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Portfolio > Economy & Markets

Where to Look Now for Investment Returns: BofA

By Dinah Wisenberg Brin

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What You Need to Know

  • BofA cites long-term positives in U.S. equities markets.
  • Inflationary pressures probably have peaked, an economist from the bank says.
  • BofA likes energy stocks.

Investors need to look to income generated from stocks and bonds to fuel total portfolio returns in the current environment rather than relying heavily on price appreciation, Bank of America strategists suggested during the company’s midyear outlook Tuesday.

At the same time, the financial services company believes a long-term bull market remains in place. Its investment leaders noted the importance of portfolio diversification, reviewing asset allocations, finding opportunities in equities pullbacks, and staying focused on long-term goals.

“Our view from now to the end of the year is pretty similar to our view at the beginning of the year. Stick with total returns, stick with safe dividend yields,” said Savita Subramanian, head of U.S. equity and quantitative strategy and head of ESG Research, BofA Global Research.

“We’re past the point where price returns are going to drive your portfolio,” she added on the company’s pre-recorded webcast. “You really want to think about income as a major contributor to your portfolio returns. Look for companies that are growing their dividends, that have healthy balance sheets, good visibility in terms of earnings and can pay you a dividend while you wait for the economy to improve a bit.” 

Like other investors, retirees also should consider the idea of seeking total return via income-generating securities, suggested Joe Curtin, the head of portfolio management for the chief investment office of Merrill and Bank of America Private Bank. He recommended investors take the total-return approach, stay diversified and own yield in both equities and fixed income.

“Retirees should be thinking about the retirement paradigm a little bit differently,” he said, explaining that sometimes return is driven more by price appreciation and at other times by income. “This is one of those inflection points where we may see more of the total return coming from yield.” 

Seek Diversification

Investors could receive more yield through value, defensive and cyclical stocks and from corporate and municipal bonds, Curtin said, noting municipal bonds’ great after-tax yield. 

BofA’s favorite equities sectors now are energy and, on the defensive side, health care and consumer staples, said Subramanian, who noted the energy sector should benefit from ongoing demand for oil, among other factors.

Even as the energy sector has doubled its size within the S&P 500 in the past 12 months, “investors are possibly even more underweight the sector today than they were a couple of years ago,” Subramanian said. These are companies that are generating the highest free cash flow to price of all sectors in the S&P 500. They protect you against inflation on the commodities side but they also offer safe and stable income.”

From a broader market perspective, looking for free cash flow is important in identifying companies that may benefit from a capital expenditure cycle, Subramanian added. Many companies, despite declining demand trends, indicate they’ll continue to spend more than expected on capex, whether it’s automating more expensive labor, nearshoring or reshoring, she said.

A theme to consider even in this volatile market” is what companies are going to benefit from a real capex cycle that we haven’t seen in a very long time, and here we like select industrials, we like automation plays, we like energy and we also think that small caps could benefit from a real capex cycle,” said Subramanian.

Bullish Long-Term View

Longer term, BofA expects healthy performance from equities.

“I think that stocks are going to continue to outperform bonds; I think that parts of the market look incredibly attractive from an equity perspective,” Subramanian said.

“Do I think that there’s more continued downside risk to the market from here through the end of year? Possibly, and that really depends on the trajectory of the economy, it depends on the pace of the Fed, it depends on the place of inflation resolving itself,” she said. “The critical question is are we moving into a period of stagflation or a period where we start to see inflation moderate and the economy starts to slowly heal, and I think that would be the good-case scenario for equities.”

With market gyrations, Curtin said, investors should understand downside risk and proper asset allocation for their situation, and periodically rebalance portfolios to get back to center to meet long-term goals.

Marci McGregor, senior investment strategist for the chief investment office, suggested investors take a holistic approach when it comes to rebalancing, including taxable and tax-efficient accounts, and consider rebalancing in a tax-efficient way, such as responding to portfolio losses by using tax-loss harvesting.

“I would think about that big picture and think about all the different investments you have when you think about rebalancing,” said McGregor, who expects investors will see rebalancing opportunities between now and the spring. Once inflation reaches an acceptable level and the Fed pauses interest rate hikes, markets might calm and regain stability, she said.

“We’re still believers (that) we’re in a long-term, secular bull market, so I would keep an eye out for these shifts as opportunities to rebalance and to position and reset for where we are in the cycle,” said McGregor. The probability of a negative return in the S&P 500 over a decade is just 6%, “so time in the market matters,” she said. 

Consider Alternative Investments

Qualified investors might consider expanding their portfolios beyond traditional stock and bond holdings, McGregor suggested, noting that alternative investments can offer diversification benefits, diverse income streams and longer-term capital appreciation. 

That may mean adding hedge funds, private equity, managed futures or real assets, such as commodities and private real estate. “I would be using all the tools in my investor toolkit right now,” she said.

When rightsizing their allocations, investors should consider liquidity, she added, because certain alternative investments have a different liquidity profile and investors can use these assets as strategic, longer term holdings to further diversify portfolios.

McGregor noted that companies are resilient and adapt to long-term trends like innovation and shifts in consumer preferences, which ultimately drives earnings and markets higher. “So I would say this isn’t necessarily a time to be taking big tactical swings but remember to go back to those core principles of diversification, being really balanced in your approach to investing, and staying disciplined to those longer term goals,” McGregor added. “Now is a time I would really be well diversified.”

Inflation Heading Down?

Michael Gapen, head of U.S. economics, BofA Global Research, noted the unusual nature of the current economic cycle and said it’s likely to persist for 18 to 24 months. The economy is dealing with “some reorientation, some restructuring … a reopening phase. We’re having difficulty rebalancing supply and demand coming out of the pandemic,” he said.

“I think we’re probably at the peak of inflationary pressures,” Gapen said. “They’re coming from strong aggregate demand, they’re coming from pandemic-influenced supply chain disruptions, they’re coming from geopolitical tensions on energy prices. There’s some evidence that a few of these are finally turning. We’ve been waiting for core goods prices, things that we buy, to begin to reverse and decline. There’s some evidence that that is indeed happening.” 

He estimated it could take two, possibly three, years to get inflation back to levels that are comfortable to the Fed.

While the economy is likely to record two quarters of negative growth this year, the question is whether high inflation and Fed monetary policy weaken household spending, Gapen said.

“I really think it’s about services demand and services spending,” he said. “If that spending holds up, hiring is likely to hold up, the economy likely continues in its growth phase; if spending on services slows, at some point you would think demand for labor would slow and then maybe we have a mild downturn in front of us.” 

Dinah Wisenberg Brin

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