Multi‑Asset and chief investment officer (CIO).

Many economic indicators, Page notes, are flashing red. But lingering distortions from the COVID pandemic make it hard to distinguish the signal from the noise—the useful information from the meaningless data points.

The strongest bear argument, Page says, is that the economic impact of 500 basis points (bps)1 of interest rate hikes by the U.S. Federal Reserve has yet to be fully felt. “Every time the Fed has slammed on the brakes in the past, someone’s head has gone through the windshield,” he warns. “And we’ve already found out that some banks weren’t wearing their seat belts this time.”

Although the banking crisis appears contained, its impact on credit conditions will be felt with a lag, notes Arif Husain, head of International Fixed Income and CIO. Resolution of the political dispute over the U.S. debt ceiling also could squeeze market liquidity in the second half, he says, as the U.S. Treasury rebuilds its depleted cash account at the Fed.

Yet, opportunities can be found in select sectors, including small‑cap stocks and high yield bonds. Cheaper valuations and a weaker U.S. dollar also could make global ex‑U.S. equity markets attractive, says Justin Thomson, head of International Equity and CIO. Positive yield curves could do the same for global ex‑U.S. bond markets, Husain adds.

In an uncertain environment, careful security selection will be critical. “Skilled active management can help investors avoid riskier exposures,” Page argues.

1A basis point equals 0.01 percentage points.

Risks

Fixed-income securities are subject to credit risk, liquidity risk, call risk, and interest-rate risk. As interest rates rise, bond prices generally fall. Investments in high-yield bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. Investments in bank loans may at times become difficult to value and highly illiquid; they are subject to credit risk such as nonpayment of principal or interest, and risks of bankruptcy and insolvency. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets. Mid-caps generally have been more volatile than stocks of large, well-established companies. Small-cap stocks have generally been more volatile in price than the large-cap stocks. Investing in technology stocks entails specific risks, including the potential for wide variations in performance and usually wide price swings, up and down. Technology companies can be affected by, among other things, intense competition, government regulation, earnings disappointments, dependency on patent protection and rapid obsolescence of products and services due to technological innovations or changing consumer preferences. Although actively managed investments have the potential to outperform an index, this is not guaranteed, and they may trail the index. There is no assurance that any investment objective will be achieved. Diversification cannot assure a profit or protect against loss in a declining market.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of June 2023 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.

T. Rowe Price cautions that economic estimates and forward-looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual outcomes could differ materially from those anticipated in estimates and forward-looking statements, and future results could differ materially from historical performance. The information presented herein is shown for illustrative, informational purposes only. Forecasts are based on subjective estimates about market environments that may never occur. The historical data used as a basis for this analysis are based on information gathered by T. Rowe Price and from third-party sources and have not been independently verified. Forward-looking statements speak only as of the date they are made, and T. Rowe Price assumes no duty to and does not undertake to update forward-looking statements.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.

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Next Steps

  • Discover the future we see for financial markets and how we’re investing to prepare for it in our 2023 Midyear Market Outlook Insights.

  • Contact a Financial Consultant at 1-800-401-1819.