Traders work on the floor of the New York Stock exchange during morning trading Tuesday in New York City. The stock market opened on an upswing with the Dow Jones gaining over 600 points, the S&P 500 jumping 2.20% and the Nasdaq Composite with a gain of 2.6% adding to the gains that began on Monday.
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In the midst of volatile markets, continued steep rate hikes from the Federal Reserve, and a lackluster third-quarter earnings season, investors have plenty of reasons to be wary.
Those with a traditional portfolio of 60% stocks and 40% bonds—a mix intended to provide good risk-adjusted returns—have seen their holdings drop about 20% through the third quarter. Stocks staged a turnaround Monday and were rising Tuesday—amid better-than-expected bank earnings and as the U.K. reversed course on tax proposals that had hit the British pound—but the S&P 500 was still down nearly 23% through Monday’s market close.
Despite losses and continuing uncertainty, Leo Grohowski, chief investment officer at BNY Mellon Wealth Management says investors haven’t panicked, so there hasn’t been the kind of broad, indiscriminate selling that marks a market bottom.
Investors worried about market conditions—particularly wealthy business owners accustomed to handling problems one way or another, often by exiting them—still may instinctively want to sell at this point. But Grohowski says, “this is not one of those times for remediating a problem [by exiting] in our view.”
Instead, the firm’s advice is “remain forward-looking and invested.”
Penta recently spoke with Grohowski on how to navigate current markets as third-quarter earnings reveal how corporations are doing so far at handling inflation and rising rates.
The Direction for Earnings Is Down
Corporate earnings overall may be flat year over year for the third quarter—Grohowski isn’t expecting a disaster yet—but he doesn’t believe current earnings expectations for 2023 are accounting for the 70% chance of a recession BNY Mellon now forecasts.
Analysts expect S&P 500 earnings of about US$240 a share in 2023, according to a consensus forecast by Yardeni Research, but Grohowski says the figure is likely to be closer to US$200 a share.
“2023 earnings expectations have a long way to come down,” he says.
The Fed’s plans to continue raising rates is increasing the chance of recession, Grohowski adds. In his view, the central bank should ease up, considering the U.S. economy is already showing signs of slowing. He points to housing, with existing home sales down for seven consecutive months and the latest S&P CoreLogic Case-Shiller National Home Price Index falling 0.3% month-over-month (from June to July), the first drop since January 2019.
“The economy is cooling but it’s not yet showing up in the inflation statistics,” Grohowski says. That combination—high inflation and a slowing economy—is worrisome.
Looking for ‘Dislocations’
Investors with at least a 12- to 18-month time horizon could begin to look for opportunities in stocks that have fallen in price with the rest of the market and are discounting a bad recession.
Grohowski can’t name specific companies, but he says investors could look at the industrial and healthcare sectors within public stocks, in addition to businesses likely to benefit from major fiscal legislation passed in Washington.
For example, the CHIPS and Science Act passed in August is designed to encourage domestic research and semiconductor manufacturing in the U.S. while the Inflation Reduction Act should encourage spending on renewable energy companies and related infrastructure.
BNY Mellon’s September note to clients advised clients “to invest alongside the government, so to speak.”
Grohowski cautions that while certain broad sectors may be attractive, investors need to look “company by company” and they should have a mix of stocks that represent a good value in addition to those poised for growth.
“You want to be sector diversified and stylistically diversified,” he says.
Sectors that are less appealing to BNY Mellon at the moment include consumer discretionary stocks and technology, which had led the bull market run of the last decade. Some valuations in tech are starting to look interesting, Grohowski says, but many remain pricey especially given the likelihood of still rising rates.
Buy Private Market ‘Diversifiers’
When the S&P 500 was delivering a more than 16% annualized rate of return for a decade, investors weren’t as interested in less correlated alternative investments, such as private equity or hedge funds, which BNY Mellon calls diversifiers. This year, some of those diversifiers may not be preventing losses, Grohowski says, “but they are preventing the magnitude of loss in a traditional 60-40 portfolio.”
Periods of distress are often good entry points for investing in private markets. Specifically, BNY Mellon is looking at private-equity funds that are buying so-called secondaries, which are stakes in existing private equity funds or portfolios. Forced liquidations by companies that hold these stakes could offer opportunities to buy at significant discounts, Grohowski says.
In private debt, BNYMellon is looking at so-called specialized credit funds that can take advantage of dislocations resulting from higher rates and widening yield spreads for certain credits. Managers of these funds “can take advantage of assets being sold for non-economic reasons” in a variety of sectors, from U.S. high-yield corporate bonds to emerging market sovereign debt, he says.
Investors can also lend directly to companies in private markets using floating-rate structures that will benefit from rising rates, Grohowski adds.
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