Large-Cap Value Stocks Will Power the Market Rally From Here, This Strategist Says

Subramanian moved to BofA in 2008 when Bank of America bought Merrill in the teeth of the financial crisis. She was named head of U.S. equity strategy in 2011.

In March, she raised her S&P 500 year-end price target to 5400 from 5000, then one of the most bullish calls on Wall Street. The index topped that level on June 12 after the release of the consumer price index for May, which indicated that inflation had cooled, but she isn’t planning to change her target now. “There are parts of the S&P where we’re more constructive but our directional conviction is lower given that market sentiment has moved from bearish to more neutral,” she said.

Barron’s spoke with Subramanian on June 9, and via email on June 12, about her favorite market segments, her concerns about tech stocks, and her career. An edited version of the conversation follows.

Barron’s: The S&P 500 rose 24% last year, and is up again this year. Can stocks keep climbing from recent levels?

Savita Subramanian: If I were going to buy one kind of investment for the next 12 to 24 months, it would be large-cap value. That’s where you’re going to get the most bang for your buck. That’s what will lead over the next few years, given the macro environment.

What worries me about the market is that at the beginning of the year, there was tremendous skepticism around the longevity of the rally. Today, there is far more bullish sentiment. At the beginning of the year, it was much easier to be bullish because there were a lot more bears. And at this point, I feel like a lot of the bears have capitulated.

Do you blame them? Valuations seem lofty, with the market trading at 22 times next year’s expected earnings.

I’m not worried about equities from a valuation perspective because these multiples are sustainable. We’re moving from a period of uncertainty. Prior to the Federal Reserve hiking interest rates by more than five percentage points, nobody knew how we were going to escape zero rates. Today, interest rates are well above that. The Fed has done a lot of the hard work already.

Inflation volatility has subsided. This is where clients probably disagree with me the most, but I feel that what the Fed does now is less important because it has already done the extreme process of hiking.

How many rate cuts do you expect this year?

We could see one cut in December. But the risk is, if the Fed doesn’t cut, what happens? There is a high probability that the Fed holds rates steady for the rest of the year. And if inflation comes back with a vengeance, the Fed could be forced to hike. What happens in that scenario?

Until we get to that moment where the Fed says we’re at peak rates, inflation is coming down, and we can be more accommodative, you want to hold inflation-protected sectors such as energy, materials, and financials. These are more cyclical than defensive sectors.

Is inflation still the biggest concern for investors and the Fed, or is it secondary to fears about the economy and job market?

The monthly and weekly economic data are noisy. Over a three- or four-month time period, they look worrisome because they’re all softening. But when you look at them from a longer-term time horizon, they look fantastic.

When we were in more of an inflationary environment, we wrote about how the best environment for equities was 2% to 4% inflation. That’s where we are right now. The best environment for equities is when real wage growth is positive and nominal sales growth is at reasonable levels.

There is the potential for a cyclical recovery. Even though the recent ISM manufacturing data wobbled a bit, the numbers aren’t as low as a couple of months ago. We are looking at things through the wrong end of the telescope. Every week there is cause for recession or stagflation concerns. But in the grander scheme of things, we’re seeing economic data normalize from very hot levels after the Covid pandemic and all the fiscal stimulus to levels that are good for equities, especially cyclical companies.

We keep hearing that this rally will broaden out. Meanwhile, Microsoft, Apple, and Nvidia account for 20% of the market valuation of the S&P 500. Are you concerned about that concentration?

I’m not concerned because it isn’t a negative signal. But I am surprised by how narrow the market has become. I would have expected a broadening out to have happened earlier.

The earnings of the megacap tech cohort are so high that we are more likely to see a deceleration than an acceleration. Another reason to expect a broadening out is that we got positive guidance across the board, and not just from tech companies, during first-quarter earnings season. The other major market sectors were all posting more positive than negative guidance.

A couple of years ago, you mentioned in an interview that you liked big, old, boring U.S. companies. Is that still the case?

I don’t know if I would say I still like big, old, boring companies. I like a mix of companies that are generating strong free cash flow and enjoying the benefits of this tech revolution, but also companies that are potentially becoming more labor light. If you think about the areas that could benefit from generative artificial intelligence, it’s banks, legal services, and IT [information technology] services.

And if you think about cash flow, it isn’t just tech but also utilities, power, infrastructure, and energy companies that are generating substantial amounts of cash. Some are exciting, and some are boring. But they are mostly big. That’s where I differ from a lot of other bulls. I don’t think you want to buy all small-caps, because while some of them are economically sensitive and will benefit from better gross-domestic-product growth in the U.S., others are morphing into smaller-cap companies because they used to be large.

I also like companies like Alphabet and Meta Platforms that have decided to start paying dividends. These are stocks that will probably show up in value benchmarks in a year. What I don’t like are companies that don’t make any money and might not be able to hack a higher-for-longer rate environment.

How nervous should investors be about the U.S. elections in November?

In the U.S., elections are less important than they might be in other regions of the world. We’ve seen contentious races, and the outcome has been somewhat of a nonevent. Former President Donald Trump’s win in 2016 was OK for stocks and the economy even though we initially thought there could be big changes.

The differences between Trump and President Joe Biden are around things like healthcare spending, immigration policy, and maybe the regulatory landscape. We aren’t going to see massive corporate regulations levied, especially at techs or banks, because these are the two sectors that are critically important for the U.S. to retain its position of primacy. You can’t choke off all the lending at the banks with regulations, because the economy would come to a halt. The regulatory backdrop is potentially less punitive than it might have been in prior election cycles.

The fact that both candidates agree that they want to bring back manufacturing from China and other regions of the world to the U.S. has created more jobs. While these policies are protectionist and inflationary, they are also pro-growth.

You’ve been at BofA and its predecessor company, Merrill Lynch, for more than 20 years. What has it been like to work in one place that long, both personally and from the standpoint of an investment strategist?

It has helped me become a better investment strategist. At some level, I find it easier to forecast things that I’ve lived through.

The credit crisis taught us that leverage can be evil. Short-term debt can be evil. But in a weird way, that created an environment much more suited to managing higher rates. We all took our lumps during the financial crisis, and now big corporations don’t have massive leverage risk. The lessons learned in 2008 prepared the economy for what is happening now. It is good to live through different types of shocks and see how companies and consumers adapted to those crises.

What has surprised you most about how the investment world has changed during your tenure?

Time horizons have gotten faster. Technology has gotten better. But it might not be an easier or a harder time to be a strategist. It’s easier because there is more data, but it’s harder because you have to filter out more irrelevant information.

Right now is the most interesting time to be a market strategist, in my opinion. We’re back to a more rational market. When we were in a zero-interest-rate, massive-stimulus-driven market, it was hard to forecast what would happen next. Events were in the hands of central bankers.

Today, inflation volatility has subsided. It is interesting to see how companies are recalibrating, and what the lay of the land is in each region of the world and each sector. The outlook depends less on central bankers, and more on corporations and consumers.

Thanks, Savita.

Write to Paul R. La Monica at paul.lamonica@barrons.com