Expect more downside from the S&P 500 at year's end: Analyst

Jill Carey Hall, Head of U.S. SMID-Cap Strategy at Bank of America Global Research, joins Yahoo Finance's Brian Sozzi and Emily McCormick to discuss the market outlook for the remainder of 2021.

Video Transcript

BRIAN SOZZI: Jill Carey Hall is a US equity strategist and head of US small and mid-cap strategy at Bank of America. Jill, always nice to see you here. Find me a bull market because all I'm hearing on earnings calls is supply chain problems, inflation. Where should investors navigate to now?

JILL CAREY HALL: Great to see you again. Yeah, I think, you know, even though we're a bit more cautious on the S&P 500 at these levels, we expect more downside than upside risk through year end. And we're looking for sort of a flattish market between now and the end of 2022, just given some of the risks that we're seeing right now within the market, given how elevated sentiment is, given how elevated valuations are. We do still see opportunities within equities for investors.

So one of those areas is small caps, which I cover. And we think that the outperformance of the US relative to some other regions over the next year, the pickup in CapEx spending by corporations, which we're seeing evidence of the starting season, that that's typically bullish for smaller, more domestic companies. And small caps aren't as stretched on valuations. So you're seeing that smaller stocks trade at multi-decade lows relative to where they usually trade versus larger stocks.

So the longer term returns, if you're a long-term investor, could actually be pretty bullish for small caps right now, after they saw a long period of underperformance. So we're projecting based on where valuations are today that small caps could actually see mid to high single digit annualized returns over the next decade, whereas for the S&P 500, our models are actually suggesting you could see flattish to slightly negative annualized returns over the next decade.

EMILY MCCORMICK: Jill, this is Emily. A couple of stats were really eye popping and stood out to me in a recent note from Bank of America. Your firm pointing out the supply chain mentions on third quarter earnings calls were now up 412% year on year. That's a record increase. And labor mentions were up 320%. When you look at numbers like this, is this the peak here for these concerns on the supply side constraints, or are some of these concerns going to be continuing to impact companies well into next year?

JILL CAREY HALL: Yeah, I think that that's certainly a risk that a lot of these issues could persist into 2022. And companies have been able to continue to expand their margins. So, you know, S&P 500 margins this quarter have continued to surprise to the upside. Companies have been able to exercise operating leverage, been able to price through, but we think the risk is really just given how much inflation and some of these supply chain issues have surged-- and companies are obviously talking about this on earnings calls that, you know, expectations for companies' margins next year look a bit too optimistic to us.

Analysts in aggregate are expecting that S&P 500 margins will increase to new highs. So we think given the risks that are out there, that seems a bit optimistic, so we're a bit below consensus on earnings growth for next year. We're only expecting about 7% earnings growth consensus is closer to 10%.

BRIAN SOZZI: Jill, it's pretty cold out where I am. It's giving me visions of a potentially worse than expected winter storm season. If we do get a few bad storms, oil shoots higher to $100, do you think the market shrugs it off?

JILL CAREY HALL: That's a great question. I think we do see risk that oil goes above 100 next year. That is our commodity strategist forecast. And the sensitivity of the market and the economy to oil can change over time. And that's one of the risks that we've been writing about recently is that even though for the S&P 500, higher oil prices were historically a benefit to corporates.

We think that now there's risk that that reverses, and that could actually be a headwind to corporates the way that it typically can be to consumers because we've seen the energy sector and the areas that benefit from higher oil prices are now a shrinking share of the US stock market, the shale revolution that we've seen a maturing of this. We've seen a number of factors that made oil positive start to reverse. This has been a supply driven shock. So, certainly, this is another area of risk to corporate earnings as we continue to move forward.

EMILY MCCORMICK: We're getting another Federal Reserve monetary policy statement and press conference, of course, from Fed Chair Jerome Powell on Wednesday. When it comes to where interest rates might be headed, what is your expectation for next year and 2023? And how do you expect that to impact equities, large cap, mid-cap, and small cap, going forward?

JILL CAREY HALL: Yes, so we expect the taper to be announced in November. And we think in terms of interest rates, they're likely to move higher and not lower from here. We do expect that given where rates are today, still low, but expecting higher rates.

A way that investors should position for this is they want to own inflation protected yield, so looking for areas of the market that pay an attractive yield if rates are going to stay low, but go higher, but can actually grow those dividends or in areas of the market that are better protected from inflation remaining elevated, areas like energy, which has a very healthy free cash flow and dividend yield right now.

Financials, we see dividend growth potential. This is a sector that's been increasingly returning cash to shareholders. So those are the areas that we would think-- we would recommend that investors position for a gradually rising rate backdrop. And again, we do think that small caps are still well positioned. The segment has obviously thrived on access to cheap capital. But if rates are rising in the context of an improving economy, typically, this is still a bullish backdrop for smaller stocks.