3 Charts Explaining Why 2023 Should be a Better Year for Stocks
Stocks are much cheaper, tend to bounce back after a bad year, and ‘year 3’ of the presidential cycle is overwhelmingly positive
High inflation. Increasing interest rates. Recession fears. These are all good reasons why one should be cautious when investing in stocks during the upcoming year. Last year I predicted why 2022 was probably going to be a bad year for stocks. That turned out to be a good call, with the S&P 500 down by over 19 percent. I explained my reasoning in three charts. I’ve updated two of them, and included a new one, to show why 2023 could be a good year for stocks. One caveat that I’ve previously written about: it isn’t easy to make accurate predictions.
Reason 1: Stocks are Much Cheaper Than Last Year
Nobel laureate Bob Shiller and co-author John Campbell conducted research that suggested that when valuation metrics are high, the stock market outlook is not favorable. They created a metric popularized as Shiller’s CAPE. CAPE stands for cyclically-adjusted price-earnings. The ratio takes the current price level of the S&P 500 index and divides it by the average of the past ten years of earnings for these 500 firms. The metric differs from the typical trailing price-earnings multiple that is based on last year’s earnings. Here’s what the chart looks like, back to 1881.
The long-term average CAPE is 17.3 times. Last year it was more than double that, around 38.3 times. The all-time peak of 44.2 times occurred in 2000, just before the bursting of the dot-com bubble. Prior to that record level, the previous one occurred in 1929, just before the Great Depression and major stock market decline. The CAPE has been consistently above its long-term trend for thirteen years. It now stands at 28.3 times. The good news is that CAPE decreased by over 26 percent over the past year. While still not cheap, stocks are much more fairly priced than a year ago, suggesting a much less dangerous overvaluation situation. The one danger is if earnings drop, which will cause a higher multiple. We…