The bear market could make a comeback

A version of this story first appeared in CNN Business’ Before the Bell newsletter. Not a subscriber? You can sign up right here. You can listen to an audio version of the newsletter by clicking the same link.

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Investors who believe the bear market is over are “ignorant,” Lisa Shalett, chief investment officer of Morgan Stanley Wealth Management, told CNN.

It’s not that investors don’t have some cause for optimism: markets are soaring, corporate earnings are beating expectations, employment is strong and the Federal Reserve is easing its rate hikes.

But those investors would be wrong, said Shalett. She believes a bigger drop is on its way as the Fed’s rapid interest rate hikes reduce economic growth down the road. Investors, she said, haven’t yet priced that hit to the economy into stock prices.

Unlike most of Wall Street, Shalett’s team doesn’t expect a rate cut anytime soon. They do, however, see increased interest rates as a long-term positive.

Elevated rates will stop speculative “zombie” companies (debt-laden firms that don’t make enough to even cover their interest payments) from procuring easy money and create a shift in asset allocation that leads to a new era of gains, she said.

Shalett predicts that the US is on the brink of a productivity renaissance as the economy and markets restructure post-Covid. This will ignite a multi-year US capital investment cycle, with focus shifting from finance and tech to semiconductors, automation, and AI.

Before the Bell spoke with Shalett about how investors should prepare for these potential changes:

BTB: Consumer tech companies like Apple, Amazon and Google have had a very tough 2022 but appear to be rebounding now that the Federal Reserve is easing up on interest rate hikes? How do you see them fairing going forward?

Sharlett: In every era there were companies that people said that they would never sell that were as dominant as Apple and Facebook and Google are today. There was a time when people said they would never sell their Exxon, that they would never sell their IBM, that they would never sell their AT&T. It’s the law of numbers: When a company gets to a certain size it becomes impossible to keep growing at above average rates. How do you grow when you already have such a large percentage of the market share? This isn’t about technology being a really important sector in our economy. It’s just going to be different technologies.

How bad do you think markets will get?

Inflation is dangerous because it creates illusions. Companies raise their prices by 10% and management convinces themselves they’re doing a good job. They’re not, all they did was raise their prices by 10%. When all of a sudden they can’t raise their prices by 10% anymore, the emperor that has no clothes is exposed, that’s going to hurt stocks and the economy. It’s not going to feel good.

So how do investors stay afloat when this happens?

This is a time for active stock-picking. Investors should be setting portfolios up for a shift in leadership—away from the great companies (but no longer great stocks) of mega cap consumer tech and toward areas like health care, energy, financials, enterprise tech and infrastructure. We’re telling investors to avoid obvious brand names. If it has Tesla in the title, just walk away.

AbbVie and Disney: What investors are watching today

▸ This week brings a big test for pharma-giant AbbVie. For two-decades the company has held the exclusive right to sell anti-inflammatory drug Humira in the US which allowed the company to increase prices (sometimes to more than $50,000 a year per patient) and rake in about $200 billion in sales. That all changes on Tuesday when the world’s best-selling drug faces competition for the first time.

Amgen is expected to launch a version of the drug, and as many as nine new Humira competitors could hit the market later this year. That should send prices of the drug tumbling, investors will be watching to see if the same happens to stock prices. 

AbbVie reports fourth quarter earnings on Thursday, the company’s stock is down about 10.5% this year. 

▸ More labor unrest at Disney. Unionized workers at Disney World have rejected a contract proposal from the company that would have given them at least a $1 an hour raise each year over the five-year life of the rejected offer.

The 32,000 Disney employees, members of six different unions, had been urged by their unions’ leadership to vote no. More than 14,000 votes were cast and 96% voted no.

Disney is due to report financial results for the final three months of 2022 on Wednesday, with analysts surveyed by Refinitiv forecasting that revenue will be up 7% from a year earlier, but earnings will be down 27%.

Get ready for the ‘no landing’ scenario

Over the past year there’s been a lot of talk about whether the Federal Reserve’s efforts to fight inflation by raising interest rates would lead to a hard or soft landing. That is, whether the Fed’s hikes would lead to a recession or if they’d manage to limit price increases without crashing the entire economy. 

Now, economists who are perplexed by the resiliency of the labor market (the unemployment rate declined to the lowest level since 1969 in December), are floating a third outcome: The “no landing.” 

“Under the no landing scenario the economy does not slow down, and upside risks to inflation are coming back after the initial decline in inflation driven by supply chain improvements,” wrote Torsten Slok, chief economist at Apollo Global Management in a recent note. 

That’s not good for markets as higher rates for longer increase downside risk for tech and highly leveraged companies that will see larger interest payments for longer.

“In short, the no landing scenario brings back the volatile market action we saw in 2022 because it reintroduces uncertainty about inflation and about the Fed,” wrote Slok.