2023 Equity Outlook: Select Alpha Opportunities Emerge

Companies have been tested over the past several years as unprecedented pandemic-fueled headwinds changed the game for many. And while broad monetary and fiscal actions have papered over many cracks, this support is now waning and could begin to separate the wheat from the chaff. 

The market has consistently differentiated companies by their ability to navigate this challenging environment, creating alpha opportunities even in a broadly beta-led market. Successful companies have tended to have nimble management teams, strong pricing power, financial strength, and competitive positioning – and their reward has been growing profits, market share gains, and strong business backlogs. 

Looking to 2023, higher interest rates could limit the beta potential in the market. At the same time, investors are starting to fear that even companies that have weathered recent headwinds will begin to succumb to macro pressures. While our bottom-up research signals that companies remain optimistic despite these macro concerns, as evidenced by our proprietary market sentiment indicator (see below), the market appears worried that many companies will eventually take a hit.

Company Sentiment Has Remained Broadly Positive Despite Macro Woes

Source: FactSet, PineBridge Investments. Stock universe is Russell 1000. 31 December 2003 to 30 September 2022.

Our view is that alpha opportunities exist in all market environments – and that they are as compelling now as ever. Broader fears have created opportunities to upgrade our equity portfolios by investing for the medium to long term in high-quality companies at attractive valuations.

Key Convictions for 2023

We have uncovered abundant investment opportunities heading into 2023 through our industry cluster conversations, which bring together PineBridge investment professionals across all asset classes and regions to distill the results of thousands of company meetings per year. Here we’ve briefly summarized the outcome of these discussions and how they’re informing our 2023 outlook.

1. Consumer companies: A hunting ground for portfolio upgrades.

Most consumer companies are well versed in navigating rising costs and continue to earn their stripes in the current environment. Companies that have benefited from relatively inelastic demand over time could be tested, however, and we are tending to avoid the largest beneficiaries, particularly at current valuations. Rather, we have identified select companies that are benefiting from longer-run tailwinds, including rising global affluence, increased demand for technology enablers, and corporate transformations. Examples include luxury products, digital advertising, and companies with proven management teams. Broader market fears have, in several cases, presented opportunities to upgrade portfolios with quality names at historically attractive valuations. Additionally, we continue to seek companies that help other companies (namely, their customers) achieve their ESG targets. ESG factors are increasingly important determinants of new business wins, a trend that the market has yet to fully appreciate.

2. Industrials: Watch out for overvalued companies and upgrade to those that benefit from longer-term themes.

Industrials are a diverse sector, and now more than ever, they can’t be painted with a broad brush. Covid-related supply bottlenecks lent tremendous pricing power to most industrials and enabled larger players with greater scale to take share from smaller competitors, which drove their revenues and operating profits up substantially. Yet when looking at companies’ earnings expectations for 2023 compared with pre-Covid levels, we question whether markets are sufficiently discounting potentially frothy earnings. While markets don’t appear to be fully buying into the sustainability of these increases, as recent broad declines show, the substantial variations from company to company mean there will be winners and losers in the year ahead. Active, stock-by-stock analysis is needed to gauge what to expect and what is priced in – and to determine which companies will benefit from key investment themes, such as automation, net-zero spending, and near-shoring.

3. Technology: Look past beta and the obvious names for idiosyncratic success stories in 2023.

Tech stocks are struggling, but it’s not all bad news. As with the broader industrials segment, bullish sentiment in technology had dominated overall amid strong Covid-related tailwinds over the past two years, though questions about the sustainability of these effects began to grow late last year. While the crash came in early 2022, tech companies only began cleaning house toward the middle of the summer, by downgrading earnings and capex plans and some considering inventory write-downs. In semiconductors and hardware, most of the cuts have been driven by consumer-related markets, such as PCs and smartphones, as well as worsening US-China trade tensions; investors are currently focused on whether hyperscale computing and datacenter end-markets will drive the next leg down. Cuts in software have not been as drastic given the resilience of software as a service (SaaS) business models, but the segment is still suffering from macro volatility that is denting IT spending. Although we remain cautious on hyperscale, datacenter, enterprise, and auto end-markets, we’re focused on longer-term opportunities and look to add high-quality tech names with strong pricing power and intellectual property that are now trading at more attractive valuations. 

4. Healthcare: Amid uncertainty, pay attention to bottom-up narratives and revisit attractive names.

Innovation is alive and well, but someone has to pay for it. Overall demand is improving, with use of healthcare services returning to normal levels as patients return to hospitals and doctor’s offices, and higher costs and supply chain issues are also gradually easing. We are finding opportunities in certain high-quality products and services names whose valuations have contracted far more than their operating results. We’re also investing in innovation, with exciting therapies on the horizon to treat cancer, autoimmune disease, diabetes, and obesity. We see opportunities in biotech and new drug developers as well as their outsource partners and technology enablers. While the market favored large and safe defensive plays in 2022, we see a rotation back to these leading-edge companies at some point in 2023. Meanwhile, government policy is putting pressure on prices. New regulations in the US are calling for greater negotiating power for Medicare, which may change drug-price dynamics more broadly, and China’s government has been aggressively implementing value-based purchasing of drugs and devices, trading high volumes to lower prices.

5. Financials: Hold tight or buy selectively in 2023.

Fundamental strength meets a weak point in the cycle. With recession looming or already a reality in large swaths of the global economy, the current location in this cycle is not a strong entry point for investment in financials, given that these companies operate in what is necessarily a highly leveraged business model. That said, fundamentals remain strong overall, and while we see pockets of weakness, especially in Eastern Europe amid the ongoing war in Ukraine, other areas, including Indian banks, are performing well. Overall, while financial companies are showing few signs of stress and we find opportunities to buy high-quality banks during dislocations, we see other more attractive segments at this point in the cycle.

A discerning approach to equities in 2023

For longer-term investors, we believe the generalized sell-off provides opportunities to buy attractive companies with strong individual stories that diverge from the gloomier top-down narrative. That includes companies set to benefit from powerful longer-term trends shaping the world, including digitalization, the push for net-zero, and diversification of supply chains. These opportunities could prove fleeting, so now is the time to take a hard look at equity portfolios with an eye to selectively upgrading holdings.

For more investing insights, visit our 2023 Investment Outlook.