Expert to Expert meets The Bid
A market outlook for ― and by ― the generations
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Past performance is not a reliable indicator of current or future results.
Featuring:
Tony DeSpirito, CIO of U.S. Fundamental Equities
Caroline Bottinelli, Co-Portfolio Manager, U.S. Growth team
Host/Moderator:
William Su, Co-Director of Research, U.S. Income and Value team.
William Su: For many investors, 2022 has been a year to forget. But history books may remember it as a lesson for the generations.
Welcome to this special edition of Expert-to-Expert meets The Bid, BlackRock’s award-winning podcast that breaks down what’s happening in the markets and explores the forces changing the economy and finance.
Today we’re bringing together investors from BlackRock’s Fundamental Equities group to examine the powerful dynamics shaping the outlook for the U.S. stock market.
I’m your host Will Su, Co-Director of Research for the U.S. Income and Value team. I’m joined today by my colleagues Tony DeSpirito, CIO of U.S. Fundamental Equities, and Caroline Bottinelli, Co-Portfolio Manager with our U.S. Growth team.
From inflation to sustainability, together we’ll dig into the topics on investors’ minds and, in the process, debate how expectations for the year ahead may be colored by time horizon and our own experience of market history.
Tony, Caroline … welcome!
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William Su: So, I’ll start by asking each of you, how has your own experience or study of history shaped your view of the markets this year?
Tony DeSpirito: I’ll start with that, Will. I think history is incredibly important. And as both of you know, Larry Fink often talks about the importance of being a student of the markets. And part of that is being a student of market history. And given today’s topic, I figured history would come up. So, I brought with me two quotes that I wanted to share, so I’ll read them.
One is from Winston Churchill. He says: “The farther back you can look, the farther forward you are likely to see.” And I think that applies to a range of fields ― obviously, politics, sociology, but also markets. And then John Kenneth Galbraith, specifically talking about markets, says: “For practical purposes, the financial memory should be assumed to last at maximum no more than 20 years. This is normally the time it takes for the recollection of one disaster to be erased, and for some variant on a previous dementia to come forward to capture the financial mind. It is also the time generally required for a new generation to enter the scene, impressed as had been its predecessors, with its own innovative genius.” And he’s talking a lot about financial bubbles, and that’s how he relates that quote.
So, I absolutely do think studying history is important. And Will, as you know, on our team, we went back in 2021 when we saw inflation starting to increase, we went back and asked all our analysts to study the 1970s because that was the last bout of significant inflation. And not only did we ask them to look at stock returns and stock prices, but we also asked them to go back and read 10-Ks, to read what management was saying in their reports year by year, and to see how that inflation impact evolved.
And that really helped us set our playbook for this year. And so, I think that’s really what active management is about. It’s about, you know, studying history, studying the current data, but then adding judgment to that. Because data and history doesn’t see around corners. Human judgment does. I think that in a nutshell is how we can add value as active investors.
William Su: Some great wisdom in those words. Our Fundamental Equities group surveyed over 1,000 U.S. individual investors in the first half of this year, and it was interesting to see the differences in views by generation. The younger investors, the Millennials, were more comfortable increasing equity allocations this year. So, Caroline, as a fellow Millennial, what do you make of this phenomenon?
Caroline Bottinelli: Well, I think there are two factors at play here. The first is that investors of my generation just haven’t seen a period of sustained high inflation in their lifetimes as the forces of globalization and technology and demographics have put downward pressure on inflation and rates over the past 40 years. And since we’ve been in this environment of tame inflation for so long, we’ve grown accustomed to the Fed (Federal Reserve Board) being quick to pause or even pivot at the first signs of economic weakness. And so, I think because of this experience of relatively recent history, younger investors are maybe more inclined to believe that the Fed will pivot here, which would be positive for equities.
The second and I think the more important factor at play here is just that this younger generation has a longer investment horizon. So, sure, equities could fall further from here. But over the long term, it’s earnings compounding that drives returns. And we know that missing out on just a handful of the best days in the market can significantly negatively impact those returns. And so, it’s important to stay fully invested. You know, as they say, it’s time in the market, not timing the market.
Tony DeSpirito: I think that’s great wisdom. I’ve lived through multiple bear markets, right? 1990, 2000, 2008. And, you know, at the time, they all seemed massive and they’re quite frightening, to be honest. And so, but when you get some historical perspective, they start to look like small speed bumps on the way to, you know, good long-term returns. I mean, that’s the power of compounding, right? That’s your point about staying in the market. It’s time in the market, not trying to time the market.
And so, you look at this year and, you know, the market’s down about 25% through the third quarter. Earnings estimates have actually gone up over this time period, so the multiple contraction is even greater. And it doesn’t feel good. But the reality is stocks are on sale now. Now, could they go down from here? Absolutely. But I think once we get some time between now and then and get some hindsight, this will look like an attractive opportunity to be adding to equities.
It reminds me of my own experience in 2008. You know, I started to increase my equity exposure in October. Was that early? Yes. But with hindsight, those were great investments that I was making at that time. I think that’s the lesson.
William Su: And just to expand on that, Tony, so, you know, speaking of long horizons, you’ve been investing for over 30 years? Gen-Xers like yourself and Boomers to an even larger degree, were less willing to increase equity allocations this year. So, what does your experience kind of tell you about allocating capital and managing through periods of elevated market volatility like today?
Tony DeSpirito: Yeah, I think Caroline’s points on time horizon is what’s really critical. You know, if you’re invested in equities, you should be investing with a long-term time horizon. And certainly, you know, the earlier you are in your career or your life, the longer your time horizon.
William Su: Persistence is key. So, you know, one thing that all the respondents in the survey agreed on was that inflation was the biggest risk to stocks over the next six months. And certainly, inflation and higher rates have been particularly hard on growth stocks. So, Caroline, as a growth manager, what’s your outlook for growth stocks at this moment?
Caroline Bottinelli: Well, the pandemic, no doubt, created excesses, for example, in the spending on goods over services. And some of those excesses are now being worked off. And combine that with higher rates, which disproportionately impact growth stocks as longer-duration assets, and some of this repricing was warranted. That being said, we’re long-term investors and the secular tailwinds that we’re investing behind continue whether that’s the trend toward e-commerce or public cloud adoption or automation, innovation is not slowing.
I’d also add that the odds of a recession, you know, have increased, and recessionary environments tend to favor growth stocks just given a scarcity of economic growth. So, the macro is highly uncertain here, but valuations for growth stocks, in particular, have come in and the sell-off has been pretty indiscriminate, which I do think creates attractive opportunities for active managers to pick up quality growth stocks with secular tailwinds and with pricing power to manage through a potentially inflationary environment for a longer period of time at a now attractive price.
William Su: Tony, it’s a different story for value stocks, which is what you specialize in. Value tends to outperform in periods of high inflationary regimes. Are you concerned at all that value could fall out of favor as inflation recedes?
Tony DeSpirito: So I go back to the history, and I think it’s important to keep in mind just how unique the decade after the Global Financial Crisis was, right? It was a period marked by really low growth, really low inflation, and really low rates. That’s a tough time on a relative basis, at least to be a value investor, right? So, value stocks went up during that period, just a lot less than growth stocks or the market.
While I do see inflation rolling over from here so I think it’s very likely inflation has peaked and is coming down I don’t see it going back to the levels of the post-Global Financial Crisis era for a couple of reasons.
One is, I think there are just some structural things in place that are just going to mean higher inflation. It’s some of the things you mentioned earlier, Caroline ― the deglobalization, decarbonization, as well as demographic changes. All those lead to higher inflationary forces. So, I think we’re, you know, as investors, it’s not our job to look at the last decade, it’s to ask what’s the next decade going to look like? And so, I think that’s going to be one that’s much more favorable to value investing.
Also, starting points matter. And one of the things that we look at is valuation spreads. So, value stocks are always statistically cheaper than the market, but how much cheaper varies over time. So sometimes those spreads are pretty narrow and sometimes they’re really wide. As we sit here today, those spreads are very wide. And in fact, statistically you’d say two standard deviations wider than normal.
So, Caroline’s just told you why growth stocks are interesting. I just told you why value stocks are interesting. How do you square that? I think that’s a natural question. We went back and looked and said, what if you took a portfolio of growth stocks and a portfolio of value stocks and blended them 50/50 and then compare that to investing in the market? And what you see is that growth-and-value blend is actually very cheap versus the market today. So, what that’s telling you is the stuff in the middle, the stocks in the middle, are actually very expensive. And, you know, historically from this starting point, you do really well blending that growth and value.
William Su: It’s great. I mean, there’s a lot of opportunities on the board. So, let’s talk about the risk. So let me just ask you both. Right. We did the survey of investors in January, then again in May, and inflation was cited as the top risk both times. It’s October now. Do you think inflation will still be the biggest risk to stocks in the next six months?
Caroline Bottinelli: I do, because I think it’s inflation that’s ultimately driving the Fed’s rate hikes. I mean, of course, the Fed is going to talk tough on inflation because they need the market to believe that inflation will not be persistent. But the reality is that if inflation begins to moderate, it gives the Fed room to pause. My concern is that the inflation that we’re seeing right now is supply driven and broad based, and we have this very tight labor market. And I think it may be difficult for the Fed to tame inflation with the tools that they have without causing a recession.
Tony DeSpirito: Yeah, from my perspective, you know, if you go back to the beginning of the year, I had two concerns, right? One was the Fed was clearly behind the curve in raising rates. So, I think spiraling inflation was a real risk at the beginning of the year. The other risk was, well, they tighten significantly and that could cause a recession. Obviously, the Fed’s goal was right up the middle: soft landing, although history again, going back to history, would tell you, don’t expect a soft landing. The only soft landings we’ve ever seen have been when the Fed’s ahead of the curve, not behind the curve.
And so fast forward to today, the Fed’s actually done a lot of work since then. We’ve never seen such dramatic or since Volcker, we haven’t seen such dramatic rate hikes in such a short period of time. And we all know rate hikes affect the real economy with a lag at least six months, but most economists would tell you something more like 18 months. And so, I think there’s a strong likelihood that the Fed overshoots and that we do end up in a recession. And so, you know, in the portfolios I’ve run, we’ve lowered the beta of those portfolios in an effort to protect ourselves from a potential recession.
William Su: It’s great. Let’s shift gears to sustainability. In our survey, Millennials showed greater interest in sustainable investing than either Gen-Xers or Boomers. And it’s certainly a newer and growing area of investing. So, as active investors, how do you define the investing opportunity in sustainability here?
Tony DeSpirito: I’m really excited about the alpha potential, and I think that it’s important to emphasize the alpha potential of ESG investing. And I look at it just like I look at other alpha drivers, but I do think ESG is becoming an increasingly important driver of alpha. And I think about it in terms of it’s about companies following consumers, where their minds are and where they’re headed. It’s about attracting the talented workforce and helping the company execute on its strategy better. And it’s about cost of capital. You know, if a company manages their ESG risks better, they have a lower cost of capital. And so, all those things generate alpha.
And then as an active investor, I think there’s a real opportunity for us to go beyond the rating agencies, coming up with our own ratings of companies based on ESG. And there’s also the opportunity for us to think about how companies might improve on ESG, to create more value for shareholders, to lower their cost of capital, etc.
Now, there’s also some opportunities to be a little bit more contrarian and a little bit more thoughtful. And, you know, I’m actually going to bring you into this, Will, because you’re our resident expert on energy. And I think we’ve done some interesting thinking on positioning around ESG there. So why don’t you talk about that?
William Su: Yeah. I mean, perhaps we can do another episode to go through the many nuances of energy and sustainability. But in general, I think what unfolds this winter in Europe is going to be a pretty watershed moment in this whole discussion. The market’s kind of realizing that pushing too quickly into intermittent renewables without them achieving scale first is a recipe for inflation and energy insecurity, right? And it’s a regressive tax for the least financially well-off in our society today.
So, you know, I also see, you know, continue to see a big opportunity to invest in natural gas, which has a key role to play for decades to come, replacing coal in power generation, emitting half the carbon emissions of coal.
And finally, you know, I think that some of the largest oil and gas companies today, for as much as they’re vilified, can play a key role, right? In two things: They can generate inflation-protected dividend income for investors’ portfolios and at the same time, with high commodity prices, they can also develop some of the key technologies that we need for them to become the largest renewable energy companies in the coming one, two, three decades.
So, let’s turn to another sector in the headlines,technology. Caroline, tech and innovation are a big part of growth investing. So, what do you see for technology stocks as we get closer to turning the page to 2023?
Caroline Bottinelli: Yeah, well, the technology sector holds a lot of these poster children of growth stocks where the earnings were supercharged during the pandemic and higher rates have had a significant impact on valuations. But I’d emphasize again that the secular tailwinds driving these businesses continue. And I actually think that the challenges businesses are facing today from a tight labor market and higher input costs could drive greater adoption of technology as businesses just look for efficiencies. So, I’m optimistic about the tech sector as the market rewards earnings growth over the long term, and you do now have a more attractive entry point.
But I’d also point out that I think you can find innovation across sectors what, for example, healthcare or industrials, and the technology sector itself is a pretty heterogeneous sector. So, I think that active management again here is really important, and picking your spots is critical.
William Su: It’s fantastic. So, look, no matter how much you’ve seen, studied or how long you’ve been investing in the markets, 2022 was an unusual and humbling year for all investors. So, what was your biggest learning that you’ll take with you as you invest next year and beyond?
Caroline Bottinelli: For me, it’s the importance of knowing what you don’t know. So, if we rewind to this time last year, valuations for growth stocks were stretched versus history and inflation was elevated. And so, in retrospect, it might seem obvious that a sell-off in growth was overdue. But you have to remember at the time that valuations for growth stocks had been stretched or elevated, I guess versus history, for years. And there were all these reasons to believe that the inflation we were seeing at the time was transitory, just a by-product of these temporary supply bottlenecks.
So, the lesson for me is that these regime changes or inflection points in markets are just really, really difficult to predict. And I think our job is to be aware of the risks and to diversify our portfolios.
Tony DeSpirito: Yeah, so when I think about this year in inflation and rates, I think about Dornbusch’s Law. And the gist of Dornbusch’s Law is, you know, in finance or economics, whatever you think should happen ultimately takes much longer to start happening. But once it does start, it moves at a pace way faster than you would have expected.
And so, I think that’s what we’ve seen with inflation and rates this year. I mean, for over a decade, the Fed was trying to get inflation up and it couldn’t and then it finally did. And once it did, it started to rise at a pace that far exceeded policymakers’ expectations. And that’s a lesson I think we just see over and over in financial markets.
William Su: Great. This is a fantastic conversation. And thank you guys for your time and your insights. Thank you, Tony. Thank you, Caroline.
Thank you for tuning into this special edition of Expert-to-Expert meets BlackRock’s podcast, The Bid. For more equity market insights, check out Tony’s recent episode of The Bid, A stock picker’s guide to inflation. We also invite you to visit BlackRock Fundamental Equities’
Millenials: Also known as Generation Y, generally denotes people who were born between 1981 to 1996.It is the generation between Gen X and Gen Z.
Gen Xers: Refers to the generation of Americans born between the mid-1960s and the early-1980s. Gen Xers, which fall between baby boomers and millennials
Boomers: Baby boomers, often shortened to boomers, are the demographic cohort following the Silent Generation and preceding Generation X. The generation is often defined as people born from 1946 to 1964, during the post–World War II baby boom.
Fed: short for US Federal Reserve, which is the central bank of the United States of America.
DISCLOSURE
The survey referenced herein was conducted online in January and May 2022. Respondents (1,083 in January and 1,091 in May) were Americans aged 25+ with a minimum of $250,000 in investible assets. The survey was executed by Material Holdings, an independent research company.
This material is provided for educational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of October 2022, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the listener/viewer. The material was prepared without regard to specific objectives, financial situation or needs of any investor.
This material may contain forward-looking information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of yields or returns, and proposed or expected portfolio composition.
Investing involves risk. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Diversification does not ensure profits or protect against loss.
Important information
Glossary:
10-K A 10-K is a comprehensive report filed annually by a publicly-traded company about its financial performance and is required by the U.S. Securities and Exchange Commission (SEC). The report contains much more detail than a company's annual report, which is sent to its shareholders before an annual meeting to elect company directors.
the Fed The Federal Reserve often referred to as the Fed is the central bank of the United States.
multiple contraction Multiple compression is an effect that occurs when a company's earnings increase, but its stock price does not move in response
longer duration Duration is a measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates.
macro economics in terms of whole systems especially with reference to general levels of output and income and to the interrelations among sectors of the economy.
standard deviation a parameter that indicates the way in which a probability is centered around its mean and that is equal to the square root of the moment in which the deviation from the mean is squared.
beta a measure of the risk potential of a stock or an investment portfolio expressed as a ratio of the stock's or portfolio's volatility to the volatility of the market as a whole
alpha term used in investing to describe an investment strategy's ability to beat the market, or its edge.
Quotes:
Winston Churchill: The farther back you can look, the farther forward you are likely to see. What Churchill actually said was, The longer you can look back, the farther you can look forward. https://winstonchurchill.org/resources/quotes/quotes-falsely-attributed/ John Kenneth Galbraith: For practical purposes, the financial memory should be assumed to last at maximum no more than 20 years. This is normally the time it takes for the recollection of one disaster to be erased, and for some variant on a previous dementia to come forward to capture the financial mind. It is also the time generally required for a new generation to enter the scene, impressed as had been its predecessors, with its own innovative genius. From A Short History of Financial Euphoria, Penguin Publishing Group, July 1, 1994.
