In the early weeks of 2023, US stocks that suffered losses in 2022 have been making impressive gains and are leading the market higher. However, some investors are doubtful that the trend will continue. Stocks of companies like Nvidia, Netflix, and Meta Platforms that struggled in the previous year have rebounded in 2023, which has had a positive impact on the technology and communication services sectors. Additionally, smaller stocks that took a hit in 2022 have also performed well this year. The Goldman Sachs basket of unprofitable tech stocks, for example, rebounded 21% in 2023, dwarfing the S&P 500’s 6.5% gain.
Various factors are driving these moves, including the appeal of beaten-up stocks, a boost from falling bond yields, and investors unwinding bearish bets against stocks. Despite this, some investors remain skeptical that the gains will last, particularly if the markets continue to recalibrate expectations for how high the Federal Reserve will need to raise rates to keep inflation under control. Walter Todd, the Chief Investment Officer at Greenwood Capital, stated, “the extent to which it’s occurred is pretty dramatic. It certainly can’t continue at the extremes it has been.”
Many investors have raised their equity positioning, encouraged by several months of easing inflation readings, which has led to a 6.2% jump in the S&P 500 in January. One measure, equity positioning for systematic investors, has climbed to its highest in a year, according to a report from Deutsche Bank. Moderating bond yields, which surged in 2022 as the Fed raised interest rates to fight soaring inflation, have further bolstered the case for buying last year’s losers.
However, falling yields have caused many to question the sustainability of the recent rally. While lower interest rates generally boost the appeal of equities, they are particularly advantageous for technology and growth stocks whose valuations suffered in 2022 when yields shot higher. Since falling yields often increase the allure of equities, lower quality and longer-duration assets do well, according to Rob Almeida, Global Investment Strategist at MFS Investment Management.
Investors will be closely watching Tuesday’s release of US consumer price data for signs of continued inflation moderation. Some strategists at the Wells Fargo Investment Institute believe that the market leaders to-date are vulnerable to higher-for-longer interest rates and a slowing economy. They prefer not to chase equity rallies at this time and view the recent breadth and leadership as unsustainable.
David Kotok, Chief Investment Officer at Cumberland Advisors, is skeptical of the latest rally and some of the stocks leading the current run. His firm is underweight many of the big tech and growth stocks that have rebounded in 2023, preferring healthcare and defense shares and keeping a big allocation in cash. “Either the deterioration last year from an overvalued space is over, or this is a dead cat bounce in a wounded large sector, and the bear market of last year is not over,” Kotok said. “I am in the latter camp.”
While there are some signs that the leaders could continue to do well, there are concerns that the gains will not last. The three best-performing sectors in January since 1990 went on to post an average return of 11.3% over the next 12 months versus the S&P 500’s average gain of 9.3% over that time, according to investment research firm CFRA Research. It is likely that some of last year’s most beaten-up stocks could continue moving higher in the near term as investors cover more short positions. However, senior portfolio manager at Northwestern Mutual Wealth Management Company, Matt Stucky, believes that while the trend may last for a quarter or two, it is unlikely to persist throughout.