Many investors are anxious for the major North American stock indices to do what they want them to do instead of what they’re actually doing.

That is not finding a bottom yet and continuing to drift lower as a recession in earnings is just getting started.

Globally, however, emerging markets (EEM:US) and Japan (EWJ:US) appear to be further ahead in the cycle as those kinds of stocks are leading the way higher.

See the hi-lights of this 2023 strategy report for which regions and countries will have the strongest returns next year and for recommendations on the types of stocks in which to invest.


by Morgan Stanley Research

Key investment ideas

• Buy early-cycle Emerging Markets (EM) and Japan equities for 11-12% returns:

Valuations are clearly cheap and cyclical winds are shifting in favour of EM as global inflation eases quicker than expected, the Fed stops hiking in January (and starts cutting in 4Q), and the US dollar rolls over.

Emerging Markets and Japan Starting to Move

Global growth troughs in 1Q with a recovery led by Asia, helped by domestic demand resilience.

MSCI EM typically outperforms in early cycle and we see 12% price returns in 2023, with 11% for Japan’s broad TOPIX index.

S&P 500 to finish at ~3,900, but it won’t be a smooth ride:

Consensus earnings are simply too high for 2023, where our estimate of US$195 implies 16% downside to consensus as companies hoard labour and see operating margins compress in a very slow growth economy.

We expect 2023 to be a rough start with a strong finish.

Bottom line, our more recent tactical bullish call for the S&P 500 to reach 4,000-4,150 will ultimately roll over, with the index likely making this bear market’s low in 1Q/23 as 2023 earnings revisions become more severe, and liquidity remains tight from the Fed’s hiking and qualitative tightening (QT) programs.


In terms of how to outperform in this environment over the next 12 months, our advice is to stay the course on our current recommendations of owning defensives and companies with high operational efficiency.

Both of these strategies have worked well all year, and we expect this to continue until the bear market lows are in.

Even during this tactical rally that has been led by the Dow and small-caps, defensives and high operational efficiency stocks have continued to outperform as well.

As evidence, our Fresh Money Buy List has outperformed the S&P 500 by 6.5% since October 13, suggesting that investors can stay the course on the defensive playbook for now even if this rally continues.

It’s also an indication that the bear market is likely not over for the reasons we mentioned – i.e., earnings risk is high.

Modest upside for European equities:

We see European equities with a 6.3% total return over 2023 as lower inflation drives a price-to-earnings (P/E) re-rating from 11.5x to 13.3x.

This should ultimately more than offset the 10% EPS decline we expect from weaker top-line growth and material margin disappointment.

We prefer financials and energy over cyclicals.


Financials and energy screen well, particularly in Europe.

In Asia/EM, we prefer Korea and Taiwan (for semis and hardware), as well as Japan, Saudi Arabia, and Brazil, and look for quality growth and small/mid-caps to take leadership after some momentum reversal.

Stay defensive in the US via healthcare, utilities, and staples.

The earnings adjustment is just starting in the US and Europe:

Earnings forecasts are now just starting to be lowered in the US and Europe, following almost two years of downgrades in China and EM, while Japan is holding on to a record-high earnings level, helped by favourable yen/US dollar translation.

We lower our forecast for S&P 500 EPS another 8% to US$195 in 2023 and stand 16% below consensus, with our 2023 forecasts for Europe 14% below consensus, versus just 2% below consensus for TOPIX and 7% above consensus for MSCI EM.

Our forecasts for each region imply a healthy 19% aggregate earnings recovery in 2024, led by the US as Fed policy and the US dollar ease, and positive operating leverage resumes.


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