RBC says the stock market bottom may have already passed — or could arrive very soon. Here's what investors should buy on the way back up.

  • RBC says stocks have probably hit their low point for the year, or will within a few months.
  • Head US Equity Strategist Lori Calvasina says a recession already looks priced in.
  • She says that the upcoming Congressional elections could help send prices higher as well.

According to RBC, the answer to the biggest question dogging investors is yes, the stock market has hit its low for the year — or it will very soon.

The firm’s head of US equity strategy, Lori Calvasina, says that if the US is headed for a continued slowdown, or even a relatively brief and mild recession, stocks won’t pierce their lows established in mid-June.

“The stock market tends to bottom 4 to 5 months before the end of a recession, and our work on defensive sector valuations, which are back to peak vs. secular growth and cyclicals, has been telling us that defensives have gotten overbought, something we’ve typically seen when risks are priced in,” Calvasina wrote in a recent research note.

There are also signs that investor sentiment is starting to bounce back, while the declines in overall stock indexes and in market price-to-earnings ratios have been large enough that a recession is already priced in. That means there probably won’t be a period of more intense selling or “capitulation.”

“Investors appear to have been wanting companies and sell-side analysts to “rip off the Band-Aid” when it comes to lowering 2022 and 2023 earnings guidance and outlooks,” Calvasina said. “We may be facing a situation in which the Band-Aid is pulled off more slowly and not completely removed until later this year.”

The upcoming midterm elections are also potential catalysts, she added, as the S&P 500 index tends to turn higher about a month before the vote. Calvasina says that if polls are correct and the elections produce a divided government, that will also encourage investors.

“The combination of a Democratic President and split-or-Republican led Congress also tends to be the most favorable backdrop for the stock market,” she said. “As the mid-terms grow closer, equity investors seem likely to revisit that playbook and bake it into their 2023 views.”

In keeping with her comment that defensive stocks are getting overly expensive, Calvasina says she recommends growth stocks over value equities. She says growth stocks tend to rank higher in quality factors that translate to long-term success, and since 10-year bond yields are fading, it’s more likely they’ll outperform.

“Growth tends to outperform when the economy is running below trend, which we think will remain the case,” she wrote. “Growth is starting to look a little better than Value on the rate of upward EPS estimate revisions, suggesting that earnings sentiment is a little better in Growth at the moment.”

While she didn’t recommend any specific growth investments, some of growth-focused ETFs investors could use to play this theme include the Invesco S&P 500 GARP ETF (SPGP), the iShares Russell 1000 Growth ETF (IWF), and the Vanguard Mega Cap Growth Index Fund ETF (MGK).

Calvasina also thinks the strong dollar and better economic performance limit downside for US stocks, which she prefers to international stocks.

“Though the US still looks overvalued vs. non-US equities, US valuations have improved considerably. Recession expectations also remain higher for EU,” she said.

Finally, she wrote that it’s time for investors to overweight small-cap stocks, as recessions are good chances to buy them at rock-bottom prices.

“They tend to underperform while stocks are falling heading into / early on in a recession, and then tend to lead once the broader US equity market has bottomed mid way through the recession,” Calvasina said. “Much of our work on Small Caps speaks to the idea that they’ve come very close to pricing in recession already.”

Some small cap-focused ETFs for investors to consider include the JPMorgan Diversified Return US Small Cap Equity ETF (JPSE), the Invesco S&P Small Cap 600 Equal Weight ETF (EWSC), and the First Trust Small Cap Core Alphadex Fund (FYX).

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