Five Allocation Ideas for 2023
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Commentary
Five Allocation Ideas for 2023
Downside potential still exists, although riskier asset classes
and segments could offer attractive rewards in the new year.
KEY TAKEAWAYS
• Equities are my top pick by asset class for 2023, partly based on valuation spreads
that historically have pointed to better odds of upside than downside.
• High-volatility stocks could outperform other equity groups for the year, based on
Denise Chisholm the combination of low valuations and the past performance of high-vol in periods
Director of Quantitative when leading economic indicators weakened.
Market Strategy
• Mid cap stocks may outperform large caps in 2023, since poor fundamentals appear
to be largely priced in as of the beginning of January.
• Emerging-markets equities show the potential to be an outperforming region,
provided the US dollar continues to weaken versus other currencies.
• Materials—especially metals—look even better than energy at the start of 2023,
based on supportive valuations and this industry group’s past performance in
periods of weaker manufacturing data.
Conventional wisdom points to many reasons investors might want to stay cautious
as we enter 2023, including an inverted yield curve, potential for recession, a
hawkish Fed, a war in Europe, and a trend of earnings revisions to the downside.
Added to this mix is continued uncertainty about the future rate of inflation.
While I’m cognizant of these and many other risks, my approach is to look at the
market data through a historian’s lens. When I do this, I see most of the leading
economic and market indicators that I track in continued decline. Historically, the lower
these numbers get, the better the odds of a future market advance—not because the
news cycle is improving, but because markets have priced in so much negativity.
For this reason, I believe it’s too late to be bearish on the markets. At the start of
2023, I’m looking for bullish ideas by asset class, stock factor, market cap, region, and
sector/industry group, searching for situations in which I believe fundamentals have
heavily discounted a downturn. Based on this analysis, some of the best potential
opportunities I’m seeing are among the badly lagging segments of 2022.By Asset Class: Stocks Could See Upside When earnings trends degrade, multiples often
Staying the course in equities may be a prudent move expand to cushion the blow. Once again going back to
in 2023, partly because valuation spreads looked 1963, multiples expanded in 89% of 12-month periods
historically wide at the end of 2022, recently reaching when earnings contracted the previous year. At about
the top quintile, a level not seen since 2020 and only 15 times forward earnings, multiples for the S&P 500 at
one other time since the Global Financial Crisis. Going the end of 2022 were in line with valuations seen in the
back to 1990, this quintile produced a higher average past when earnings contracted the previous year. They
return than any other. did not look historically high.
EXHIBIT 1: Valuation Spreads and Returns EXHIBIT 2: Valuations Have Tended to Rise as
Average NTM S&P 500® Returns in Quintiles of Combo Valu- Earnings Contract
ation Spreads, 1990–Present Historical S&P 500 Odds of Price-to-Earnings Multiple
Expansion in Quartiles of Future Earnings per Share Growth,
20% 19% 1963—Present
12M Odds of Expansion, Coincident
15% 100%
89%
11%
10% 80% 72%
10%
7% 7%
60%
5%
40%
28%
0% 20%
Bottom 1 2 3 Top
5%
Quintile Quintile
0%
Combo valuation spread measures the average percentile rank of the earning Bottom Quartile Q2 Q3 Top Quartile
yield spread and the book yields spread. The spread is the difference —Contraction 0%—13% 13%–22% —Above 22%
between the 25th and the 75th percentile. Past performance is no guarantee
of future results. NTM is next 12 months. All data measured monthly. Past performance is no guarantee of future results. P/E: Price to earnings.
Sources: Haver Analytics and Fidelity Investments, as of 11/30/22. Analysis based on the P/E price multiples of the S&P 500 measured
monthly since 1963, and arranged in quartiles of 12-month forward per-
share earnings growth. Sources: Haver Analytics, Fidelity Investments, as
of 9/30/22.
Just as important, this valuation-spread quintile
produced a higher risk-reward ratio—as measured by
the upside vs. downside range of outcomes—despite Lastly, I see the 20%-plus move lower for crude oil
having the lowest odds of positive earnings growth. prices in the latter half of 2022 as an encouraging
Degrading earnings trends remain a worry for many sign for stocks in 2023. I believe this could result in
investors, although perhaps they shouldn’t. A look improved consumer spending and, in some cases,
at S&P 500 index performance going back to 1963 lower costs, which have yet to be fully reflected in
suggests that stocks rose 65% of the time over the next quarterly earnings reports. Going back to 1970, the S&P
12 months when aggregate earnings contracted.1 The 500 index produced a 14% return, on average, in the 12
lower the prior-year returns, the higher the odds of a months following a 20% decline for the price of crude.2
market advance the following year. This is because Of course, energy prices also could rise from here.
stocks often discounted bad news in advance. We’ll be watching energy prices closely all year.
Five Allocation Ideas for 2023 | 2By Stock Factor: Volatility Could Outperform Higher-volatility cyclicals have also performed well
Higher-volatility stocks may be poised to lead if we see following past periods of credit-spread tightening.
an upward trend for equities overall. Volatility hasn’t Notably, option-adjusted spreads widened to a 2022 high
been a great factor to own over time. Over the long in October, then narrowed in the fourth quarter of 2022.
term, its returns have been roughly on par with the
By Market Cap: A Focus on Mid Cap Stocks
market, but with greater risk. That said, volatile stocks
in the S&P 500 index rose after periods in which their Mid caps present a potential opportunity with meaningful
valuations were especially low versus the broader valuation support based on two different measures: Both
market. Since 1991, when the volatility factor has the relative price-to-book and the relative price-earnings
been in the cheapest 40% of its historical range, it has of mid cap versus large cap stocks are at bottom-decile
outperformed the market by 3.6% over the next levels not seen since the early 2000s.
12 months, on average.3
Many investors argue that it doesn’t make sense to
EXHIBIT 4: Russell MidCap vs. Top 200
buy high-volatility stocks, which tend to be cyclical (or
Median Stock to Median Stock, P/B & Fwd P/E Percentile
economically sensitive), because leading economic
Rank vs. History
indicators (LEIs) have weakened. This logic may seem
persuasive, although it’s not consistent with history. Relative P/B Percentile Rank
Relative Fwd P/E Percentile Rank
When the year-over-year change in LEIs has been the
worst—in the bottom 40% of its historical range— 100%
volatility has outperformed the broad market by 4.5%
80%
over the next 12 months.
60%
EXHIBIT 3: Weakening LEIs have been good for risk. 40%
High-Volatility Stocks’ NTM Average Relative Performance
20%
After Year-over-Year Changes in LEIs, 1991–Present
5% 4.50% 0%
Dec 90 Dec 98 Dec 06 Dec 14 Dec 22
4% Past performance is no guarantee of future results. P/E is price/earnings
and P/B is price to book. Data for each is measured monthly and compares
3% valuations of the Russell Mid Cap Index versus the top 200 stocks in the
Russell 1000 since 1990. Sources: Haver Analytics and Fidelity Investments,
2% as of 12/15/22.
1%
The fundamentals of mid caps are currently, by any
0%
measure, worse than large caps, although this hasn’t
-1% mattered much historically, as mid caps with relatively poor
fundamentals still have outperfomed in many past periods.
-2% -1.70%
Valuation has been much more predictive than
Weakest Two Quintiles Strongest Two Quintiles
of YoY Change in LEIs of YoY Change in LEIs fundamentals. Going back to 1990, each quartile of lower
relative valuation versus the overall S&P 500 proportionally
High volatility stocks are the top-quartile of stocks in the S&P 500 based on
standard deviation, measured monthly, since 1991. Relative performance is increased the odds for mid cap outperformance versus
measured by quartile versus the S&P 500. Leading indicators are measured large caps. At top quartile levels, the odds and alpha
by The Conference Board Leading Economic Index. Past performance is no
guarantee of future results. NTM is next 12 months. YoY is Year-over-Year. both look compelling to me. Said differently, the poor
Sources: Haver Analytics and Fidelity Investments, as of 11/30/22. fundamentals look likely to be priced in.
Five Allocation Ideas for 2023 | 3EXHIBIT 5: Russell Midcap vs. Top 200 EXHIBIT 6: Historical MSCI EM Index Return Relative to the
Average NTM Relative Performance in Relative Valuation S&P 500
Quartile Fwd P/E and P/B, 1990–Present 350
Relative Fwd P/E, NTM Rel Perf 300
Relative P/B, NTM Rel Perf
250
6% 5.80% 5.50%
5% 200
4% 150
3% 2.50%
2.20% 100
2% 1.50%
50
1% 1998 2002 2006 2010 2014 2018 2022
0.20%
0%
Past performance is no guarantee of future results. Relative index
-0.30%
-1% comparison is indexed to 100 using weekly return data beginning June 5,
-0.80%
1998 through December 2, 2022. Sources: FactSet and Fidelity Investments,
Q1—Cheap Q2 Q3 Q4—Expensive as of 12/2/22.
Past performance is no guarantee of future results. NTM is next 12 months.
P/E is price/earnings and P/B is price to book. Data for each is measured
monthly and compares the Russell Mid Cap Index versus the top 200 stocks
in the Russell 1000 since 1990. Sources: Haver Analytics and Fidelity
The chart above reflects that the last major downtrend
Investments, as of 11/30/22. for dollar strength, starting in roughly 2002, set the
stage for a multiyear trend of outperformance for EM
stocks versus the S&P 500 that carried through the
By Region: Watch Emerging Markets Great Recession. EM stocks then underperformed
Emerging-markets (EM) equities show the potential for more than a decade, corresponding with a
to be a strong-performing region, depending on the strengthening dollar.
relative performance of the US dollar, which began to Another reason to watch for this possible change in the
weaken in November. It’s not my highest-conviction relative trend is that Fidelity’s Asset Allocation Research
idea, but it’s on my radar. Team believes emerging markets could see the highest
A continued downtrend for the US dollar index, real (inflation-adjusted) return potential for any public
which measures the dollar exchange versus other market asset class through 2041, driven by superior
major currencies, could help set the stage for EM economic growth and better starting valuations.
to outperform versus US large caps. This makes
fundamental sense, as higher US rates and a stronger
dollar tax the economic activities in emerging markets.
A weakening dollar lowers this tax.
Five Allocation Ideas for 2023 | 4By Sector: Materials Could Shine For example, at the end of 2022, valuations in the
Energy stocks over the past two years enjoyed a metals & mining segment within materials traded at
run superior to every other sector in any other two- bottom-decile price-earnings valuations. Going back
year time frame going back to 1962. The trend may to 1976, metals & mining stocks in the bottom decile
continue to be energy’s friend. produced a 12-month rolling relative return of 14.5%,
on average, far better than any other quintile.
From my perspective, the materials sector looks even
better at the start of 2023. Much like energy, materials Conclusion:
stocks appear cheap based on price-earnings and free
Many professional investors see the S&P 500 closing
cash flow at the start of the new year. Yet unlike energy,
2023 lower for the year. It’s possible that the S&P 500
supportive valuations could offer strong potential for
could still breach lows set in the fourth quarter of 2022
alpha in certain segments, even if margins decline.
and experience meaningful volatility over roughly the
next 12 months. It’s also hard to rule out a hard landing
for the economy.
EXHIBIT 7: Metals & Mining Relative Performance in
That said, the level of pessimism I’m seeing and the
Various Valuation Quartiles & Deciles
historical market response when I’ve seen a similar
1976–Present, 12M Rolling
amount of pessimism has encouraged me to look
14.5% opportunistically for bullish opportunities. I believe
15.0%
looking at specific segments with historically low
12.0% starting valuations could increase the chances of
9.0% positive returns in 2023, and I plan on keeping an eye
6.0%
out for these types of opportunities for much of the year.
4.2%
3.2%
3.0%
0.0%
-3.0%
-6.0%
-9.0% -7.5%
-8.9%
Bottom Bottom Quartile
2 Quartile
3 Top
Decile Quartile 2 3 Quartile
Past performance is no guarantee of future results. Relative performance is
measured using a list compiled by Fidelity Investments that seeks to include
the top 3000 stocks in the US by market cap since 1976. Metals and mining
stocks within this list of 3000 is then compared with the entire list. Valuation
measured by relative forward price-earnings. All data gathered monthly.
Sources: FactSet and Fidelity Investments, as of 11/30/22.
Five Allocation Ideas for 2023 | 5Information provided in this document is for informational and educational purposes only. To the extent any investment information in this material is deemed to
be a recommendation, it is not meant to be impartial investment advice or advice in a fiduciary capacity and is not intended to be used as a primary basis for you
or your client’s investment decisions. Fidelity and its representatives may have a conflict of interest in the products or services mentioned in this material because
they have a financial interest in them, and receive compensation, directly or indirectly, in connection with the management, distribution, and/or servicing of these
products or services, including Fidelity funds, certain third-party funds and products, and certain investment services.
Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or a solicitation to buy or sell any
securities. Views expressed are as December, 2022 based on the information available at that time, and may change based on market and other conditions.
Unless otherwise noted, the opinions provided are those of the author and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume
any duty to update any of the information.
Third parties mentioned are independent entities and not affiliated with Fidelity Investments.
Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk. Nothing in this content should be considered to be legal
or tax advice, and you are encouraged to consult your own lawyer, accountant, or other advisor before making any financial decision.
Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Foreign
markets can be more volatile than US markets due to increased risks of adverse issuer, political, market, or economic developments, all of which are magnified in
emerging markets. The securities of smaller, less well known companies can be more volatile than those of larger companies.
Investing involves risk, including risk of loss.
Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. The energy
industries can be significantly affected by fluctuations in energy prices and supply and demand of energy fuels, energy conservation, the success of exploration
projects, and tax and other government regulations. The materials industries can be significantly affected by the level and volatility of commodity prices, the
exchange value of the dollar, import controls, worldwide competition, liability for environmental damage, depletion of resources, and mandated expenditures for
safety and pollution control.
Past performance is no guarantee of future results.
Diversification and asset allocation do not ensure a profit or guarantee against loss.
All indexes are unmanaged, and performance of the indexes includes reinvestment of dividends and interest income, unless otherwise noted. Indexes are not
illustrative of any particular investment, and it is not possible to invset directly in an index.
Earnings yield spread measures the differences in per-share earnings relative to the stock price per share among equities in the S&P 500 index at the 25th and
75th percentiles. Book yield spread measures the differences in the ratio of market cap of an underlying company versus its book value of equity among equities
in the S&P 500 index at the 25th and 75th percentiles.
Price to earnings measures current share price relative to per-share earnings.
Price to book is the ratio of a company’s market capitalization relative to its book value of equity, which is the sum of total assets minus intangible assets minus
total liabilities, all divided by the shares outstanding.
Alpha is the investment return above that of a benchmark, such as the S&P 500 index.
Five Allocation Ideas for 2023 | 6Author 1
Data measures the earnings of the S&P 500 in aggregate based on the sum of its components
since 1963, the forward 12-month performance of the index, then the ratio of index gains versus
Denise Chisholm losses following an annual decline in aggregate earnings, as of November 30, 2022. Sources:
Director of Quantitative Market Strategy Haver Analytics, Fidelity Investments, as of July 31, 2022.
Denise Chisholm is a market strategist in the 2
Analysis performed using monthly price data for both the S&P 500 index and West Texas
Quantitative Research and Investments (QRI) Intermediate crude oil from January 1970, as of November 30, 2022. Sources: Bloomberg
division at Fidelity Investments. In this role, she Finance L.P. and Fidelity Investments, as of November 30, 2022.
is focused on historical analysis, its application 3
High-volatility stocks defined as the most-volatile 25% of stocks in the S&P 500. Volatility
in diversified portfolio strategies, and ways as measured by the monthly standard deviation of returns over the prior 12 months. Relative
to combine investment building blocks, such valuation reflects the percentile rank vs. history of the valuation of high-volatility stocks relative
as factors, sectors, and themes. In addition to to the S&P 500. Valuation reflects equal weighted trailing price-to-earnings, forward price-to-
her research responsibilities, Ms. Chisholm is earnings, price-to-book, and price-to-free cash flow ratios, using monthly data from January 1,
a popular contributor at various Fidelity client 1991 through July 31, 2022. Sources: Haver Analytics, Fidelity Investments, as of July 31, 2022.
forums, is a LinkedIn 2020 Top Voice, and S&P 500 Index is a market capitalization-weighted index of 500 common stocks chosen for
frequently appears in the media. market size, liquidity, and industry group representation to represent US equity performance.
Prior to assuming her current responsibilities in MSCI Emerging Markets Index is a market capitalization-weighted index that is designed to
September 2020, Ms. Chisholm held multiple measure the investable equity market performance for global investors in emerging markets.
roles within Fidelity, including sector strategist,
Russell Midcap Index is a market capitalization–weighted index designed to measure the
research analyst on the Megacap Research team,
performance of the mid-cap segment of the US equity market. It contains approximately 800 of
research analyst on the International team, and
the smallest securities in the Russell 1000 Index.
sector specialist.
Russell 1000 Index is a market capitalization–weighted index designed to measure the
performance of the large-cap segment of the US equity market.
Fidelity Thought Leadership Vice President Mike
The Conference Board Leading Economic Index seeks to signal peaks and troughs of the
Tarsala provided editorial direction for this article.
business cycle. Components of this index include average weekly hours in manufacturing, average
weekly claims for unemployment insurance, and manufacturers’ new orders for consumer goods
and materials, among others.
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