How to survive a sideways market

Sameer Samana, a senior global market strategist for Wells Fargo Investment Institute, shares his outlook for the rest of the year.

Q: What’s your outlook for the stock market in the second half of 2023? A:

Our year-end target for the S&P 500 is 4000 to 4200. We’re within spitting distance of that, but we’d caution people against assuming a calm, uneventful journey. It could be more of a harrowing ride down and then back up, as opposed to sideways.

Q: Do you expect a recession? A:

We expect a moderate recession in the second half that bleeds into early 2024. It will probably have to be more than a mild recession to solve the problem of inflation, and that’s what’s driving markets.

Q: Where do you see interest rates headed? A:

We think the Federal Reserve is close to being done, but I’m not sure we’ll see yields fall all that quickly. The Fed has been saying they’re going to take rates up and keep them up. The market has been too optimistic about how quickly inflation will resolve and how quickly the Fed will pivot from hikes to cuts. We don’t think cuts come until the first part of 2024. Remember, this is the Fed that made the mistake of calling inflation “transitory.” The onus is on them not to declare premature victory.

Q: We’re already in a corporate earnings recession (two quarters of declines). Is that a big deal? A:

It is. The consensus of analysts expects earnings to pop back up after a weak first quarter. We think that’s too optimistic. The reason we think earnings will keep deteriorating has a lot to do with how profit margins will evolve.

Once a recession gets under way in the second half of the year, revenues will start to fall. Unfortunately, for companies, costs will be a lot more stubborn, which means margins will contract. So revenues will fall, but earnings will fall faster. I don’t see profitability improving until early to mid-2024.

Q: What should investors do? A:

We want to play defense, but not like during the worst of the downturn. A trading range is a good opportunity to employ tools like dollarcost averaging [investing like amounts at regular intervals]. Investors should favor large-company U.S. stocks, and with fixed income, we’d favor high-quality Treasuries, adding some duration risk opportunistically as rates jump up.

Q: When you say “add duration risk,” that means lock in longer-term rates? A:

Exactly. The yields we’re seeing now on longer-term fixed income are at the upper end of the recent historical range. If anything, as a recession gets under way, some of those yields will melt lower once again.

Q: And stocks? A:

Try to favor sectors with durable demand and high-quality companies, with high profitability, strong balance sheets and wide economic moats that allow them to have stronger competitive positions. I would highlight three sectors: energy, health care and tech.