- Strong market fundamentals justify the current rally despite weak economic data, said David Waddell.
- Waddell is considering a rotation back towards growth equities to navigate a slowing economy.
- To capitalize on a weakening dollar, he also recommended investors buy international stocks.
Following a slide into official bear market territory, stocks suddenly reversed course last month to pare back some losses, with the S&P 500 and Nasdaq Composite up almost 10% and 13%, respectively, since mid-July.
Some investors, like Bank of America’s Michael Hartnett and former PIMCO CEO Mohamed El-Erian, believe that current economic data paints too gloomy a picture for the bear market rally to continue. But David Waddell, who serves as the CEO and chief investment strategist of the $1.4 billion firm Waddell and Associates, disagrees with this sentiment.
“The markets are projecting forward that inflation’s coming down, which means valuations can go up. Because of that, I do think the market bottom is in,” Waddell told Insider in a recent interview. “There’s a lot more opportunity than people see, and the pessimism makes me bullish.”
Even before the rally began, Waddell predicted that markets would fare better in the second half of the year, in part due to extremely negative investor sentiment and a belief in mean reversion. Historically speaking, after the market has dipped by double digits — like it did in the first half of 2022 — it’s typically up by 20% twelve months later, he explained.
Despite last quarter’s negative GDP print and threats of another higher rate hike, Waddell still hasn’t wavered on his forecast. Not only does he believe that inflation has already hit its peak, but he also believes that current market valuations and future earnings expectations look extremely strong.
“We have broadcast this recession — this is a recession by appointment. So companies have been able to manage their affairs in a way that has continued to generate upside surprises and earnings,” he said, explaining that the market has already seemingly priced in any future economic decline. “Now analysts are trimming those earnings, but let’s remember the long term average for earnings growth is about 6%, and they’re forecasting 9% right now for 2023.”
Rotate into small caps and international growth stocks
Value stocks have been an investor favorite since they stole the show in 2020, after more than ten consecutive years of consistent outperformance from their growth counterparts. But for Waddell’s recession trade, he’s considering rotating his portfolios back towards growth stocks.
“If we’re going into sort of this choppy, slow economy mode for a while, then we might need to tilt a little bit more. So we’ve been looking towards growth,” he explained. “I think it’s possible to get into growth at lower valuations just by opening up the aperture to be a little bit more global.”
Simultaneously, this trade also means pivoting away from high-dividend, value compression stocks back into dividend growerswhich are favored during recessionary periods for their predictable cash flows and revenue growth, and includes sectors like healthcare, consumer staplesduck technologyhe explained.
“Some of those have dividends and have had enough valuation compression to really be pretty attractive again,” Waddell said of the tech sector, referencing the five FAANG stocks as an example. “But we’re trying to rotate in a cautious manner and not chase those broken tech stocks, because I think they’re broken for the right reasons.”
Within tech, Waddell is a fan of the broader semiconductor sector, especially Intel, which he predicts has room to rally after a particularly disappointing second-quarter earnings report. He also recommended investors consider buying blue-chip, quality stocks with stable business models like Apple, Microsoftduck Google.
“They have big balance sheets and earnings power. The other thing I like about them is if the dollar rolls over, they get a whole lot of their revenues from overseas, and that could be accretive to earnings,” explained Waddell. “We’re in an environment now, economically worldwide, where the spoils go to the victors — the larger companies.”
The biggest trade opportunity Waddell sees is a weakening dollar, due to the Federal Reserve’s current mandate and better-than-expected growth in Europe. Buying into global equities can also help investors unlock a lot of additional returns offshore, he added.
“I would overweight internationals because everybody’s left those for dead,” said Waddell, specifically pointing out emerging markets spirit Chinese and European equities. “They didn’t get extra punishment from the strength of the dollar, but I think they’ll get extra benefit from weakness in the dollar when we get there.”