Bearish Investor Sentiment Could Mean a Stock Market Rally in 2023

The largely negative market sentiment of 2022 is potentially positive news for the new year but what appears certain is the degree of uncertainty in the global financial markets in 2023. 

January 9, 2023 - According to recent research from Acuity Trading, the stock market rallies through 2020 and 2021 were steeper than the most bullish analysts had predicted. The S&P 500 jumped 16.3% in 2020 and ended 2021 with more than 27% gains, representing the third consecutive year of double-digit growth. The benchmark index closed at record highs 70 times, with investors looking forward to the global economy recovering after the pandemic.

Investors Lose Their Mojo

Bears were on the prowl for most of 2022, especially in the second half of the year. This is because all major economies began reeling under the pressure of soaring inflation. Here’s the year-to-date losses of the major stock indices:

• S&P 500: -15.11%
• Nasdaq 100: -27.61%
• EuroStoxx 600: -9.90%
• German DAX: -8.53%

Central banks around the world, including the Federal Reserve, Bank of England and ECB, responded with aggressive interest rate hikes. While the aim was to contain inflation, the impact of rate hikes is that they pull the reigns on economic growth.

The Fed’s rate hikes also meant a soaring US dollar, which adversely affects all other economies. The situation was further aggravated by the energy crisis in Europe, brought on by the Russia-Ukraine conflict. The Acuity AssetIQ Widget illustrated overly negative sentiment for the major indices.

More Than a Silver Lining

The largely negative market sentiment of 2022 is potentially positive news for the new year. Stock valuations are low, creating attractive buying opportunities that institutional investors will be looking to grab. Sentiment can typically turn positive in the holiday season, which is what causes the so-called Santa Claus rally. This is a phenomenon observed in the last five trading days of December and the first two of the new year, when stock markets tend to yield positive returns. For this to convert into a sustainable rally in 2023, investor sentiment needs to remain bearish into the holiday season.

Acuity’s Assets Overview widget indicates that sentiment is overly bullish for many of the tech giants, which means risk appetite is subdued going into the holiday season. This is a good sign. Investors turning too optimistic, too quickly may lead to a sudden upturn that bears will be able to reverse very fast. This could mean significant volatility in a predominantly downward sloping graph.

What Will Support Investor Sentiment in 2023?

In the back half of 2022, prospects of a recession grabbed the headlines. Given the aggressive rate hikes by the US Fed and other major central banks, this is not an unfounded concern. However, the market has already responded to these prospects and the bad news is already largely baked into stock valuations.

On the other hand, the major central banks may begin easing their aggressive monetary tightening. The US Fed has already indicated that the extent of the rate hikes will ease starting from December itself. The central banks taking a less aggressive approach to rate hikes will support risk sentiment in the financial markets.

As the Fed begins cutting back on its monetary tightening, the US dollar may cease its sharp uptrend against other currencies. In fact, it could begin to ease from the current elevated levels. This will support other economies around the world, which conduct trade in the US dollar, and improve market sentiment globally. Any decline in the US dollar will also support the demand for commodities by foreign currency holders.

The prospects of China are also improving. The country has begun easing its strict covid restrictions, after three consecutive years of lockdowns. As the Chinese economy reopens completely, growth is likely to reaccelerate. Any news of a recovery in the Chinese economy supports sentiment in the global financial markets.

Moreover, all it takes for overall market sentiment to turn positive is for a few big stocks to perform well. The tech giants are already getting ready to combat a challenging macro environment next year, with massive layoffs and other cost-saving initiatives being rolled out. What appears certain is the degree of uncertainty in the global financial markets in 2023.