Consumers have also been reducing spending. According to data releases on Wednesday, US retail sales fell 1.1% in December on the month, the largest decline in a year. A 0.4 percentage point downward revision left November retail sales down 1%.
So, even though the tech sector has fallen a long way both in absolute and relative terms with a 31% decline in the MSCI World IT index for 2022 versus a 19.5% decline in the broader MSCI World, we expect information technology to continue to underperform value stocks in the current environment of rising rates and slowing demand. We retain our Least Preferred rating on tech.
Inflation risks remain despite the recent moderation in price pressures. Recent inflation prints in the US and the Eurozone have been encouraging. Most recently, US producer prices underlined lower inflation pressures in the pipeline with a 0.5% month-over-month fall, the fastest monthly price fall since April 2020 at the height of the pandemic. This also caused markets to scale up the expected pace of Federal Reserve rate cuts in 2023, with fed funds futures pointing to a decline in rates to 4.31% from an implied peak of 4.84% in June. If realized, rate cuts would likely be positive for the tech sector.
But there is still a long way to go before central banks would feel confident that inflationary risks are behind us. Tight labor markets add to the uncertainty, as price and wage inflation may prove stickier than expected, and may not fall smoothly back down to central bank target levels. Historically, value stocks have outperformed growth stocks, such as tech, when inflation has been above 3%, and we only expect inflation to fall below 3% toward the end of this year.
Tech valuations have yet to turn the corner. After more than a decade of expanding valuations, the IT sector’s price-to-earnings ratio has declined from 29x to 19.1x, but this is still 4% above its 10-year average. We see continued headwinds for the sector. Its performance has been negatively correlated to the rise in real rates. In addition, more earnings downgrades can be expected from tech firms, amid lukewarm consumer demand and a muted enterprise outlook. Tense US-China relations and the race for global tech supremacy are other risks facing certain tech industries.
While we do expect a more sustained risk-on turn during 2023, the current environment is still more favorable for defensive, value, and quality income stocks. We expect global earnings growth to turn negative in 2023 (–3% vs. +2% consensus forecast), and we see US earnings contracting 4.4%. Earnings momentum is also deteriorating, with downgrades outpacing upgrades. Given these indicators in negative territory, we expect equity volatility to stay high. Therefore—with the current backdrop remaining one of high inflation, rising rates, and slowing growth—we believe a combination of defensive, value, and income opportunities should outperform.
But we still expect the year 2023 to bring inflection points as inflation falls, central bank policy shifts away from tightening, and growth bottoms. This should mean that the backdrop for investors should improve as the year evolves, and certain parts of the market could rally swiftly when the inflections arrive. More risk-tolerant investors can consider opportunities in early-cycle markets such as German equities and beneficiaries of China’s reopening.
Main contributors - Mark Haefele, Daisy Tseng, Christopher Swann, Sundeep Gantori, Jon Gordon
Content is a product of the Chief Investment Office (CIO).
Original report - Tech layoffs underscore challenging backdrop for growth, 19 January 2023.