If you’re relatively new to investing and think 2022 has been a year from hell, imagine being in the stock market for over 40 years.
That would have put it through the Great Financial Crisis of 2008-2009, the dot-com crash of 2000, the crash of 1987, and the savings and loan debacle of the 1980s, plus the bear of the pandemic.
If you are humble enough to learn from the tough times, you have a lot of wisdom to share. That’s the case with Bob Doll, an investment strategist I’ve enjoyed talking to 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 consulting with this seasoned market veteran, now out of retirement to work with Crossmark Global Investments, on what to do about the many crossroads facing the economy and investors today.
High-end takeaways: Stocks will be trapped in a trading range this year. It is a merchant’s market. Take advantage of it. We’re not going into a recession this year, but the odds increase to 50% by the end of 2023. Favor old school value, energy, finance and technology. (See names below.) Bonds will continue to be in a bear market as yields continue to rise, medium term, and watch out for 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 big banks like JPMorgan Chase JPM,
Bank of America BAC
and Morgan Stanley M.S.
have reported decent results.
“These companies are making money in an environment that is not the simplest in the world,” says Doll. This suggests that other companies can achieve this as well.
Meanwhile, the sentiment is dark enough to warrant optimism at this point.
“I would buy here, but not much higher,” he said on April 19, when the S&P 500 SPX
it was around 4,210.
We are certainly not seeing the surprises that we were “coddled” with for many quarters once the pandemic began to subside. (As of the morning of April 19, with 40 S&P 500 companies reporting, 77% beat earnings estimates with earnings growth averaging 6.1%.) “But it’s still very respectable, and if that continues, the stock will be fine.”
the next 12 months
We are looking at a trader’s market over the next year. Why? There is a huge tug-of-war between investors.
“Pulling hard on one end of the rope is reasonable, even though it is slowing down, economic growth and reasonable earnings growth. Pulling in the other direction is inflation and higher interest rates,” says Doll.
The push and pull will frustrate the bulls and bears.
“This is a market that is going to confuse a lot of us because it is relatively trendless,” he says.
To do: Consider negotiating. Use yourself as your own sentiment gauge.
“When your stomach doesn’t feel right because we’ve had a few bad days in a row, that’s a good time to buy stocks. On the contrary, when we have had a few good days, it is time to cut back. I want to be sensitive to the stock price.”
To put some numbers together, 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 offset was just below 4,200 around the start of the Ukraine war. Doll’s year-end price target on the S&P 500 is 4550. In theory, the trade may be safe, because we probably won’t see a bear market until mid-2023. (More on this below).
Inflation is in the process of peaking in the coming months and will be 4% at the end of the year. Part of the logic here is that supply chain problems are getting better.
Otherwise, Doll reasons that with compensation growth of 6% and productivity gains of around 2%, the result will be 4% inflation. When companies get more output from the same number of hours worked (the definition of increased productivity), they don’t feel the pressure to pass on 100% of wage earnings to protect profits.
There will be no recession this year, says Doll. Why not? The economy continues to respond to all the stimulus from last year. Interest rates remain negative in real terms (below inflation), which is encouraging. Consumers have $2.5 trillion in excess cash because they cut back on spending during the pandemic.
“I don’t think that just because the Fed starts raising rates, we have to raise the recession flag,” he says.
But if inflation falls to 4% by the end of the year, the Fed will have to continue raising interest rates and tightening monetary policy to control it, while doing so cautiously for a soft landing. This is a difficult challenge.
“The Fed is between a rock and a hard place. They have to fight inflation and they are lagging behind,” says Doll.
The result: Recession odds rise to 50% by 2023. Most likely to come in second half. This suggests the beginning of a bear market within 12 to 15 months. The stock market often trades in the future six months ahead.
Sectors and values to favor
* Value Stocks: They have outperformed growth this year, which usually happens in an environment of rising rates. But value is still a buy, as only about half of value’s advantage over growth has been realized. “I’m still leaning toward value, but I’m not hitting the table as much,” he says.
* Energy: Doll still likes the group but, in the short term, it’s worth cutting back because it seems overbought. “I think I have another chance,” she says. If she doesn’t have any, consider starting positions now. Energy names she favors include Marathon Petroleum MPC
and ConocoPhilips COP.
* Finance Doll continues to favor this group. One of the reasons is that they are cheap relative to the market. Financial P/E ratios are in the low double-digit range compared to high teens for the market. Put another way, financials trade at roughly two-thirds of market value, while they historically trade at 80%-90% of market valuation.
Banks benefit from a positively sloping yield curve as they borrow at the short end and lend at the long end. Insurers benefit from higher rates because they invest much of their float in bonds. As their bond portfolios roll over, they convert the funds back into higher-yielding bonds. Here, favor Bank of America, Visa V,
and Mastercard MA,
and MetLife MET
and AFLAC AFL
* Technology: Doll divides the technological world into three parts.
1. First, you like to trade old-school tech at relatively cheap valuations. Think Intel INTC,
and AMAT Applied Materials.
Borrowing a phrase from the world of bonds, Doll describes them as “low duration” tech companies. This means that many of your long-term gains come here and now, or in the very short-term future. That makes them less sensitive to rising interest rates, just like short duration bonds. “These are not the brightest lights for the next decade, but stocks are cheap.”
2. Next, Doll favors established mega-cap technology like Microsoft MSFT
and Apple AAPL
about Netflix NFLX,
and the father of Facebook Meta Platforms FB.
3. You’re avoiding “long life” technology. This means tech start-ups that now make little or no money. The lion’s share of your earnings is in the distant future. Like long duration bonds, these are the ones that suffer the most in an environment of rising interest rates such as the one we find ourselves in.
what else to avoid
In addition to long-lived technology, Doll is underweight utilities and communications companies. Fixed income is also an area to avoid because we haven’t seen the high bond yields for the cycle. (Bond yields rise as bond prices fall.) With 8% inflation, even a 10-year 2.9% yield is meaningless. He says the 10-year bond yield will be in the 3% range.
In the short term, bonds could bounce higher because they seem oversold.
“We could be in for a fixed income riot,” he says. “It’s hard to find someone bullish on bonds. When everyone is on one side of 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 has suggested BLK, JPM, BAC, MS, MPC, MA, MET, AFL, INTC, MSFT, APPL, NFLX, AMZN and FB in his stock newsletter Brush Up on Stocks. Follow him on Twitter @mbrushstocks.