Stocks traditionally do well under higher rates: Strategist

Portfolio managers may have to adapt and revise their interest rate forecasts as it is increasingly likely the Federal Reserve may extend its higher-for-longer hold on rates. With a waning rally from the S&P 500 (^GSPC) in 2024's second quarter, where are the entry points into the market investors to consider when managing their portfolio?

BMO Capital Markets Chief Investment Strategist Brian Belski joins The Morning Brief to discuss elevated interest rates remaining higher for longer may actually be in the best interest of investors and how they can take advantage of it.

Belski offers advice he thinks investors should be aware of: "We think that most investors are massively underexposed [to] small and mid-cap [stocks]... If you had $100, only $8 out of that $100 is comprised of small/mid-cap stocks that are publicly traded [and] based in the United States, that's Apple (AAPL) and half of Microsoft (MSFT). Think about that. If you're a stock picker, right? You're salivating at that because then you can say I can have tracking my portfolio and add some really great small/mid-cap franchises... From a large-cap perspective, we like tech and financials, and it's not all Magnificent Seven, because the Magnificent Seven is not all tech stocks..."

For more expert insight and the latest market action, click here to watch this full episode of Morning Brief.

This post was written by Nicholas Jacobino

Video transcript

SEANA SMITH: You got to take a look at the S&P 500 because it's dropped just about 4% this month as investors worry about the Fed potentially delaying its first rate cut. Despite though, those recent concerns, we've got our next guest. Who says they higher for longer scenario actually isn't necessarily bad news for stocks. Brian Belski joining us here at the desk. BMO Capital Markets chief investment strategist. So Brian when everyone's worried about it, you can see it clearly reflected in the market. But maybe it's not necessarily bad news.

BRIAN BELSKI: It isn't, Seana. Thank you so much for having us. Good morning, Yahoo. It's just great to be here with the Smiths. We became a little bit more cautious on a near term basis about six weeks ago and several people questioned, you're not bullish anymore? No, no, no, we're bullish. And in fact, 12 years ago, today we launched US strategy product at BMO. And we said, listen, stocks have entered a 25 year secular bull market. And that call remains the same. However, we do believe that momentum and the FOMO trade, and got a little bit ahead of itself.

I think the key thing that you said in your preamble was earnings remain the litmus test, the key. And from a fundamental perspective, earnings are stronger than everybody thought. I think most people I know, most people thought, we were heading into this March cut. I think the last time I was on your network, I talked about, I saw no analytical evidence that we're going to see some a March cut. But yet so many people are so macro focused. And that they're looking at Fed funds futures and giving Fed funds futures so much credit.

Whereas, I think we're missing the forest through the trees. Here's the forest through the trees. Since 2007, this has not been normal. This has not been normal since the great financial crisis pre that, very normal. And in fact, if you look at the correlation between interest rates and the stock markets, it's basically met. However, in a higher interest rate environment, certainly higher than 0% to 1% or 0% to 2%. Stocks traditionally do very well. So I think we're recalibrating that, we still think from these levels stocks are higher at year end.

Now our official year end target is 5,100. Our bull case is 5,500. We published that in November. So we think that the market post earnings could get a little bit softer and give us an opportunity to be a little bit more aggressive in terms of buying stocks lower.

BRAD SMITH: Does that mean new all time highs then? Or would expect-- investors should expect even if we don't see any rate cuts this year?

BRIAN BELSKI: Yeah. So that's a great question. And so when we came out with our year ahead in November of last year. We said, there's a very good chance the Fed's not going to cut it all. Because employment situation fundamentals are so strong. And I think people didn't really notice that because again so many people were so focused on Fed funds futures. But what we think is going to end up happening is this return to normalization in terms of the normal, the average 10 year Treasury over the last 75 years is 5%. So if we can hover between this 4% and 5% range. And still have strong employment. But most importantly, have very strong earnings.

And by the way, cash flow. I think the market can do very well as we continue to migrate and understand that North American stocks are the place to be.

SEANA SMITH: Yeah. Talk to us a little bit more about that normalization process in terms of where investors should be positioned, maybe companies or even sectors specifically that you expect to hold up a little bit better as we do see that normalization?

BRIAN BELSKI: So we have the very good fortune at BMO to run 12 separately managed account portfolios for real live clients in both Canada and the United States. And then two ETFs. So we look at stocks from a bottoms up basis. And we think that most investors are massively underexposed small mid-cap. Doesn't mean that you're going to go and buy all small mid-cap. For instance, if you had $100, only 8 of that $100 is comprised of small mid-cap stocks and a publicly traded base in the United States.

That's Apple and half of Microsoft. Think about that. So if you're a stock picker. You're salivating at that because then you can say, I can have tracking in my portfolio and add some really great small mid-cap franchises. That being said, to answer your question from a large cap perspective, we like tech and financials. And not all the magnificent 7 because remember the magnificent 7 aren't all tech stocks. That's number one. Financials, we love the money center banks. The really small banks. So bifurcated, very big banks and very small banks and asset managers, and brokers.

And then in mid-cap areas, we like communication services, consumer discretionary as well as tech.