Sameer Samana is a senior global market strategist for Wells Fargo Investment Institute, the global investment strategy arm of Wells Fargo Bank. Read on as we ask Samana about opportunities in the current market, as well as the phases of a bear market and which sectors to avoid.
What’s your outlook for the stock market in the second half of 2023? The analogy I’d use is that it’s like looking out over a valley. Once you’re on the other side, you’ll be on level ground around the same height. Topographically, you’ll probably descend into a valley, then spend the latter half of the year climbing back up. For markets, that means we’re range bound, but the risk will be to the downside. Our year-end target for the S&P 500 is 4,000 to 4,200.
We’re within spitting distance of that, but we’d caution people against assuming a calm, uneventful journey. It could be more of a harrowing ride down and then back up, as opposed to sideways.
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Has the market seen its bear-market low? It’s hard to tell. We try our best to think about the fundamentals and the economy, and whether those underpinnings are getting better or worse. Right now, those underpinnings are still weakening. We see corporate profitability trends, economic trends and liquidity trends heading in the wrong direction – we still think that things are deteriorating.
That said, since the market started this journey in early 2022, the S&P 500 is about 700 points lower. It wouldn’t surprise us if we revisited recent lows between 3,500 and 3,700, but we’ve probably seen the worst of the drawdown.
You’ve talked before about the phases of a bear market. Where are we now? There are three major phases. The most troubling is the initial drawdown. We saw a good bit of that in the latter part of 2022. Phase two is the consolidation phase, when you spend time in a pretty wide range. The bulls see the market climbing a wall of worry; the bears see it setting up for the next round of disappointments.
That’s the lay of the land now. We’ll go back and forth between those two camps. When we get toward the upper range, headwinds start blowing harder and you find fewer bulls. Get to the lower end, and tailwinds start blowing and the bears become fewer because valuations are improving. That’s going to be the game plan for the rest of the year.
What’s phase three? Phase three is when the pieces that we’re looking for fall into place – the outlooks for profits and the economy improve, and inflation comes under control. That’s when the market will break out of its range – let’s call the upper end 4,200 to 4,300.
When we see levels significantly higher than that, that would sound the all-clear. We don’t think that happens until the third or fourth quarter, but we wouldn’t wait to put money to work. Because the worst of the downturn is over, we want to accumulate high-quality stocks and fixed-income investments, especially when yields go up and stocks sell off.
Do you expect a recession? We expect a moderate recession in the second half that bleeds into early 2024. It will probably have to be more than a mild recession to solve the problem of inflation, and that’s what’s driving markets. Inflation is the straw that stirs the market’s drink.
Where do you see interest rates headed? We think the Federal Reserve is close to being done, but I’m not sure we’ll see yields fall all that quickly. The Fed has been saying they’re going to take rates up and keep them up. The market has been too optimistic about how quickly inflation will resolve and how quickly the Fed will pivot from hikes to cuts.
We don’t think cuts come until the first part of 2024. Remember, this is the Fed that made the mistake of calling inflation “transitory.” The onus is on them not to declare premature victory – that would be the worst-case scenario for this Fed.
We’re already in a corporate earnings recession (two quarters of earnings declines). Is that a big deal? It is. The consensus of analysts expects earnings to pop back up after a weak first quarter. We think that’s too optimistic. The reason we think earnings will keep deteriorating has a lot to do with how profit margins will evolve.
Once a recession gets under way in the second half of the year, revenues will start to fall. Unfortunately, for companies, costs will be a lot more stubborn, which means margins will contract. So revenues will fall, but earnings will fall faster. I don’t see profitability improving until early to mid 2024.
What should investors do? We want to play defense, but not like during the worst of the downturn. A trading range is a good opportunity to employ tools like dollar-cost averaging [investing like amounts at regular intervals].
Investors should favor large-company U.S. stocks, and with fixed income, we’d favor high-quality Treasuries, adding some duration risk opportunistically as rates jump up.
When you say “add duration risk,” that means lock in longer-term rates? Exactly. The yields we’re seeing now on longer-term fixed income are at the upper end of the recent historical range. If anything, as a recession gets under way, some of those yields will melt lower once again.
And stocks? Try to favor sectors with durable demand and high-quality companies, with high profitability, strong balance sheets and wide economic moats that allow them to have stronger competitive positions. I would highlight three sectors: energy, healthcare and tech. All three should have some resiliency in the midst of a recession.
What sectors would you avoid? Sectors we think are most vulnerable are consumer discretionary [nonessential consumer goods and services] and real estate. Consumers will feel a little more shaky as the economy weakens. And although people are going back to work and shopping in person, it’s just not back to where we were before the pandemic. A lot of these more leveraged real estate properties will continue to struggle.
What about international markets? We’re warming up to some areas. Clearly last year wasn’t as bad as anticipated in Europe – it dodged an energy crisis. And there are some good, high-quality European and Japanese companies that would fit this quality characteristic we’re looking for.
The tricky part is the direction of the dollar. We’ll look to pick our spots in developed markets. We feel differently about emerging markets. We’ve never had a Fed rate-hiking cycle when we didn’t see some of the weaker emerging markets start to break, financially. We think that lies ahead of us. We’re also cautious about China economically and geopolitically.
When should investors switch from defense to offense? You can do it when the market falls to a price where the risk-reward ratio turns favorable. The 3,500-to-3,700 zone on the S&P 500 seems to be a good enough spot, where we think you get paid to take the risk in equities. Or you can do it closer to or in the middle of a recession.
When others start to get fearful, that’s when we’d be greedy. Right now, we don’t see any of those signs. But I will say, this is a time when you want to be very nimble. Keep your head on a swivel. Our best guess is that the market bottoms somewhere in the third or fourth quarter. But we want to make sure we’re coming in every day with an open mind.
Note: This item first appeared in Kiplinger’s Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.
