Despite a positive earnings picture, the overall macro backdrop has become less favorable for the equity market, Bob Doll observes in a first quarter update to his annual top 10 predictions.
Doll, Chief Investment Officer at faith-based investment firm Crossmark Global Investments, noted at the beginning of the year that this year’s theme is a “tug of war between earnings tailwinds and valuation headwinds,” and that appears to be holding true. “The combination of elevated market valuations, revenue and earnings growth losing steam, a war and higher oil prices, and rising bond yields point to a more difficult year with more frequent pullbacks and higher volatility,” Doll says in his Q1 update.
War and Inflation
In addition to the S&P suffering its first quarterly decline since the low point of the pandemic in 2020, the biggest development of the first quarter was the “dramatic repricing” of the Fed rate hike path and expectations for an earlier start to and more aggressive balance sheet runoff phase, Doll observes. “The hawkish Fed policy shift drove a big backup in bond yields, and Treasuries suffered one of their worst quarters on record. In addition, geopolitical tensions became a much bigger issue for the market as the quarter witnessed Russia’s invasion of Ukraine,” he writes.
Doll adds that it remains to be seen whether equities can sustain recent advances against a backdrop of high and risking bond market volatility. During the last economic expansion, equities benefited from low inflation and central banks’ policy support whenever investor confidence sagged, but there is no such latitude today, he notes. Moreover, central banks now face the prospect of having to engineer slower growth to tame inflation.
Still, Doll believes there is a low probability of a U.S. recession developing this year. “Despite high inflation, U.S. consumer spending should remain strong in the year ahead, buttressed by a strong job market, healthy balance sheets and the reopening of the service sector as COVID headwinds fade,” he says.
Doll expects volatility to remain a feature of capital markets. His firm continues to recommend a weighting in stocks, underweight in bonds (notwithstanding their view of a positive short-term trade) and overweight in cash. In addition, valuation will be of “paramount importance” in positioning equity portfolios, he says, believing that it makes sense to lean modestly in favor of value/cyclicals.
As for his January predictions, Doll says that so far, three are heading in the “right direction,” none is heading in the “wrong direction,” and that it’s “too soon or too close to call” for the remaining seven.
- U.S. real growth and inflation remain above-trend but decline from 2021 levels—while looking acceptable with the prediction so far, it’s still too early to call, as the year still has eight months to go.
- Inflation falls, but core inflation remains stuck at around 3%—too early to call, as inflation has yet to peak, but Doll still feels good about this prediction.
- For the first time since 1958/1959, 10-year Treasuries provide a second consecutive year of negative returns—heading in the right direction.
- Stocks experience their first 10% correction since the pandemic and fail to make the gains that are widely expected—noting that the first half of the prediction is in the “history books,” it’s too early to determine whether the second half will pan out.
- Cyclical, value and small stocks outperform defensive, growth and large stocks—while growth stocks did better than value stocks in March and big has modestly outperformed small, it’s still too early to call.
- Financial and energy outperform utilities and communication services—heading in the right direction.
- International stocks outperform the U.S. for only the second year in the last decade—too early to call, as this “horse race is nearly neck and neck.”
- Values-based investing continues to gain share—too early to call, but anecdotal evidence points in favor of the prediction.
- After a 60-plus-year low in 2021, federal interest expense as a percentage of revenue begins a long-term move higher—heading in the right direction, noting that with both federal debt and interest rates rising, this prediction had a tailwind coming into the year.
- Republicans gain at least 20-25 House seats and barely win the Senate—too early to call, but early polls give the House prediction reasonable likelihood.
Photo: Crossmark Global Investments
