If you’re relatively new to investing, and you think 2022 has been a year from hell, imagine being in the stock market for over 40 years.
That would’ve put you through the Great Financial Crisis in 2008-2009, the dot-com crash in 2000, the crash of 1987, and the savings and loan debacle of the 1980s — besides the pandemic bear.
If you’re humble enough to learn from the rough times, you’ve got a lot of wisdom to share. That’s the case with Bob Doll, an investment strategist I’ve enjoyed talking with 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 out of retirement to work with Crossmark Global Investments — about what to make of the many crossroads facing the economy and investors today.
High-level takeaways: Stocks will be trapped in a trading range this year. It’s a trader’s market. Take advantage of it. We’re not going into recession this year, but the odds increase to 50% for late 2023. Favor value, energy, financials and old-school tech. (See the names, below.) Bonds will continue in a bear market as yields keep rising, medium term, and be careful with utilities.
Now for more detail.
The here and now
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 MS have reported decent results.
“These companies are making money in not the simplest environment in the world,” says Doll. This suggests that other companies may pull this off, too.
Meanwhile, sentiment is dark enough to warrant bullishness right now.
“I’d buy here, but not too much higher,” he said April 19, when the S&P 500 SPX was at around 4,210.
To be sure, we aren’t seeing the surprises we “got spoiled with” for many quarters once the pandemic started to ease. (As of the morning of April 19, with 40 S&P 500 companies reporting, 77% beat earnings estimates with an average of 6.1% earnings growth.) “But it is still very respectable, and if that continues stocks will be OK.”
The next 12 months
We are looking at a trader’s market over the next year. Why? There is a big tug-of-war among investors.
“Pulling hard at one end of the rope is reasonable, albeit slowing, economic growth and reasonable earnings growth. Pulling in the other direction is inflation and higher interest rates,” says Doll.
The tug of war will frustrate bulls and bears.
“This is a market that is going to confuse a lot of us because it is relatively trendless,” he says.
What to do: Consider trading. Use yourself as your own sentiment indicator.
“When your stomach doesn’t feel good because we had a few bad days in a row, that is a good time to buy stocks. Conversely, when we have had a few good days, it is time to trim. I want to be price-sensitive on stocks.”
To put some numbers on it, it could well be that the high for the year was an S&P 500 at 4,800 in early January, and the low for the year was when the comp was just below 4,200 around the start of the Ukraine war. Doll’s year-end price target on the S&P 500 is 4,550. Trading may theoretically 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 over the next few months, and it will be 4% by yearend. Part of the logic here is that supply chain issues are improving.
Otherwise, Doll reasons that with compensation growing at 6% and productivity gains of around 2%, the outcome will be 4% inflation. When companies get more product out of the same number of hours worked (the definition of rising productivity), they do not feel pressure to pass on 100% of wage gains to protect profits.
There won’t be a recession this year, Doll says. Why not? The economy is still responding to all the stimulus from last year. Interest rates are still negative in real terms (below inflation), which is stimulative. Consumers have $2.5 trillion in excess cash because they hunkered down on spending during the pandemic.
“I don’t think just because 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 tame it — while doing so gingerly to finesse a soft landing. This is a tough challenge.
“The Fed is between a rock and a hard place. They have to fight inflation and they are behind the curve,” Doll says.
The upshot: The odds of recession rise to 50% for 2023. It will more likely come in the second half. This suggests the start of a bear market 12 to 15 months from now. The stock market often prices in the future six months in advance.
Sectors and stocks to favor
* Value stocks: They have outperformed growth this year, which typically 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 am not pounding the table as much,” he says.
* Energy: Doll still likes the group, but, short term, it’s worth trimming because it looks overbought. “I think I get another chance,” he says. If you don’t own any, consider starting positions now. Energy names he favors include Marathon Petroleum MPC and ConocoPhilips COP.
* Financials Doll continues to favor this group. One reason is they are cheap relative to the market. Price-to-earnings ratios on financials are in the low double-digit range compared to the high teens for the market. Put another way, financials trade at about two-thirds of the market value, whereas historically they trade at 80%-90% of the market’s valuation.
Banks benefit from an upward sloping yield curve since they borrow at the short end and lend at the long end. Insurers benefit from rising rates because they invest so much of their float in bonds. As their bond portfolios turn over, they roll the funds back into bonds with higher yields. Here, he favors Bank of America, Visa V, and Mastercard MA, and MetLife MET and AFLAC AFL in insurance.
* Technology: Doll divides the tech world into three parts.
1. First, he likes old-school tech trading at relatively cheap valuations. Think Intel INTC, Cisco CSCO and Applied Materials AMAT. Borrowing a phrase from the world of bonds, Doll describes these as “low duration” tech companies. This means a lot of their long-term earnings arrive in the here and now, or the very near-term future. That makes them less sensitive to rising interest rates, just as low duration bonds are. “These are not the brightest lights for the next decade, but the stocks are cheap.”
2. Next, Doll favors established mega-cap tech like Microsoft MSFT and Apple AAPL over Netflix NFLX, Amazon.com AMZN and Facebook parent Meta Platforms FB.
3. He’s avoiding “long duration” technology. This means emerging tech companies that earn little to no money now. The lion’s share of their earnings is in the distant future. Just like long duration bonds, these suffer the most in a rising rate environment like the one we are in.
What else to avoid
Besides long duration technology, Doll underweights utilities and communication services companies. Fixed income is also an area to avoid because we have not seen the high in bond yields for the cycle. (Bond yields rise as bond prices fall.) With inflation at 8%, even a 2.9% 10-year yield doesn’t make sense. He says the 10-year bond yield will go well into the 3% range.
Near term, bonds could bounce higher because they look oversold.
“We could be in a fixed-income riot,” he says. “It is hard to find anyone bullish on bonds. When everybody is on one side of the trade, you never know where it is 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.