Looking for free cash flow is also important when looking for companies that benefit from a capital expenditures cycle, she said. “Despite the fact that [companies] are seeing slowing demand trends, they are still intimating that they are going to continue to spend more than we expect on capex, whether that’s on automating more expensive labor, whether that’s on near-shoring or reshoring,” she said. Small-caps could benefit from that capital expenditures cycle too, she said.
When asked by Hyzy if we’re still in a long-term secular bull market as opposed to the short-term cyclical bear market, she said Merrill believes stocks are going to continue to outperform bonds and that time is, as always, on stocks’ side if you have a longer time horizon.
As far as recession, Gapen said there are likely to be two quarters of negative growth ahead. “Recession risk right now is really dependent on your outlook for services spending. We all expect goods consumption to be soft. Households are rebalancing away from goods and towards services. … I think the idea here is, does the Fed tighten to the point where spending on services is weak? Is inflation strong enough over time that it eats into household expenditures, in a way that means we don’t have a lot left after food and gas to spend on a discretionary basis?” If services spending holds up, he said, hiring is likely to hold up, and the economy will likely continue its growth phase. But if services spending slows, that could affect labor “and maybe we have a mild downturn in front of us.”
There’s still a lot of demand for labor, however, and even here he sees room for catch-up in things like automotive production, Gapen says. “The data suggests that retailers have rebalanced well, but other parts of the economy have not, so it may be that any kind of modest slowdown is taken as an opportunity by some sectors to kind of right-size.” But any shedding of labor could be short-lived, he said. He added that he wouldn’t be surprised to see a downturn at the same time there were growing vehicle assemblies. “You’d never find that historically, but it’s a different type of cycle.”
As far as the political environment, the midterm elections mainly promise more gridlock, and, as Subramanian augured, “Gridlock is actually the best recipe for equity market returns.”
Ian Bremmer, a political scientist, founder of consulting firm the Eurasia Group and the author of The Power of Crisis, put the current economic situation into a global historical context.
He said that we’re in a new Cold War with Russia, but it’s very different from the old one. While the current standoff may involve a hot war in Ukraine, the new Cold War has united Europe, led to the expansion of NATO, and decoupled only Russia from the Western community.
“Europe, the U.S., Canada, and even countries like Japan and South Korea, they are cutting the Russians off,” Bremmer said. “They are freezing Russian assets. The Russian economy, which will contract some 10% this year, will get worse in coming years as nobody needs them anymore from the developed world. The developing countries will still do food business with them—fertilizer and energy—but that’s not enough to keep the Russian economy working. Especially because this historically has been a manufacturing economy, an industrial economy. A defense and arms-producing economy. Those things will fail.”
While Russia is weakened, the rest of the world is realigning, and the U.S. relationship with China has stabilized. Neither side wants confrontation in this economic environment, he said.
“Increasingly, we’re talking about the creation of a global security alignment with the United States and its advanced industrial allies all over the world. And of course, the Chinese look at that and say, ‘We feel like we are being contained by this thing—by the advanced democracies—and we don’t like that at all.’ So you are seeing the emergence of competing architecture.”
At the same time, “the Americans and the Chinese are doing an incredible amount of business with each other. An incredible amount of finance with each other. And every American ally has no interest in a Cold War with China. They don’t want to be forced to choose between an alliance with the United States and doing more business with the Chinese. So we don’t want to go too far in suggesting deglobalization. Yes, the Russians are being deglobalized … but the Chinese are doing business everywhere.”