Learned Lessons and Market Musings From CIO Bob Doll

The Crossmark investment leader expects 2022 to be more challenging for investors, as central banks unwind supportive policies in response to the ongoing economic recovery and macroeconomic conditions drive higher inflation.
By DJ Shaw

During a webinar hosted by Bob Doll discussing his annual top 10 predictions for the year, the Crossmark Global Investments chief investment officer (CIO) noted that this year’s theme is a “tug of war between a good earnings tailwind and a modest valuation headwind,” which he says points to a difficult year ahead with more frequent pullbacks and higher volatility.

Doll said he expects 2022 to be more challenging for investors as the Federal Reserve and other central banks progressively unwind accommodative policies in response to the ongoing economic recovery and elevated inflation readings. While he says he expects solid economic and earnings growth will be a tailwind for equities, rising interest rates and stubborn inflation will be headwinds, likely creating volatility.

Despite a positive earnings picture, Doll says, the overall macro backdrop will become less favorable for the equity market in 2022. The Fed’s recent tapering announcement marks the beginning of a shift toward a less accommodative monetary policy stance—a situation likely to be complemented by reduced fiscal stimulus, he added.

The following is a summary of Doll’s 10 predictions for 2022.

  1. U.S. real growth and inflation remain above-trend but decline from 2021 levels.

Doll’s discussion: “2021 was gargantuan. Real gross domestic product (GDP) was up 5.5%, and, of course, we don’t have the final number, but we will come in somewhere in that zone, most likely, depending on the fourth quarter. If it’s anywhere close to that, that’d be the strongest U.S. economy since 1984.

“We expect quite good growth in 2022, call it 4%, but noticeably slower than 2021, and a modest downtick in inflation, which we think is a bit of a confusing sign.

“Economic growth this year, as I just stated, in our view will be above trend, but it’s slowing. The economy is still reopening, but it’s not uniform. It’s bumpy. We still have the tailwinds, have massive monetary and fiscal stimulus, but we’re past our peak.”

  1. Inflation falls, but core inflation remains stuck at around 3%.

Doll’s discussion: “Inflation is as high as it’s been in nearly 40 years, so most people don’t remember anything but low inflation. And yet we think the inflation rate is nothing like we’ve seen in other periods in our history, even for many of us old folks remembering the 1970s, where gasoline and oil price inflation infected the whole system.

“The Fed obviously is part of that story. And our argument is the Fed has finally, belatedly, moved from fighting unemployment to fighting inflation. Again, if you believe inflation was transitory then we wouldn’t even worry about it so much, but if you’ve come to the view that it’s not totally transitory, you got to get on the stick.

“We think that that 2022 is going to be confusing for inflation. We think it will fall because some of the transitory factors will disappear. Some of the supply shortage problems will get solved. But our point is that core bedrock of structural inflation is not going back to the 1% to 2% level; it’s going to be between 3% and 4%.”

  1. For the first time since 1958-59, 10-year Treasurys provide a second consecutive year of negative returns.

Doll’s discussion: “2021 and 2022 are likely to be the first back-to-back years where you lose money in a 10-year Treasury bond since 1958 and 1959. We have a series of conditions that tell us that interest rates will creep higher, hopefully not at the pace we’ve seen so far in the early part of this year. But if 10-year Treasury yields move up this year by the same amount they moved up last year, we’ll have a 10-year Treasury at the end of this year at 209 basis points (bps).

“The Fed, every cycle, if you remember or study economic and market cycle history, always moves from our best friend to our worst enemy. The time frame between the two is always different and hard to speculate, but that’s the discussion that goes on. There are various signs of the Fed taking the punch bowl away, to use another common phrase.”

  1. Stocks experience their first 10% correction since the pandemic and fail to make the gains widely expected.

Doll’s discussion: “The consensus is basically saying ‘earnings grow and that’s how much stocks will be up this year.’ We do not have anything to quibble with regarding earnings, and we think earnings will be robust this year.

“Like our analysis on the economy, we’ve got the puts and the takes for the stock market. The first positive is an important one, i.e., no recession. We do not see a recession and without a recession, it is hard to envision a big, sustained move down in the stock market. We can have a noticeable smack, but we recover if there is no recession, because in the long run, earnings do move stocks. The inflation rate falling this year is another good sign, but be careful, because we don’t think the market made much of an adjustment for the fact the inflation rate has moved higher.

“On the negative side is valuation levels. Now, you can complain about that for a long period of time and in the short run valuation really doesn’t matter much, but over the intermediate and longer term, it is the driver to where stock prices go. Again, like No. 3, the Fed is taking away the punch bowl. The big tailwind to the stock market over the last, I’m going to call, a decade has been easy policy, zero interest rates.”

  1. Cyclical, value and small stocks outperform defensive, growth and large stocks.

Doll’s discussion: “We’ve had a long period of time, for example, where growth has beaten value, and if you look at that one in particular, you can see value stocks are very cheap compared with growth stocks. You do not often see this dichotomy at this magnitude.

“As I said earlier, the valuation of something like a stock does not alone indicate where it’s going, it just means that when it goes in a new direction, it’s likely to have further to travel, and we’ve seen that at the beginning of the year.”

  1. Financials and energy outperform utilities and communication services.

Doll’s discussion: “Financials are our favorite sector. They’re pretty cheap, the stocks, in our view. It is the area where the analysts have the most bearish earnings expectations this year. We think they’re being too cautious. If interest rates move higher and the economy’s OK, financials will tend to do very well.

“When it comes to energy, obviously, the sector tore it up last year. We think they’ll do well again this year, as we see, in terms of supply and demand, an imbalance. Supply is curtailed partly for political reasons, and demand, with the improving economy, is pretty robust, so the path of least resistance for prices of oil and gas has been higher.

“Here’s another interesting way to look at industries and sectors: Analyses show that, when interest rates rise, certain sectors traditionally outperform and underperform. The outperformers tend to be the more cyclical areas, sectors such as financials, materials, industrials and energy, and the ones that don’t do so well tend to be far more defensive stocks, things such as consumer staples and utilities.”

  1. International stocks outperform the U.S. for only the second year in the past decade.

Doll’s discussion: “It’s amazing by magnitude and the number of years that the U.S. has outperformed the rest of the world. We’re not urging people to run out and sell all their domestic stocks and buy a bunch of international stocks. We’re just saying if you’ve been fortunate enough to be primarily invested in the U.S., stand up and take a bow, and then do some dollar-cost averaging slowly but surely.

“The U.S. is the most defensive stock market in the world, so in slow growth environments, the U.S. tends to outperform, but in other conditions such as those we see emerging, international stocks tend to do better. When rates rise, the U.S. tends to lag.

“Another wild card, to get this one right or wrong, could be the need for some dollar weakness. The dollar has remained pretty strong over the past couple of years. Our guess is that, with a defensiveness of the world slowly dissipating, as people begin to realize it’s safe to come out from under the covers and go do some shopping, that we will see pressure on the U.S. currency.”

  1. Values-based investing continues to gain share.

Doll’s discussion: “People are saying they want to line up their investments with their values. This goes by all kinds of names—environmental, social and governance (ESG) investing or socially responsible investing (SRI) or others—depending about what kind of person you’re talking to.

“The way to implement this is to figure out what companies are doing harm, according to your values, and avoid them. On the other hand, figure out which companies are doing good and embrace and own those. Then, where appropriate, engage with other companies to figure out where they are, where they’re going and maybe help them realize what some of these issues are.

“This is an area that has been growing, we think it will continue to grow.”

  1. After a 60-plus year low in 2021, the federal interest expense, as a percentage of revenue, begins a long-term move higher.

Doll’s discussion: “It’s not just the amount of debt, it’s the interest rate on the debt. And over the past decade or so, until recently, interest rates have fallen faster than the debt has gone up, such that interest expense has fallen as a percentage of revenue. Our point is that the tailwind is over and we’re going to go back up the other side, hopefully for not too many years. We’re going to be in this pickle for quite some time. There is no free lunch. When you borrow money, you are borrowing from the future.”

  1. Republicans gain at least 20 to 25 House seats and barely win the Senate.

Doll’s discussion: “The 10th prediction is always a political prediction because politics affects investments. The U.S. has undergone the most political volatility and, a lot of years, the party in power has been removed seven of the last eight elections, and our guess is that will happen. The Democrats will lose both houses of Congress and the Republicans will have it, and then the mark will be on their head to produce, otherwise, they’ll be kicked out of office.

“How does all this affect the markets? We’ve looked carefully at midterm election years and we have the following observations. For starters, since the S&P 500 was created in the 1920s, 73% of the years the market has gone up. So, about a quarter of the time, it goes down. But, if you only look at every fourth year, i.e., the midterm election year, only 62% of the time has the market gone up. And then, if you further look at those years, and only look at the subset of the first term of a president, growth occurred only 44% of the time. In other words, more than half the time it’s gone down.

“The biggest decline is in the second year, which is the midterm election year we’re in now. I hope these patterns don’t repeat themselves, but they’re worth pointing out. The good news is, post the midterm election, since 1950, the next 12 months has always gone up. Let’s hope this one is repeated.”

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