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Portfolio > Economy & Markets > Stocks

Sam Stovall: 5 Pieces of Advice Your Clients Need Now

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The worst is far from over for the stock market, says Sam Stovall, chief investment strategist at CFRA research and analytics firm, in an interview with ThinkAdvisor.

“The bear market will be retested,” he argues. “We have further to go. That will likely occur in the first quarter of next year.”

The whole first half of 2023 will be marked by continuing uncertainty as to whether the U.S. will go into a recession, he says.

Stovall’s predictions are based on market and economic history, his areas of deep research.

In the interview, he also discusses sectors and specific stocks that he and analysts at CFRA, which is based in Rockville, Maryland, predict to be the market leaders of 2023.

In addition, Stovall presents his outlook for interest rate hikes and the rate of inflation, as well as five pieces of advice that advisors ought to give clients now, including buying the S&P 500’s “Dividend Aristocrats” and not to “bail out on bonds.”

The certified financial planner helps CFRA analysts choose GARP stocks (growth at a reasonable price) by informing them of how markets typically perform during various economic cycles.

Stovall served as managing director and chief investment strategist at S&P Global for more than 27 years before joining CFRA, where he writes the firm’s ”Sector Watch” and “Investment Policy” reports for its MarketScope Advisor platform, as well as contributes to CFRA’s newsletter, “The Outlook.”

ThinkAdvisor interviewed Stovall by phone on Dec. 9. Speaking from his base in Allentown, Pennsylvania, the author of “The Seven Rules of Wall Street” and “Standard & Poor’s Guide to Sector Investing” made this practical recommendation:

“The best thing” for clients who can’t “extract their emotions from the [investing] equation” is to “embrace a rules-based investment strategy.”

Here are highlights from our conversation:

THINKADVISOR: Amid all the market volatility and economic uncertainty, what should financial advisors be telling their clients?

SAM STOVALL: There are five things they can do to help them.

First, I like to use stock market history to serve as virtual Valium to calm their nerves.

On average, it has taken [just] three months to go from a bear market bottom to a new bull market. Further, the S&P 500 has gained an average of 47% in the 12 months after bear markets associated with recessions have ended.

What’s the second thing?

Engage in tax-loss harvesting. I’m sure a lot of investors have losses [this year]. Take them. For example, sell out of one ETF to buy another, one stock to buy another, and so forth.

And the third thing?

Have clients rebalance. If you have a 60/40 portfolio, history says that even those tend to recover.

Remember that in the past 50 years, there have been [only] nine times that a 60/40 portfolio — 60% S&P 500, 40% 10-year Treasurys — posted a decline. In the year after that, the portfolio was up an average 13%, rising in price 78% of the time.

And I’ve pulled apart the leaves of the artichoke and got to the heart of the matter to find that in all but two cases, it was the stock portion of the 60/40 that dragged down the 60/40 into negative territory.

So, basically, don’t bail out on bonds.

Your fourth suggestion is…

Buy those stocks that you kicked yourself for missing on the way up that are now quite attractively valued.

If looking for income, why not go for [S&P 500’s] “Dividend Aristocrats” — companies that have increased their dividends for a minimum of the last 25 years.

Buy and hold them because they’re offering very attractive dividend yields. Exxon is a good example. Even though oil stocks have done exceptionally well, the energy sector is now trading at a greater than 50% discount to its average P/E.

That is, they’re still trading at a very low P/E.

What’s your fifth piece of advice for advisors?

If your client is the type who can’t extract their emotions from the equation, the best thing they can do is go fishing: Buy, hold and close your eyes.

The best investment advice I ever got came from Clint Eastwood as Dirty Harry in “Magnum Force.” He kept mumbling, “A man’s got to know his limitations.”

I know my limitations: There are times I can be so indecisive that my favorite color is plaid. I’m so impatient that I get upset if I miss a slot in a revolving door.

I can experience fear and greed at the exact same moment. So the best thing I can do is extract my emotions from the equation by embracing a rules-based investment strategy.

Is the worst over for the stock market?

I don’t think so, because we haven’t had the traditional capitulation when, at the bottom, clients call their advisor telling them, “Sell everything! Get me out!” It hasn’t reached that point yet.

This bear market has been shorter and weaker and less impactful than your traditional bear markets. Maybe that’s all we’re going to get. But I feel that maybe we haven’t done enough penance!

Please elaborate.

I think the bear market will be retested. We have further to go, and that will likely occur in the first quarter of next year.

What about inflation? When did it peak?

In June, at 9.1%. The core CPI [Consumer Price Index] likely peaked in September at 6.6%. And we see it hitting 5.9% by the December report [6% through November, the report said] and then approaching about 2.5% by the end of 2023.

That’s what the Fed is hoping, if not aiming, for, is it not?

Yes, and that’s what our economists are projecting.

What’s your overall outlook for 2023?

In the first half, we think there’s still going to be an awful lot of uncertainty — and as a result, volatility — as to whether we fall into recession.

But as we move into the second half of next year, investors will have begun to look across the valley, realizing that if we do have a recession, it’s going to be a mild one.

We forecast that the Fed will end its rate-tightening program by the end of the first quarter and begin contemplating, if not acting upon, a rate reduction cycle by the end of 2023.

Do you predict a recession?

Yes, but [CFRA] economists don’t think there will be one.

I’m a big historian when it comes to the stock market. Since the late 1940s, every time we’ve had a year-on-year percent change in headline CPI exceeding 6%, we’ve had a bear market with a recession.

Second, the inverted yield curve is the deepest since 1981, when we had an inflation-influenced recession.

Third, every time the LEI [leading economic indicators], goes negative on a year-over-year basis, we’ve fallen into recession.

Lastly, it’s increasingly likely that we’ll go into an S&P 500 earnings recession because the fourth quarter of this year is expected to be negative.

The first quarter of 2023 is expected to be barely positive; the second quarter, negative.

So a lot of downward revisions are taking place.

What do you see for GDP growth next year?

Pretty mild. This year we expect a December-over-December reading of 0.04%, rising to only 0.09% next year and moving up to 2% and then 2.5% by 2024 or 2025.

[Clearly], it looks like growth might be a bit anemic.

That seems to be in sync with a recession. Doesn’t it?

Yes, but our economists, who think there won’t be a recession, point more toward payroll. They see unemployment rates remaining below 4% through the end of 2023.

Do you agree?

Yes, but my question is: Where have all the people gone? Do they have that much money that they don’t have to work?

Many consumers built up savings during the worst of the pandemic.

Yes, consumers, investors, businesses seem to have a lot of cash on the sidelines.

A lot of people have been preparing for a recession; and as a result, it either won’t come or it will be mild.

What sectors of the stock market will be the leaders coming out of 2023?

Investors will rotate across the currently strong defensive sectors of consumer staples, health care and utilities, and gravitate toward the beaten-up growth areas, such as consumer discretionary and technology.

We also think that energy will do relatively well.

One reason for this rotation is that any time we’ve had a market decline of 15% or more, the four sectors and the 10 sub-sectors that were the worst performers on the way down, on average beat the market 12 months later. And the times that they missed, they didn’t miss by much.

So those defensive sectors that traditionally hold up the best when we go into a correction or bear market, on average never beat the market 12 months later.

Is there rhyme or reason to that?

The rhyme is: When no longer in doubt, throw them out — the defensive ones. And the reason is that companies priced to go out of business created a vacuum of valuations that were quickly taken advantage of by very opportunistic investors.

Those are the ones that tend to recover, or at least advance, the quickest in the first 12 months of a new bull market. It doesn’t mean that they recoup all they lost. It means that their percent change ends up being higher than that of the market as a whole.

My understanding is that CFRA is keeping a strong buy rating on Microsoft. Is that right?

Yes. We still have a 5-star strong buy recommendation. Our analysts said that our target remains $330 a share.

They aren’t surprised by the FTC’s vote to block Microsoft’s acquisition of ATVI [Activision Blizzard] and hope that Microsoft executives take the hint and give up the deal that, if completed, might end up a pyrrhic victory of executive distraction and expensive regulatory concepts.

Can you name any other specific stocks that you like for 2023?

Some of the worst performers have been the semiconductor stocks. Our favorite is Nvidia (NVDA).

Apparel, accessories and luxury goods is among the worst-performing groups. Tapestry is part of that group and has the highest ranking.

Auto parts and equipment is a sector that did poorly. Aptiv PLC [APTV] is an auto parts company [we like].

In cable and satellite, we have Comcast (CMCSA), which we think will do well.

What’s your philosophy of market movement?

I’m a big believer in momentum [velocity of price changes]. How many investors are going to brag to their friends about their stocks that just hit a 52-week high?

Well, those friends will probably go out and buy those stocks, which keeps the momentum going.

I came up with and maintain an Industry Momentum Portfolio that CFRA has on its electronic research website. It’s up 9.6% year-to-date. I select subindustries that are the best in terms of momentum and then default to the companies within those indexes that have the highest buy-hold-sell rankings.

What are your thoughts about international investing?

International looks pretty attractive, but it has looked attractive for a while. A lot of people are saying, “Why should I have international at all because anywhere from 40% to 50% of the revenue for the S&P 500 comes from overseas operations?”

What [those companies] don’t tell you is where — because the executives don’t want to give away their “best fishing holes.” They’re not required to say where the international sales are, just that they’re non-U.S.

Some investors say, “With that much coming from overseas, why do I need international exposure?” All I’m doing is adding a level of risk from currency.

So while the valuations look pretty attractive for international stocks — developed internationals are trading at an 18% discount on a relative P/E basis — it may take a while for people to start to warm up to them again.

Our economists are projecting another 2% rise in the value of the dollar in 2023. So that could be less of a headwind than we had in 2022 — but a headwind nonetheless.


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