2023 Global Investment Outlook: A year for yield

Morgan Stanley Research

12/05/22

Summary: In an environment of slow growth, lower inflation, and new monetary policies, 2023 may have upside for bonds, defensive stocks, and emerging markets.

Image of a yield sign

Investors may find themselves a bit whiplashed in 2023 as inflation and other dominant market trends of 2022 fully reverse themselves, according to the 2023 Investment Outlook from Morgan Stanley Research.

“For markets, this presents a very different backdrop than 2022, which was marked by resilient growth, high inflation, and hawkish policy,” says Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley Research. “Overall, 2023 will be a good year for income investing.”

Overall, 2023 will be a good year for income investing.

Andrew Sheets, Chief Cross-Asset Strategist, Morgan Stanley

Bonds—among the biggest losers of 2022—may be the biggest winners in 2023, as global economic trends temper inflation and central banks pause their rate hikes. This is particularly true for high-quality bonds, which historically have performed well after the Federal Reserve stops raising interest rates, even when a recession follows. Similarly, emerging market equities and debt, which were early to underperform in this economic cycle, could be early to recover in the next, as was the case after the dotcom bust of the early 2000s and in 2009 following the financial crisis.

Other key takeaways from Morgan Stanley’s 2023 Investment Outlook:

  • 10-year Treasury yields will end 2023 at 3.5% vs. a 14-year high of 4.22% in October 2022
  • With favorable pricing, securitized products, such as mortgage-backed securities, may offer upside
  • S&P 500 will likely end the year near where it started, but with material swings along the way
  • U.S. dollar will peak in 2022 and decline through 2023
  • Emerging-market and Japanese equities may deliver double-digit returns
  • Oil will likely outperform gold and copper, with Brent crude, the global oil benchmark, ending 2023 at $110
Overall, investors will want to pay close attention to the economy, legislative and regulatory policy, corporate earnings and valuations, says Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. “Because we are closer to the end of the economic cycle at this point,” Wilson says, “trends for these key variables can zig and zag before the final path is clear.  While flexibility is always important to successful investing, it's critical now.”

Bonds make a comeback

In 2023, with interest rates set to decline, conditions bode well for stable and attractive bonds, as prices move in the opposite direction of yields. Morgan Stanley fixed-income strategists forecast high single-digit returns through the end of 2023 in Treasuries, investment-grade bonds, municipal bonds, mortgage-backed securities issued by government sponsored agencies and AAA-rated securities in the U.S. However, investors should keep a close eye on quality. U.S. high-yield corporate bonds may look enticing, but they may not be worth the risk.

Conversely, securitized products, such as mortgage-backed securities, auto-backed securities and collateral debt obligations, could offer income opportunities. Spreads—or the excess yield versus low-risk government bonds with similar maturities—are the widest they’ve been since the pandemic. Meanwhile, rising rates are limiting the supply of new securities coming on the market.

This is particularly true for agency mortgage-backed securities. “Not only are they the most liquid asset, they’re also starting from the most attractive valuation. Nominal spreads on mortgages produced today have not been this wide since the fourth quarter of 2008,” says Tirupattur. “Additionally, slowing housing activity will shrink the net supply of these securities.” 

Trends point to high-yield equities

Equities next year, however, are headed for continued volatility, and Morgan Stanley Research forecasts the S&P 500 ending next year roughly where it started, at around 3,900. “Consensus earnings estimates are simply too high, to the point where we think companies will hoard labor and see operating margins compress in a very slow-growth economy,” says Wilson. To that end, investors may want to consider the higher-yielding parts of the equities market, including consumer staples, financials, healthcare, and utilities.

European equities could offer a modest upside, with a forecasted 6.3% total return over 2023 as lower inflation nudges stock valuations higher. In particular, financials and energy are more likely to perform well in this environment.

Emerging markets and Japan early to recover

This has been a major bear market for emerging markets, but the tide could be turning, says Jonathan Garner, Chief Asia and Emerging Market Equity Strategist. “Valuations are cheap, and cyclical winds are shifting in favor of emerging markets as global inflation eases more quickly than expected, the Fed stops hiking rates, and the U.S. dollar declines,”  he says, says, adding that over the last several economic cycles, emerging markets have recovered before U.S. markets.

Valuations are cheap, and cyclical winds are shifting in favor of emerging markets as global inflation eases more quickly than expected, the Fed stops hiking rates, and the U.S. dollar declines.

Jonathan Garner, Chief Asia and Emerging Market Equity Strategist, Morgan Stanley

The MSCI EM, an index of mid and large-cap companies in 24 emerging markets, could potentially see 12% price returns in 2023. Japanese stocks, meanwhile, could benefit from a combination of low valuations and unique tailwinds—potentially translating to 11% gains for the Tokyo Stock Price Index next year.

Another potential bright spot, EM debt could benefit from a combination of trends—including declining rates, improving economic fundamentals and a weakening US dollar.

The source of this article, 2023 Global Investment Outlook: A Year for Yieldwas originally published on November 22, 2022.

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