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After a rough couple of months for stocks, analysts at major investment banks believe there are still opportunities for gains in 2023 despite ongoing economic uncertainties.

In August, global stocks posted their second worst month this year as rising bond yields and recession worries weighed on risk appetite. The selloff has extended into September trade. However, in a research note on Friday, Madison Faller, global investment strategist at JPMorgan Private Bank, said 2023 can still end positively for investors after the late summer decline left valuations looking less stretched.

“After the late-summer swoon in stocks, valuations look less stretched than they did before, offering another chance to rebuild equity exposure — especially for those pockets of the market that haven’t rallied as much this year,” Faller commented.

The pullback has brought a “better entry point for bonds and even more protection against any unexpected spikes,” she added. Higher interest rates set by the Federal Reserve also raise the prospect of future rate cuts if inflation keeps cooling while policy remains steady. This could eventually support stocks.

Wall Street Split on Recession Odds, But Sees Opportunities Amid Higher Rates

While a slim majority of analysts still predict a U.S. recession next year, some banks believe the economy can avoid contracting. Goldman Sachs recently lowered its recession probability estimate to just 15% – in line with a normal year historically. The bank has consistently predicted a “soft landing.

“That is not a bad environment for equities, particularly when you also consider that inflation has peaked, and although rates, we think, will not come down as quickly as the market is pricing, and that’s a risk, it’s not a very bad environment,” said Goldman’s Chief Global Equity Strategist Peter Oppenheimer in an interview Wednesday.

Oppenheimer believes stocks can generate moderate returns in an environment of higher rates and slower growth. However, selectivity will be key with limited profit expansion expected. Cash and bonds are also more attractive, lessening the relative appeal of equities.

JPMorgan Private Bank also foresees a “softish landing” for the economy and no recession. Resilient consumer spending, solid retail sales and better-than-expected Q2 earnings give analysts confidence the economy can handle further Fed hikes as inflation recedes.

Corporations Increase Investments in AI and Long-Term Growth

With less focus on near-term uncertainty recently, companies are concentrating more on long-term opportunities – especially in artificial intelligence, noted Faller. Mentions of “AI” have spiked in earnings calls and presentations as firms ramp up investments across industries.

AI-focused tech stocks like Nvidia, Meta and Tesla have been top performers this year. But the surge in interest rates has differentiated between speculative, unprofitable tech and stable tech companies with strong balance sheets.

“Technology has been a crucial driver again in the equity markets this year, but there’s a huge difference now between speculative, unprofitable tech which had very high valuations but has seen that erode as interest rates have gone up, and then very profitable, strong balance sheet tech, which is seen as more defensive,” explained Oppenheimer.

Second Quarter Earnings Beat Low Expectations

Encouraging Q2 results also restored some confidence after earnings expectations were sharply reduced heading into the season. S&P 500 profits contracted just 4% instead of the anticipated 7.3% decline. Forward 12-month earnings estimates for the index have steadily improved since March as well.

Management teams seemed pleasantly surprised by the resilience of demand despite inflation and higher rates. Mentions of “inflation” and “economic slowdown” have fallen significantly on earnings calls and presentations – a positive signal.

“Rather, more of the changes seem to be happening at the margin, as consumers are shifting away from brand names and toward some thriftier options, and reorienting back toward goods after a red-hot year for services,” Faller remarked.

Fed Policy Trajectory, Geopolitics Remain Key Variables

While strategists see a constructive backdrop for stocks looking ahead, risks still loom. Mortgage rates have surged to 22-year highs, while credit card delinquencies have edged up as household finances become strained. The path of Fed policy also continues to create uncertainty.

Markets expect the Fed to start cutting rates in mid-2023 to boost growth. But other major central banks lag behind, meaning tight policies could persist longer than anticipated. Geopolitics, China’s slowdown and potential inflation setbacks also pose hazards to the outlook.

As a result, investors may want to maintain balanced portfolios despite brighter growth prospects on the horizon. Staying selective and focusing on quality companies with strong fundamentals can help endure bouts of volatility as the Fed combats high inflation without sparking a downturn.

Though the road ahead may stay rocky, long-term investors could be rewarded for looking through the present challenges. To stay updated on financial news and expert insights, subscribe to our newsletter ↗ for timely market analysis.