Markets may have seen a short-lived rally in the latter part of 2022, but with tough economic conditions ahead, it is important to focus on those companies that can sustain their earnings, says Lisa Yang, manager of the BlackRock Sustainable American Income Trust plc (LON:BRSA).

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

At the end of a difficult 2022, the US stock market showed brief signs of revival on hopes that inflationary pressures were finally easing. However, until a more permanent change in the Federal Reserve’s position, these are likely to be ‘speedbumps’ rather than a permanent change in direction. A focus on resilient companies, with quality characteristics is likely to remain crucial in navigating the year ahead.

Market action in the final months of the year reflected investors’ battle between ongoing fear and flashes of hope that the tough-talking Fed might be ready to ease its rate-hiking campaign. However, inflation still has a long way to go to move back to the Federal Reserve’s 2% target, and may not have peaked.

There are signs that the US economy is slowing: housing demand has dipped, while consumer confidence is also falling.¹ This all points to an eventual decline in inflation. However, wages remain stubbornly high and job openings are also elevated.² This is one element of “sticky” inflation that may make the retreat from peak inflation a slow one.

Against this backdrop, we view the recent periods of optimism among investors as bear market rallies rather than the start of a new bull trend. While history generally has been kind to markets in the year after a midterm election – our analysis shows that markets have not been negative after an election since 1938 ³ – this time round, markets need to navigate recession.

We believe a recession is likely: the economic consequences of rate rises have not yet been felt in full. History also suggests that inflation above 5% is a recipe for recession.⁴ That said, we think any recession could be relatively shallow in depth and duration. The consumer – which accounts for nearly 70% of U.S. GDP ⁵ – remains in relatively good shape, with low debt levels. This should support the economy from here.

Corporate resilience

This paints a picture of a difficult and uncertain market, but one that is not universally gloomy, particularly for active investors. As in prior recessions, dispersion in analyst earnings estimates is rising,⁶ which should see companies with fundamental strength assert themselves. Companies with strong balance sheets and cash flow are in a better position to defend themselves during a recession and to build market share.

In contrast, the influence of the top-five mega-cap stocks that have been dominating US index performance for the past several years may be waning. Their recent results have been, in aggregate, disappointing and there has been some “decoupling” between the top five and the broader market. Their dominance of the index is declining. The top five S&P 500 constituents represented a record high of 22% of the index’s total weight in August 2020, according to data from Refinitiv, and has been inching down since, sitting at just under 19% now.⁷  

This is good news for active funds. The major averages are market-cap weighted, with index trackers benefitting from the strong returns in these dominant stocks in recent years and active funds have struggled to keep pace. However, stock pickers should have an advantage today. They can move away from these companies whose prospects now look weaker, instead focusing on those stocks with potential to generate stronger earnings growth.

The characteristics of individual companies are, we believe, likely to be more important in the year ahead. In the BlackRock Sustainable American Income trust, we continue to look for those companies with a clear pathway of growth, strong balance sheets and a growing dividend, believing these resilient companies will be rewarded in the year ahead.

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1 https://www.forbes.com/sites/qai/2022/11/30/housing-price-index-slows-and-consumer-confidence-falls-as-potential-recession-inches-closer/?sh=746640b67b8d Fobes – 30 November 2022

2 https://www.cnbc.com/2023/01/04/workers-still-quitting-at-high-rates-and-getting-a-big-bump-in-pay.html – 4 January 2023

3 https://www.blackrock.com/us/individual/insights/taking-stock-quarterly-outlook#:~:text=rate%2Dhiking%20campaign.-,Election%20fog%20lifted,-History%20generally%20has – 15 December 2022

4 https://www.blackrock.com/us/individual/insights/taking-stock-quarterly-outlook#:~:text=About%20that%20recession – 15 December 2022

5 https://www.blackrock.com/us/individual/insights/taking-stock-quarterly-outlook#:~:text=The%20consumer%20(which%20accounts%20for%20nearly%2070%25%20of%20U.S.%20GDP) – 15 December 2022

6 https://www.blackrock.com/us/individual/insights/taking-stock-quarterly-outlook#:~:text=A%20growing%20active%20opportunity%3F – 15 December 2022

7 https://www.blackrock.com/us/individual/literature/investment-commentary/taking-stock-quarterly-outlook-en-us.pdf – 30 November 2022

Risk warnings

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

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