City analysts have begun issuing forecasts for 2023, and one has included a bunch of well-known UK companies in its list of stocks to watch over the next 12 months.
Growth stocks in 2023 have been backed for recovery after enduring their worst relative performance since 2000 during the storm caused by rising inflation and bond yields.
Morgan Stanley favours a GARP approach (growth at a reasonable price) over a broad sweep of speculative stocks, given that it expects the fall back in yields to be moderate next year.
It has already shifted the Medical Technology and Software sectors to “overweight” recommendations and is positive on luxury goods given its pro-growth and emerging markets exposure.
Overweight-rated stocks in the bank’s growth coverage, and where valuation ratios are in the bottom of their 10-year range include Segro (LSE:SGRO), London Stock Exchange Group (LSE:LSEG) and DCC (LSE:DCC).
Looking to 2023 across European equities, the bank believes the bull-bear skew is positive for the first time since the middle of 2021.
However, it believes it is too soon to start a large-scale cyclical rotation as there is more 'wood to chop' in terms of economic and earnings disappointments. The US bank expects a 10% decline in earnings per share (EPS) in 2023.
The verdict comes amid renewed market optimism after October’s US inflation print surprised on the downside, fuelling hopes that the Federal Reserve is near the top of its rate hiking cycle.
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Sentiment has improved significantly since 12 October, with the S&P 500 index up 11% and European markets also rebounding following a wretched year for investors.
The region’s recovery has been led by the FTSE 250 index, which is up 18.1% over the past month after the mood towards UK stocks also benefited from the reversal of tax cuts in September’s mini-budget. Despite the recent progress, the benchmark is still 16% lower in the year to date.
After factoring in the recent rally, Morgan Stanley’s base case target for European equities, including the UK, offers a further 3% upside by December 2023. That’s based on a forward price/earnings (PE) ratio of 13.3 and factoring in its forecast for a 10% reduction in EPS. Its bull case scenario, which uses a PE of 13.5 and flat earnings, implies upside of 18.4%.
The bank notes that equities usually trough just ahead of earnings revisions, adding that consensus forecasts are still far too optimistic based on the significant margin risk ahead.
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In terms of its positioning, the bank said a peaking US dollar should mean favouring emerging over developed markets next year. Its overweight list of European companies with above-average exposure to the Asia/EM region includes Shell (LSE:SHEL), BP (LSE:BP.), British American Tobacco (LSE:BATS) and Glencore (LSE:GLEN).
And after record underperformance this year, it expects that a shift in foreign exchange trends and falling inflation should boost small and mid-caps over large-caps.
On the FTSE 100, the bank no longer recommends an overweight position. But for investors willing to take a longer view, it says stocks that look cheap in the context of the last decade include DCC (LSE:DCC), BT Group (LSE:BT.A), 3i (LSE:III), Land Securities (LSE:LAND), British Land Co (LSE:BLND), NatWest Group (LSE:NWG) and St James's Place (LSE:STJ).
It also stays underweight on cyclicals due to the greater earnings per share risk.
While the macro backdrop favours a tactical rotation back into growth, Morgan Stanley believes the longer-term outlook still offers encouragement for value investors.
With capital scarcity likely to remain a theme for next year, it believes that stocks with a healthy free cash flow (FCF) yield should be in demand. It points out that this has been the best-performing Value factor in periods of economic recession and falling bond yields.
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Overweight rated stocks where Morgan Stanley analysts forecast a high FCF yield for 2023 include Harbour Energy (LSE:HBR), British American Tobacco (LSE:BATS), Glencore (LSE:GLEN), BP (LSE:BP.) and Shell (LSE:SHEL).
Although banks and energy companies may give back some of this year's outperformance as investors rotate back towards growth stocks, Morgan Stanley continues to like the medium-term outlook and would use any near-term underperformance to add exposure.
At 5-6 times forward earnings, it points out that both sectors continue to look very cheap alongside positive earnings momentum and attractive capital returns.
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