Market strategist: ‘This is a good time to be underweight stocks
Yahoo Finance Video
BlackRock Global Allocation Fund Managing Director Russ Koesterich joins Yahoo Finance Live to discuss market uncertainty, recessionary risks, inflation, and Fed tightening.
Video Transcript
BRIAN SOZZI: Shun stocks because the market may be underestimating recession risk. That's the blunt take on the markets served up by the team at BlackRock this week. For more on this one, we have BlackRock managing director and portfolio manager Russ Koesterich here with us. Russ, great to get some time with you, as always. My week started with this note, and this is a big call by the team to say shunning stocks. What's behind this call, and how long do you think it'll be in play?
RUSS KOESTERICH: Well, look, I think that you're normally going to own stocks in a portfolio. The way I would interpret that is really that for most investors, this is a good time to be underweight stocks, which is what we're doing in the global allocation fund. Why is that? I think there are a couple reasons, the first of which we've been living with all year. Given multi-decade highs in inflation, we're seeing the most aggressive tightening campaign from the Fed and other central banks in decades. That is causing valuations and multiples to go down.
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I think most of that process is down, but it doesn't mean it can't go a bit further. But going forward, arguably the larger risk for equities is not so much the multiple. It's earnings. And we're still in an environment where analysts have been very comfortable keeping optimistic earnings assumptions.
As the economy slows, as recession risk does go up, the odds that you're going to be able to deliver on those earnings go down. And I think one of the challenges, one of the key things for investors going forward is to look for companies that are going to be able to demonstrate earnings resiliency in a much, much tougher macro environment.
BRAD SMITH: Do you believe that software is going to be able to do that? Software has been extremely hit hard. Yet it's kind of linked in with your stable growth equities play right now in industries such as software and healthcare services.
RUSS KOESTERICH: That is correct, and we do think that these areas are going to be more resilient. And you're exactly right. Software has had a really, really difficult year. But again, why is that? It's less been about earnings. It's more been about that correction in valuations. Software companies, tech companies obviously very aggressively valued early in the year, late last year, and as real rates have had this massive adjustment.
What's happened is that the valuation for growth stocks has come down very hard, but two things to keep in mind. One, a lot of that process has already occurred. Growth versus value differentials are now back or below where they were before the pandemic.
And second, while I'd be very cautious about early growth names, in other words, companies that don't have earnings for a decade, many of the names we're talking about in software and parts of healthcare, no one ever referred to as stable growth. And again, the reason we think that they're a good place to hide is that their earnings are likely to prove more resilient than some of the more cyclical parts of the market that did well in late '21 and earlier this year.
BRAD SMITH: But software has also exhibited that it's going to continue to look for M&A opportunities. So you've got cash going out the door there. You also are not sure what their portfolio of clients is going to continue to buy into and if that growth is going to be there. Perhaps you're seeing things a little differently on that front and where that growth potential could actually come into play.
RUSS KOESTERICH: Well, the most important thing, I think, in software is, again, a lot of the companies when you think about relationship management, when you think about ways to squeeze efficiency, these are multiyear trends. And yes, we're in a more difficult environment, but the fact is, companies continue to invest in their infrastructure.
We have a continued need particularly, as we all do things remotely, for cybersecurity. These are areas that we think benefit from the secular growth trends that over, call it a two to three-year horizon, you're going to be rewarded particularly, given that you're getting in valuations that are 20%, 30%, 40% lower than they were a year ago.
JULIE HYMAN: Russ, I want to go back, broaden the lens again and go back to the beginning for a minute because one of the questions that we were talking about earlier in the show is whether the bottom is in. And obviously, from your underweight, it sounds like you guys don't think the bottom is in. We had this discussion after the June lows as well. So where's the bottom, I guess, in stocks? Like, as you're modeling this, tell me the exact number. No, I'm just kidding. But how much more downside, though, do you guys see in US stocks here?
RUSS KOESTERICH: Look, I think we're getting to a point where valuations are starting to get more interesting. But look, we all know the deal. There is no way to tell you the bottom is at a particular number. What I do think is the issue right now is, one, stocks are cheap, but they're not a bargain basement level. And other asset classes, notably credit, actually look more attractive on a risk adjusted basis.
The second issue, again, I do think you've got to be careful about the names you pick in the stock market because some of the more cyclical parts, we're likely to see some more aggressive downgrades in the coming weeks and months.
And then finally, as we've seen over the last week, whether we're talking about the Italian election, whether we're talking about the budget dispute in the United Kingdom, whether we're talking about a tax on energy infrastructure, there are a lot of hard to quantify factors out there, all of which are being compounded by the fact that liquidity is poor, financial conditions are tightening.
So, honestly, I don't think it's a matter of coming up with a number, saying, buy here. I think it's a matter of, when do we start to get some relief from the Fed? When do we see earnings estimates at a more realistic level? And the direction that some of these hard to quantify tail risks take.
BRIAN SOZZI: Russ, the team highlights this in the note, the potential for the economy to see significant economic damage. Now, for investors out there, frame that for us. What does that look like? What does it look like for GDP, people losing their jobs? Like, what is coming at investors that they can't probably see right now?
RUSS KOESTERICH: So I think there are a couple of things. And I think the truth is, most investors do see them, which is why we're at where we're at. Look, the Fed only has one instrument that they can use right now, and that is to hammer demand. You can't fix the supply issues from the perspective of monetary policy. So lower demand means you are probably going to see continued softening in the labor market.
So far, the labor market has been very resilient. We would expect it's going to soften going into next year. The manufacturing sector already under pressure, given the fact that you had a lot of pull forward demand during the pandemic and the immediate aftermath. So looking at things like the PMIs, those are likely to soften more in the coming weeks and months. Because we're going-- this is taking a fairly pessimistic direction.
Let me point to one silver lining. We do think that the employment market is going to soften. And we do think the economy is going to soften. We do also believe that the US consumer is in relatively good shape. They did not come into this situation the way they were in [INAUDIBLE] with excess debt, with a lot of leverage, with low savings rate. So while we do expect some softening of the housing sector, softening overall in consumer spending, I think that it's going to be a modest pullback relative to what we saw in 2008 and 2009.
BRAD SMITH: BlackRock managing director and portfolio manager Russ Koesterich. Russ, great to catch up with you. Appreciate the time.