Stocks hover near highs—What to buy now

The Street

With markets near record highs, here's where smart investors are putting their money.

Transcript

00:00Joining me now is Sam Stovall, Chief Investment Strategist at CFRA Research.

00:04Sam, thanks so much for joining us.

00:07Happy to talk to you again, Caroline.

00:10So, Sam, stocks are sort of searching for direction this morning,

00:13but sitting very close to all-time highs.

00:16What's your view on where the market currently is and where it goes from here?

00:21Well, I think the market currently is in sort of a pause zone right now.

00:26In many ways, the average investor probably feels like Dorothy,

00:31who was just given two different directions by the scarecrow as to where inflation is headed.

00:39We had the CPI, which sort of indicated it was not much of a concern,

00:43but then the PPI came in hotter than expected,

00:46and we will have the PCE sort of help break that gridlock when it is released later this month.

00:54So, I think with Jackson Hole coming up this week,

00:58we expect the Fed to pretty much tell us that they are still data dependent.

01:03They are going to be independent from outside influences,

01:07but I think they're probably going to set the stage for a rate cut to be announced in September.

01:14And investors are betting on this rate cut next month.

01:19You think that's realistic, and what do you think the market reaction will be if that happens,

01:24seeing as the S&P 500 is sitting at all-time highs?

01:29Well, historically, wanting is more profitable than having.

01:34In the 12 months after the last rate hike and before the first rate cut,

01:39the S&P gained almost 18% on average going back to 1990.

01:44Yet, in the 12 months after the first rate cut, the market gained less than 4%.

01:50This time around, it's a little different.

01:53The market is up more than 13%, doing quite nicely,

01:57possibly because of the pause in terms of rate cuts

02:01and allowing investors to sort of build up some excitement for when the next one will come along.

02:08So, the real question is, how much does the economy really need it?

02:13By how much will employment picture be slowing and the unemployment rate be ticking higher?

02:20So, you know, the question is, will the lower rate cut help spur earnings,

02:26or is it really helping to sort of cushion a potential recession?

02:31How much do you think the economy really needs it?

02:34Because we did see Bank of America research economists come out and say that they're convinced

02:39the Fed won't cut at all in 2025 due to stagflation.

02:43So, how concerned are you about stagflation,

02:47and what could that look like as it plays out in the markets?

02:51Well, stagflation is certainly a possibility,

02:54but we don't think it is the most likely outcome.

02:56We're still forecasting a 25 basis point cut in September,

03:01followed by a second in December,

03:04with the Fed taking a wait-and-see attitude at the October FOMC meeting.

03:09We're still forecasting about a 1.8% GDP growth in the third quarter,

03:16so a little bit of softness,

03:19but we'll probably see an uptick in the next revision for the second quarter earnings.

03:24And then I think we will see about 2% earnings growth for the fourth quarter.

03:30So, a little bit of softness, but certainly not a recession.

03:34And I think we saw that earlier this year,

03:37that bull markets don't die of old age, they die of fright.

03:42And what they are most afraid of is recession.

03:45So, with us realizing that we are not on the precipice of recession,

03:50that's why we were able to recover all that we lost in only about three months.

03:56So, this bull market sort of taking a wait-and-see approach,

04:00but where do you think it ultimately goes?

04:03Because I know historically September can be a pretty rough month for stocks.

04:07Are you concerned as we approach September?

04:09Seasonality hasn't necessarily, you know,

04:12followed suit based on the whole sell in May and go away adage.

04:17Didn't really pay off to do that this year.

04:20That's right.

04:21Seasonality has certainly not been repealed.

04:25Sometimes we might not be as pronounced as it has been in other years.

04:29And September for the S&P 500 has been by far the worst month of the year,

04:35posting the deepest decline on average and falling more frequently than it has risen.

04:40It has risen only 44% of the time going back to World War II.

04:45So, there is still a possibility.

04:47However, I would regard that more as a buying opportunity than I would as a reason to sell.

04:54So, in a sense, you're better off buying than bailing.

04:57Our year-end target is 66.50 for the S&P 500.

05:02And that's based on our 12-month target of 68.50.

05:05So, we still see upside potential,

05:08even though it remains in the mid to slightly higher single digits over the coming period.

05:15So, fill us in, Sam.

05:17What should investors be buying on a pullback or even buying despite the fact that stocks are high right now?

05:25Well, what's interesting is that history reminds us that after a sharp decline of 10% to 20% or even more than that,

05:34you are better off buying those groups that were beaten up the most

05:38because they tend to outperform 12 months later.

05:41S&P has gained an average of 24% 12 months after a decline of more than 10%.

05:50Whereas, the three worst-performing sectors were up about 35%

05:56and the 10 worst-performing sub-industries were up more than 60% 12 months later.

06:03Right now, we are seeing that kind of return.

06:06While the S&P has been up close to 30%,

06:10the best-performing sectors since the April 4th low, April 8th low, I should say,

06:18have been the communication services, consumer discretionary, and tech sectors.

06:25You could also add financials in that category.

06:28The 10 best-performing sub-industries have been up more than 45%.

06:34So, investors are sticking with momentum because that's where the power is at this point.

06:41Like whitewater rafting, investors are letting the market take them where it wants to go.

06:47But when I take a look at the most beaten-down sectors year-to-date,

06:51I see energy, health care, real estate.

06:54Would you be comfortable buying into those?

06:57We do have buy recommendations in all of those categories,

07:00but we have underweight recommendations there as well.

07:04Essentially, the feeling is that in the near term, they have a lot of weakness.

07:10Yes, you did see UnitedHealthcare pop,

07:13but that was mainly because Warren Buffett confessed to having purchased many shares,

07:19getting a good exposure there.

07:20So, shorter-term traders can look to those companies or sub-industries with RSI levels below 30,

07:29implying an oversold situation.

07:32So, that is a way that somebody can, in a sense, be looking at the market.

07:37But our belief is that since we are more long-term oriented,

07:42we focus on 12 months or longer,

07:44we think you're better off focusing on those companies with good earnings growth prospect

07:50that already have the momentum behind them.

07:54So, in that case, do you expect small caps to play catch-up then?

07:59Because the Russell is still about 7% from the highs,

08:02so they don't necessarily have the momentum behind them.

08:07Small caps and mid caps have been attractive investments,

08:11unfortunately, for the last couple of years.

08:13It's almost like how people used to describe Brazil.

08:17It's the country for the next 25 years,

08:19but unfortunately, it's been that way for the last 25 years.

08:23We have found, essentially, that large caps have outperformed mid and small caps

08:27in, what, 12 of the last 15 years.

08:30And as a result, both the S&P mid-cap 400 and small-cap 600 industries

08:36are now trading at deeper than 30% discounts

08:40to their 20-year average relative P-E ratio.

08:44So, there is an awful lot of upside potential for mid- and small-cap stocks.

08:50And we're just beginning to see some movement there.

08:53But I think, you know, unfortunately, we have been faked out several times in the past.

08:57So, what's the old saying?

08:59Fool me once, shame on you.

09:00Fool me five times, shame on me.

09:02And Sam, just finally, because we have a lot of retailers reporting earnings this week,

09:08what's your take on the consumer?

09:09And how likely would you be to invest in the consumer at this point right now?

09:16Well, we are going to be getting some retail numbers out this week.

09:20At the beginning of the reporting period, expectations were really only for about

09:25a low single-digit earnings improvement.

09:28Now, that earnings improvement is in the low double digits,

09:32really driven more by Amazon and the group called Broadline Retail.

09:37Other areas of strength are expected to be automotive retail and home furnishing retail,

09:43but still some weakness expected in apparel, computer, as well as other specialty categories.

09:51So, in general, I think the consumer still wants to spend.

09:56What's the old saying?

09:57That consumers will keep spending when the banks continue to lend.

10:02And that's what they are doing, even though they are adding to their overall debt levels.

10:07All right.

10:08Always appreciate your old adages.

10:10Sam Stovall, Chief Investment Strategist, CFRA Research.

10:13Thank you so much.

10:15My pleasure.

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