Wells Fargo Cuts 2023 Stock Forecast

Wells Fargo Investment Institute has lowered its U.S. equities year-end price targets to reflect its view that unexpectedly strong economic data will prompt the Federal Reserve to keep interest rates higher for longer and push a moderate and relatively brief recession to later in 2023.

Wells Fargo analysts now expect the S&P 500 to end the year somewhere in a range from 4,000 to 4,200, down from their previous 4,300 to 4,500 target.

They see the Russell Midcap Index ending the year at 2,700 to 2,900, compared with the previous 2,900 to 3,100 target range, and the Russell 2000 Index to close the year at 1,750 to 1,950, compared with the previous 1,800 to 2,000 target.

Wells Fargo also now expects the Fed's benchmark interest rate at year end to reach the 5.25% to 5.5% range, well above the previous 3.5% to 3.75% forecast.

"The flourish of late-2022 consumer spending and job gains buoyed equity markets early in 2023, but the broader economy is trending slower. As the economy weakens, we expect Wall Street analysts to revise earnings lower, which suggests a more volatile year for equity prices, and one that could potentially allow investors to be more opportunistic," the analysts said in a note Thursday.

"Federal Reserve policy adds potential disappointment that could cement a trading range for 2023. The fixed-income markets now have fully priced in the expectation for further Fed interest rate increases in March, May and June, but it's not clear how quickly equity investors will acknowledge even-higher-for-longer interest rates," they added.

"Financial markets appear to need more time to admit the unpleasant arithmetic of a weakening economy and higher interest rates. We believe the tug-of-war between denial and acceptance of these trends in markets is shaping this as a year that could potentially see a broad trading range — in other words, significant rallies and pullbacks but with no real direction."

Wells Fargo lowered its 2023 year-end gross domestic product growth target to 1.1% from 1.3% and raised its estimate for the December 2023 Consumer Price Index inflation change from December 2022 to 2.9% from 2.2%.

Fed Rate Likely Higher for Longer

"We maintain our outlook for recession, recovery and rebound over the coming 12 months, but expect that the strong finish to 2022 probably postpones the main economic weakness by enough that the Fed isn't likely to cut interest rates this year, and that equity markets aren't likely to begin pricing a recovery and rebound until year-end 2023," Wells Fargo said.

"Somewhat higher Fed rates, and no expectation of rate cuts this year, support our view that the dollar is unlikely to resume its former uptrend. Our outlook is for the dollar to trade around recent levels — below its 2022 highs," the firm added. "Separately, the underperformance of many fixed-income assets since last year has created higher yields and improved opportunities."

The market hasn't fully priced in declining earnings in the majority of cyclically oriented sectors, so Wells Fargo continues to favor "quality sectors" such as information technology, health care and energy, "when we believe their risk-reward balance becomes more attractive — at or near the lower end of their trading ranges," the note said.

The firm looks for opportunities to add more broadly to cyclical equity sectors "once we see evidence that investors have acknowledged the full impact of a slower economy — and earnings closer to our target — and higher-for-longer rates."

In the U.S. taxable investment-grade fixed income market, Wells Fargo upgraded government and Treasury securities to favorable from unfavorable, upgraded the securitized sector to neutral from unfavorable, and residential mortgage-backed securities to neutral from unfavorable. The firm downgraded commercial mortgage-backed securities to neutral from favorable.

It also upgraded non-U.S. developed market fixed income to neutral from unfavorable.

On Wednesday, Vanguard updated its 2023 economic outlook, similarly citing strong economy activity that could prompt the Fed to keep raising interest rates and postpone a recession. Vanguard now expects the Fed's target interest rate peaking the 5.5% to 5.75% range and continues to expect a shallow recession late this year, with odds for a "later landing" increased.

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