What’s next for the markets after a year unlike any seen in a generation? Investors from BlackRock Fundamental Equities sat down to discuss the outlook for inflation, growth and value investing styles, and key industries.
in the most recent BlackRock Fundamental Equities’ episode Expert to Expert Series, three active equity investors discussed the dynamics weighing on the markets, their views on growth and value stocks, and the outlook for the energy and technology sectors. They recounted stories from their own experience and reflected on the findings of a recent investor survey. We capture elements of their conversation here.
More time, more optimism?
In a year when it was easy to be bearish, a BlackRock Fundamental Equities survey of more than 1,000 individual US investors revealed potential signs of optimism, along with some interesting shifts in sentiment by generation. Millennials were more comfortable raising capital allocations this year, with 45% of May respondents revealing they increased their exposure, far ahead of Gen Xers (25%) and Boomers (11%). And 49% of Millennials found themselves adding more in the next six months.
Caroline Bottinelli, research analyst and portfolio manager for the US growth team, sees two dynamics at play. The first was a shorter memory, which potentially translated into less fear:
“Investors of my generation have not seen a period of sustained high inflation in their lives, as the forces of globalization, technology and demographics have put downward pressure on inflation and rates over the last 40 years” . This, Bottinelli suggests, may make younger investors more inclined to believe the Fed will back away from rate hikes, which would be positive for equities.
The second factor: the recognition of a longer investment horizon, which means more time to recover compounded profits and losses, which, according to Ms. Bottinelli, is the real driver of long-term returns. “And we know that missing just a handful of the best days in the market can have a significantly negative impact on those returns,” she says, defending the market’s “timing, not timing” wisdom.
Tony DeSpirito, CIO of US Fundamental Equities, reflected on his 30 years in the market: “I’ve lived through multiple bear markets… 1990, 2000, 2008. At the time, they all seemed huge and pretty scary… but when you look at some historical perspective, it’s starting to look like small bumps on the road to good long-term returns.
Debate on the risks of inflation and recession
All generations focused on inflation as the biggest risk to the market over the next six months, according to the survey. Will it remain the dominant risk heading into 2023?
Inflation is what is driving the Fed’s rate hikes, says Ms Bottinelli, and thus remains the markets’ nightmare. “If inflation starts to moderate, it gives the Fed room to pause. My concern is that the inflation we’re seeing right now is supply-driven and broad-based,” she says. And that could mean the Fed’s tools are insufficient to tame it without throwing the economy into recession.
Mr. DeSpirito suggests that inflation may have peaked for the cycle, but may be slow to slow. He points out that the Fed’s desired “soft landing” — curbing inflation without sinking the economy — is difficult to achieve and historically unlikely.
“Rate hikes affect the real economy with a delay of at least six months. But most economists would say something more like 18 months,” he says. “So I think there’s a very good chance that the Fed will overdo it and we’ll end up in a recession.”
From style preference to style parity
With inflation and recession in play as major market risks, investors explored what this could mean for growth and value investing styles. Historical performance shows that value tends to lead in inflationary environments, while growth generally has an advantage in slowing economies.
With both risks in view, Mr. DeSpirito says it’s important to have both investment styles well represented in today’s portfolios. A recent Fundamental Equities analysis of a 50/50 mix of the top growth and value quintiles in the Russell 1000 Index showed that the hypothetical mix is more attractively priced than the broader market.
“What it’s telling you is that stocks in the middle are actually very expensive,” explains Mr. DeSpirito. “And historically from this starting point, it (potentially) does very well at combining growth and value.”
See the fourth quarter issue of Taking Stock for the full analysis.
Review of the upper and lower sectors of 2022
A conversation about the past year would not be complete without a look at the key sectors of the market. Will Su, co-director of research for the earnings and value team, offered his outlook for the S&P 500’s best-performing and only positive sector as of Oct. 5: energy. See the chart below.
S&P 500 Sector Performance, 2022
Total return year to date
Mr. Su emphasizes that there are many nuances in the outlook for sustainability and energy, but he sees the European winter as a turning point in the overall discussion, as the continent faces dire forecasts of energy shortages.
“Pushing too quickly into intermittent renewables without them scaling up first is a recipe for inflation and energy insecurity,” he says.
Against this background, Mr. Su sees an opportunity in natural gas given its role as a viable and cleaner form of energy in the coming decades, replacing coal and other carbon-intensive fuels. He also sees some of the largest oil and gas companies playing a key role in the energy transition.
At the other end of the return continuum, Ms. Bottinelli shared her perspective for technology, a sector that bore much of the market pain in 2022 after making a strong comeback during the global acceleration of digitization amid COVID-19. 19:
“The tech sector has a lot of these children of the growth stock cartel where earnings have been supercharged during the pandemic and higher rates have had a significant impact on valuations. But… the secular tailwinds that drive these businesses continue.
Ms Bottinelli is bullish on the tech sector in the long term, describing current prices as a more attractive entry point. But it is important to “pick your spots” as the macro context still poses a risk. This, all three agree, points to the importance of active management.
Active management is about studying history, studying current data, but then adding judgment to that. Because the data and the history do not see around the corner. Human judgment yes. This is how we can add value as active investors.
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The survey referenced herein was conducted online in January and May 2022. Respondents (1,083 in January and 1,091 in May) were Americans over the age of 25 with a minimum of $250,000 in investable assets. The survey was conducted by Material Holdings, an independent research company.
This material should not be relied upon as investment forecasts, research or advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Opinions expressed are as of October 2022 and may change as subsequent conditions vary. The information and opinions contained in this publication are derived from proprietary and non-proprietary sources that BlackRock believes to be reliable, are not necessarily exhaustive, and their accuracy is not guaranteed. As such, no guarantee of accuracy or reliability is made and BlackRock, its officers, employees or agents accept no liability otherwise arising from errors and omissions (including liability to any person for negligence). This publication may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that the forecasts made will be fulfilled. Reliance on the information in this publication is at the discretion of the reader. Past performance is not a guarantee of future results.
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This post originally appeared on iShares Market Insights.
Publisher’s note: The bullet points in this article were chosen by the editors of Seeking Alpha.