U.S. stocks have seen the biggest year-to-date losses since the 1960s, but investors should still stick to the sidelines, BlackRock Investment Institute says.
As the S&P (SP500) (NYSEARCA:SPY) and Nasdaq 100 (NDX) (QQQ) fall further todayand Treasury yields (TBT) (TLT) surge, BlackRock remains neutral on stocks on a six-to-12-month horizon, chief global strategist Wei Li wrote in a note Monday.
Li outlined three reasons not to buy the dip.
Increasing downside risks for profit margins
“We expect the energy crunch to hit growth and higher labor costs to eat into profits,” Li said. “The problem: Consensus earnings estimates don’t appear to reflect this.”
“For example, analysts expect S&P 500 companies to increase profits by 10.5% this year, Refinitiv data show. That’s way too optimistic, in our view. Stocks could slide further if margin pressures increase. Falling costs like labor have fed the multi-decade profit expansion. So far, unit labor costs – the wages a company pays to produce a unit of output relative to its selling price – haven’t risen much.”
“We see real, or inflation-adjusted, wage hikes to entice people back to work,” she said. “That’s good for the economy – but bad for company margins.”
Equities aren’t much cheaper
“Valuations haven’t really improved after accounting for a lower earnings outlook and a faster expected pace of rate rises,” Li said. “The prospect of even higher rates is increasing the expected discount rate. Higher discount rates make future cash flows less attractive.”
Growing risk the Fed tightens too much
“Signs of persistent inflation, like last week’s CPI report, may fuel the latter risk,” Li said. “That’s all part of why we turned tactically neutral on equities last month. Stocks slumped last week near lows of the year. We don’t see a sustained rally until the Fed explicitly acknowledges the high costs to growth and jobs if it raises rates too high.”
“That would be a signal to us to turn positive on equities again tactically,” she added. “We see central banks ultimately opting to live with inflation instead of raising policy rates to a level that destroys growth. That means inflation will likely stay higher than pre-Covid levels.”
“We also think the Fed will quickly raise rates and then hold off to see the impact. The question is when this dovish pivot will take place. This uncertainty is why we’re tactically neutral on s tocks but overweight on a strategic, or longer term, horizon. We think the sum total of rate hikes will be historically low.”