To investors sweating sky-high federal debt, stubborn 5% interest rates and a potential economic setback, Bank of America’s top market strategist Savita Subramanian has one piece of succinct advice: chill.
In her keynote address at Morningstar’s annual investment conference in Chicago late last month, Subramanian, head of U.S. equity and quantitative strategy for Bank of America Global Research, pointed to historical charts to remind the audience of advisors, wealth managers and investors that the country has experienced high rates before without any deleterious impact on the economy–or stocks.
She pointed out that, going back 200 years, 5% rates haven’t been restrictive to the economy.
‘We’ve been in 5%-plus for a really long time and things have been OK,” she said. “We’re at 5% interest rates and everybody thinks interest rates have to come down otherwise the economy will crumple and everything will go to pieces. Not true. I think that interest rates can stay here, and things will be OK. The problem is interest rates could actually go higher.”
Subramanian went against the grain in firmly recommending large capitalization value equities. In most of the question-and-answer session, she also pointed to some areas of the market investors should avoid: health care, real estate and long-term bonds. She also downplayed the potentially negative impact of high U.S. government debt on stocks.
Stocks Do OK With High Debt
The indebtedness of the government is “off the charts,” Subramanian said. The national debt now stands at $35 trillion, 99% of gross domestic product. The debt-to-GDP ratio has hit record highs in the post-war era, she noted.
“That’s a problem, and we don’t know how that resolves itself,” she said. “But at some point, it’s gotta go down. And that is a risk to long-duration bonds.” And she emphasized, “I am not bullish on long-term bonds.”
She added, “The levers of bond yield coming down are basically behind us. And the credit quality of the U.S. is imperiled today. And U.S. sovereign bonds look very risky today.”
Subramanian also noted that the 10-year Treasury is also contending with a lack of big buyers. “All the buyers have left the building,” she said. “The Fed is no longer buying 10-year Treasurys; we're unwinding [through quantitative easing]. China's no longer buying U.S. Treasurys; they're buying gold. And Japan's no longer buying Treasurys.”
She advised investors to be careful when they “think about terming out duration in [their] portfolios” because they intend to hold them to maturity. “That's fine. But the opportunity cost of holding a 10-year bond and living through inflation that could eclipse the yield on your bond is not great,” Subramanian told the audience.
For equity investors, though, the record high national debt isn’t weighing on stocks and, in fact, might be a reliable signal of economic growth. “So, what happens when fiscal debt is high?” Subramanian asked. “Actually, it’s not bad for stocks. Stocks do OK in that environment because what we found is that typically high amounts of fiscal debt lead to periods of accelerating GDP growth. And that's actually been a pretty good environment for stocks.”
What’s Ailing Healthcare?
But this “good environment” isn’t lifting all equity boats, she said. One of the notable laggards in the current market rally has been the healthcare sector, she noted. While the benchmark Standard & Poor’s 500 Index is making a habit of posting record highs, gaining 17% this year, the healthcare sector is relatively shuffling along, returning 6%, according to S&P Global
What’s holding back healthcare? Refinancing risks, according to Subramanian.
“A bunch” of the S&P 500 companies burdened with refinancing risks are in healthcare, she said, adding that the sector has “a lot more floating rate risks” than she’d thought.
“This is one of the reasons that we’re underweight healthcare,” she said.
Besides floating rate risks, healthcare is also susceptible to election and fiscal austerity risks, meaning potential cuts in government spending. “Healthcare is one of the most government exposed sectors in the S&P besides defense, and I don't think they're gonna cut defense spending,” she said.
In addition to healthcare, real estate is another area with a “lot more floating rate risks,” she noted. “But I guess the good news there is that we saw massive derating in real estate companies coming out of 2022. So investors are aware. ... It's a known risk that is arguably priced into a lot of these companies. If interest rates double again, don't buy real estate, don't buy anything.”
However, if rates are close to peak levels, she thinks refinancing risk in the S&P is “manageable.”
In other key takeaways, Subramanian said BofA sees a “lot of good opportunities” in public credit and public equity across the high-yield spectrum.
“Public equities are marked to market on a microsecond basis,” she explained. “Same with public credit. So, I love that you're getting kind of a more transparent asset class than private credit, private equity.”
Subramanian said that she doesn’t see any legislation or antitrust enforcement in the “immediate future” to negate earnings growth of top companies, notably big tech.
“I don't see massive crippling legislature or even any meaningful change around big-tech companies remaining in pole position because we're in a tech world,” Subramanian said. “Whoever has the best tech is the superpower. And right now, the U.S. is winning and I don't think they want to do anything that will actually cripple the ability of these mega-cap tech companies to remain in the position.”