The current valuation of the S&P 500 — about 18.5 times the expected 2023 earnings of $224 — "looks too rich given current economic uncertainties and our economic expectations," Bob Doll, chief investment officer at Crossmark Global Investments, said in a note Monday.
He recommended removing some risk from portfolios and said it may be hard to keep the stock market rally going as long as Federal Reserve officials are "threatening to weaken the economy and financial markets with higher rates.
"It is difficult to see a cessation of Fed hikes if one takes the central bank at its word based on its own stated commitment to reach its 2% inflation target," Doll said.
While the global economy is proving resilient, inflation should continue to ease, and major central banks are likely to pause their hiking cycles by midyear, Doll cited several risks that call for caution.
- Stock valuations already reflect an improving macro backdrop. "We see little scope for further global re-rating in the year ahead that would coincide with strong price appreciation," Doll said.
- Unemployment rates and corporate profitability, among other factors, are consistent with late-cycle rather than early-cycle economic conditions. "The global economy is not poised to begin an extended or synchronized new expansion," he wrote.
- A decent global and U.S. economy imply inflation will be stickier and higher than markets indicate.
- Expectations that the Fed will cut its benchmark interest rate by year-end are too optimistic and will likely disappoint. "The risk is that bond yields eventually will move higher as rate-cut expectations are unwound," Doll wrote.
- While equity markets are looking through further first-half earnings downgrades to an upturn thereafter, elevated corporate profit margins and return on equity limit the scope for a subsequent earnings upturn, he said.
"Against this backdrop, we advocate taking some risk off the table," Doll said. "The recent risk-on climate has driven the global stock/bond total return ratio to an all-time high. A global 60/40 portfolio of global equities and G7 10-year government bonds has recouped about 40% of the peak-to-trough losses last year."
Global equities are 15% to 20% above their 2022 lows, while G7 10-year government bond total returns have increased 5% to 10% from last year's low, he noted.
"There remains considerable uncertainty and debate about the economic outlook, but our view remains that a noticeable economic slowdown and likely mild recession will occur this year," and leading economic indicators support that view, he wrote.
