Call us 'cautious bulls' Call us 'cautious bulls'\images\insights\article\bull-small.jpg December 7 2022 April 5 2022

Call us 'cautious bulls'

Year-end S&P forecasts for 2022 and 2023 lowered to 4,800 and 5,100.

Published April 5 2022
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Following our market memo of last week, where we outlined some of the higher-than-normal uncertainties ahead for investors (i.e., the Ukraine War outcome and whether the Fed will achieve a “soft landing” or instead provoke a recession), many readers wondered about our year-end outlooks for this year and next. The short answer: both have been lowered, with a wider-than-normal range around the targets than we previously had. 

The reason: even in our base-case scenario (the Fed nails the soft landing and the war grinds to at least a lower decibel level), raging inflation that’s being further exacerbated by the conflict is adding to margin pressure on stocks. This was behind our decision last week to modestly pare S&P 500 earnings growth forecasts to $220 and $250 this year and next, respectively, from the previous $230 and $260. With the war making inflation worse, we also think the Fed will have to ramp up the number of hikes it makes this year, pushing our year-end projection for the 10-year Treasury yield to 3.0% from 2.5%. This, and rising risks of either a Fed mistake or an unexpected re-escalation of the war, means the ongoing compression on stock valuations is likely to continue. When we add this all up, out macro team sees the S&P rising only modestly from here, to 4,800 by the end of this year and 5,100 by year-end 2023.  

Though the implied returns in stocks are even lower single digits than our previous targets (5,300 and 5,500, respectively, this year and next), we do think stock returns will prove more positive than bonds. Thus, we are maintaining a modest equity overweight, though we have trimmed positions in our PRISM® model three times in the past seven months. The latest came last week, lowering our equity position to 57%, 3 points above neutral or 30% of the allowable maximum overweight of 64%.

Image of a small bull and bear statue on a desk

We used each reduction to take profits and raise cash. As noted last week, the model’s overweight effectively is a three-part barbell of defensive value stocks, whose earnings should hold up even in a higher inflation/lower growth environment; cyclical value stocks, where many names we like are off 20% and we think are over-discounting the risk of recession; and easy-to-deploy cash, which remains preferable to bonds in this environment and stands at an overweight 6%, double its neutral 3% weight. 

The quarter ahead will be interesting. A lot of bad news already has been factored in, but it’s hard for us to conceive of better news coming. Inflation numbers keep getting worse, estimates of Fed hikes ahead continue to climb and we expect that margin guidance will be hard to come by as companies themselves face a more uncertain backdrop. Though not forecasting another correction near term, we are comforted to hold extra cash in this cloudier-than-usual environment. We’d look to review our cash overweight again if a correction does occur or, alternatively, if something unexpectedly good happens. We could get that via a rollover in the inflation prints and/or a sudden announcement of a peace deal in the Ukraine. We’ll see. 

In the meantime, we think investors need to set their expectations for more muted equity returns over the next two years, and to set their investment allocations accordingly. There are times to be a raging bull, times to be a cautious bull, and even a few times to be a growling bear. For now, call us cautious bulls. Given the long-term odds of success in stocks, that’s still better than the last alternative.

Tags Equity . Active Management . Monetary Policy . Markets/Economy .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Diversification and asset allocation do not assure a profit nor protect against loss.

PRISM® is a registered trademark of FII Holdings, Inc., a subsidiary of Federated Hermes, Inc.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Stocks are subject to risks and fluctuate in value.

Value stocks tend to have higher dividends and thus have a higher income-related component in their total return than growth stocks. Value stocks also may lag growth stocks in performance at times, particularly in late stages of a market advance.

Federated Global Investment Management Corp.