If you’re relatively new to investing and think 2022 has been a hellish year, imagine you’ve been in the stock market for over 40 years.
It would have taken you through the Great Financial Crisis in 2008-2009, the dot-com crash of 2000, the crash of 1987, and the savings and loans debacle of the 1980s – in addition to the pandemic bear.
If you are humble enough to learn from tough times, you have a lot of wisdom to share. This is the case of Bob Doll, an investment strategist with whom I have enjoyed talking for years. His impressive resume includes stints as chief investment officer at Merrill Lynch Investment Managers and OppenheimerFunds, and chief equity strategist at BlackRock BLK,
So it’s worth checking in with this seasoned market veteran – now retired to work with Crossmark Global Investments – what to do about the many crossroads facing the economy and investors today.
High-level takeaways: Stocks will be trapped in a trading range this year. It is a traders market. Take it to your advantage. We won’t go into a recession this year, but the odds increase to 50% by the end of 2023. Favor value, energy, finance, and old-school tech. (See names below.) Bonds will continue in a bear market as yields continue to rise, medium term, and be careful with utilities.
Now for more details.
The here and now
The earnings season takes over as the driving force. So far, so good. By this he means that the big banks like JPMorgan Chase JPM,
Bank of America BAC,
and Morgan Stanley MS,
reported decent results.
“These companies are making money in an environment that’s not the easiest in the world,” Doll says. This suggests that other companies could achieve this as well.
Meanwhile, sentiment is gloomy enough to warrant an uptick right now.
“I would buy here, but not too high,” he said on April 19, when the S&P 500 SPX,
was around 4,210.
Granted, we don’t see the surprises that we were “spoiled” with for many quarters once the pandemic began to abate. (As of the morning of April 19, with 40 S&P 500 companies reporting, 77% exceeded earnings estimates with average earnings growth of 6.1%.) “But it’s still very respectable, and if it continues, stocks will do well.”
The next 12 months
We are looking at a traders market over the next year. Why? There is a big showdown between investors.
“Pulling hard at one end of the rope is reasonable, albeit slowing, economic growth and reasonable earnings growth. Inflation and higher interest rates are pulling the other way,” says Doll.
The tussle will frustrate both bulls and bears.
“It’s a market that will confuse a lot of us because it’s relatively trendless,” he says.
What to do: Consider negotiating. Use yourself as your own sentiment indicator.
“When your stomach doesn’t feel good because we’ve had a few bad days in a row, it’s a good time to buy stocks. Conversely, when you’ve had a few good days, it’s time to prune. I want to be sensitive to stock prices.
To put some numbers on this, it could well be that the high of the year was an S&P 500 at 4,800 in early January, and the low of the year was when the comp was just below 4,200 at the start of the Ukrainian War. Doll’s year-end price target on the S&P 500 is 4,550. Trading can theoretically be safe, as we likely won’t see a bear market until mid-2023. (More on that below.)
Inflation is on track to peak over the next few months and will be 4% by the end of the year. Part of the logic here is that supply chain issues are getting better.
Otherwise, Doll explains that with wages growing by 6% and productivity gains of around 2%, the result will be inflation of 4%. When companies get more product from the same number of hours worked (the definition of increased productivity), they don’t feel compelled to pass on 100% of the wage gains to protect their profits.
There will be no recession this year, Doll said. Why not? The economy is still responding to all of the stimulus from last year. Interest rates are still negative in real terms (below inflation), which is encouraging. Consumers have $2.5 trillion in excess cash because they cut spending during the pandemic.
“I don’t think it’s because the Fed starts raising rates that we need to raise the recession flag,” he says.
But if inflation falls to 4% by the end of the year, the Fed will have to keep raising interest rates and tightening monetary policy to tame it, while doing so carefully to fine-tune a soft landing. It is a difficult challenge.
“The Fed is between a rock and a hard place. They have to fight inflation and they are behind schedule,” Doll says.
The result: The probability of a recession increases to 50% for 2023. It will most likely occur in the second half of the year. This suggests the start of a bear market in the next 12-15 months. The stock market often price in the future six months ahead.
Sectors and values to favor
* Value stocks: They have outperformed growth this year, which usually happens in a rising rate environment. But value is still a buy, since only about half of the value advantage over growth has been realized. “I still lean towards value, but I don’t beat the table as much,” he says.
* Energy: Doll still likes the band, but in the short term it’s worth cutting it because it seems overbought. “I think I have another chance,” he said. If you don’t have one, consider starting positions now. Favorite energy names include Marathon Petroleum MPC,
and ConocoPhilips COP,
* finance Doll continues to favor this group. One of the reasons is that they are cheap compared to the market. Price-to-earnings ratios for financials are in the low double-digit range relative to the high teens in the market. In other words, financials are trading at around two-thirds of market value, whereas historically they are trading at 80% to 90% of market valuation.
Banks benefit from an upward sloping yield curve as they borrow short and lend long. Insurers benefit from rising rates because they invest a large part of their fleet in bonds. As their bond portfolios turn over, they shift funds to higher-yielding bonds. Here, he favors Bank of America, Visa V,
and Mastercard MA,
and MetLife MET,
and AFLAC AFL,
* Technology: Doll divides the world of technology into three parts.
1. First, he likes old-school tech trading at relatively cheap valuations. Think Intel INTC,
and Applied Materials AMAT,
Borrowing a phrase from the world of bonds, Doll describes them as “short duration” tech companies. This means that much of their long-term income is coming in here and now, or in the very near-term future. This makes them less sensitive to rising interest rates, as are low duration bonds. “Not the brightest lights of the next decade, but stocks are cheap.”
2. Next, Doll favors established mega-cap technologies like Microsoft MSFT,
and parent Facebook Meta Platforms FB,
3. It avoids “long life” technology. This means emerging tech companies that are making little to no money now. The lion’s share of their income is in the distant future. Like long-dated bonds, these suffer the most in a rising rate environment like the one we find ourselves in.
What else to avoid
Besides long-running technology, Doll is underweight utilities and communication services companies. Fixed income is also an area to avoid, as we haven’t seen high bond yields for the cycle. (Bond yields rise as bond prices fall.) With inflation at 8%, even a 10-year yield of 2.9% doesn’t make sense. He says the 10-year bond yield will be well within the 3% range.
In the short term, bonds could rebound as they appear oversold.
“We could be in for a fixed income riot,” he says. “It’s hard to find someone bullish on bonds. When everyone’s on one side of the trade, you never know where it’s going.
Michael Brush is a columnist for MarketWatch. At the time of publication, he owned MSFT, APPL, NFLX, AMZN and FB. Brush suggested BLK, JPM, BAC, MS, MPC, MA, MET, AFL, INTC, MSFT, APPL, NFLX, AMZN, and FB in his newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.