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Stick With Quality Stocks in This Downturn: Strategists

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What You Need to Know

  • Strategists from BofA, Goldman Sachs and JPMorgan Private Bank weigh in on the current market rout.
  • Expected Fed interest rate hikes, which begin as early as March, are weighing on the market.
  • Stock and bond investors will be focusing on the Fed's policymaking meeting Wednesday for more direction.

The S&P 500 slipped into a correction Monday morning, down slightly more than 10% from its early January high, joining Nasdaq, which was off 15% while the VIX — the volatility index — neared its highest level in a year.

Traders and analysts cited this week’s upcoming Federal Reserve policymaking meeting, after which the central bank is expected to indicate that it will begin raising rates in March for the first time in more than three years.

The Fed is expected to hike four times and start reducing its bloated balance sheet this year.

Mohamed El-Erian, the president of Queens’ College, the University of Cambridge, and chief economic advisor at Allianz, wrote in a Financial Times column, that the  Fed needs to “send a clear message that it is serious in addressing inflationary pressures” by immediately ending its asset purchases and start hiking rates in March along with announcing plans to begin shrinking its balance sheet.

“Officials must also come clean on why they so badly misread inflation for so long,”  El-Erian wrote.

Strategists differ on whether such a clear reversal of easy monetary policy will crash the market, but three teams from big banks recommended recently that investors look to high-quality stocks.

Bank of America strategists led by Chief Investment Strategist Michael Hartnett expect negative returns in the U.S. stock market this year due to “rates shock” in the first half of the year and “recession panic” in the second.

The “Fed is hiking into overvalued credit and equity markets and Fed tightening always ‘breaks something,’ “ writes Hartnett in a recent market note. He doesn’t say how far he expects stocks will fall.

Goldman Sachs strategists led by David Kostin, chief U.S. equity strategist, are less bearish for now but acknowledge the selloff in the S&P 500 marks “a difficult start to the new year for equity investors” and is “particularly challenging for fund managers to navigate.”

Goldman strategists are not abandoning their base case for the S&P to end the year near 5,100, which is supported by an 8% rise in earnings per share. They acknowledge, however, that if corporate profits fall and the consensus EPS forecast for the S&P 500 declines from $224 in 2022 while real yields remain unchanged and the gap between real and nominal Treasury yields are unchanged, the implied value of the index could drop to around 3,914.

“Stocks are getting hit by this for two reasons,” writes Jacob Manoukian, U.S. head of investment strategy at J.P. Morgan Private Bank, in a recent note. “The rate at which investors discount future cash flows is higher, which brings down the current valuation of companies … [and] higher rates usually mean slower economic and earnings growth in the future, which can hurt stock prices now.”

Manoukian notes, however, that stocks “tend to find their footing once they adjust to higher policy rates,” noting the S&P 500 returned an average of 13% in the last six hiking cycles, which lasted 18 months on average. “Equities tend to rally during rate hiking cycles because they tend to happen when the economy is strong. We don’t see a compelling reason why this time would be different.”

Despite these varying views of the current stock market, the strategists all recommend that investors now focus on high-quality stocks.

For Goldman strategists, that means investing in companies that are highly profitable, with strong balance sheets and modest valuations. Goldman is overweight health care stocks.

At J.P. Morgan, Manoukian writes: “Focusing on profitability should be increasingly valuable as interest rates continue to rise.”