At the same time, though, consumer confidence remains “relatively strong,” said Savita Subramanian, head of U.S. equity and quantitative strategy, and head of ESG research, at BofA Global Research. “If that continues, we could get through this recession with less of an impact on earnings and consumption than we’ve seen in prior cycles.”
The inevitable recession might not be too bad, he explained, since both consumer and corporate balance sheets are in relatively good shape. “There’s a lot of good things happening in the macro backdrop,” said Subramanian.
Zeroing in on particular equity sectors, Subramanian is bullish about energy companies. They are generating free cash flow and will benefit from rising oil prices in 2023. He also likes financial services companies, which have historically faltered during recessions but this time around are “well-capitalized … with actually fairly stable earnings growth,” he said.
Other appealing sectors are utilities—“the most bond-like equity sector,” he said—and consumer staples, calling them “always a good place to be during an economic soft patch.”
For fixed income markets, Matthew Diczok, Merrill Lynch and BofA Private Bank’s head of fixed income strategy, pointed out that unlike in most of 2022, clients can now receive a yield on fixed income securities that is higher than inflation. “That’s making a very big difference,” he said.
The average dividend yield on S&P 500 stocks is currently less than 2%, he added, while the yield on the 10-year Treasury bond is close to 3.5%. “Investors can now potentially receive higher income on bonds than with dividend-yielding stocks,” Diczok said.
What’s more, short-term Treasury bond rates are slightly higher than long-term ones, he observed, a situation known as an “inverted yield curve,” which is typically a precursor of a recession. But for individual savers, said Diczok, that’s actually good news. “Now you don’t have to reach for yield,” he stressed. “You can get a lot more income now, without taking a lot of risk.”
That situation, though, is just temporary. In another year or two, he said, you might be better off with longer-term bonds. “Having a broad diversified exposure across the yield curve makes a lot of sense,” he said.
Indeed, markets may look very different in the second half of 2023. At that point, “we’re likely to see that inflation is coming down,” said Marci McGregor, Merrill and BofA Private Bank’s senior investment strategist.
The Fed will then stop raising interest rates, and the bear market in equities is likely to end, too, she said.
“So, yes, we prefer bonds over stocks in the first half of the year,” she said. But in the second half of 2023, value stocks and small-cap stocks are likely to outperform. Value stocks includes energy companies, both traditional oil pumpers and renewable, greener energy suppliers, she said. The latter half of 2023 will also be “a historic opportunity to be investing in small caps,” she said.
All in all, said McGregor, a mix of stocks and bonds seems to hold great promise. “A well-diversified portfolio, I think, is teed up in ’23 to perform better than we’ve seen in recent history,” she said.