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2023 playbook for investors’ $2 trillion cash stack

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  • Investors are sitting on a $2 trillion pile of cash, but they should wait to invest it in stocks.
  • Bank of America said “timing is everything” and investors will see opportunities to buy stocks in early 2023.
  • “History shows exceptional returns after the Fed’s latest hike,” Bank of America said.

Investors have accumulated $1.9 trillion in cash since the COVID pandemic, but they should wait for the Federal Reserve’s latest rate hike, which is expected in the first quarter of 2023, Bank of America said in a Wednesday note. .

“Timing is everything,” BofA’s Research Investment Committee said, adding that the Fed’s rate hikes and equity exits should provide investors with better entry points into the stock market early in the year. next year.

“Once rate hikes bite into labor markets, the Fed will pause and investors should deploy the $1.9 trillion…History shows bumper returns after the Fed’s latest hike,” said BofA, pointing out that the S&P 500 has generated average returns of 14% in the 12 months since the Fed’s last hike in a tightening cycle.

The Fed is expected to raise interest rates by 50 basis points next week, followed by another 25 basis points at its February FOMC meeting, according to the CME’s FedWatch tool.

On what to buy in early 2023, BofA said investors should focus on owning companies that have resilient earnings, especially as many expect a economic recession materializes next year.

“Stocks with high free cash flow have outperformed the market by 7 percentage points a year since 1991, and during major economic downturns, companies with stable earnings have outperformed by 10 percentage points,” BofA said.

But it’s not quite the time to buy yet, according to the bank. Stock flows, and specifically equity and ETF outflows, which have been mysteriously absent so far this year, are a signal the company is watching to determine if a buying opportunity is near. .

“The lack of significant equity outflows is historically unusual and has kept our asset allocation cautious this year,” BofA said. “Active U.S. residential investors, the $40 trillion whale on the stock markets, never sold aggressively enough in 2022 to reverse the $4.2 trillion in equity inflows since COVID.”

BofA expects renewed market leadership in 2023, as inflation levels of 5% become the new norm, compared to previous years of just 2%. At this high level, the bank expects equally-weighted equity indices to perform better than market-cap-weighted indices, which essentially means that smaller companies will outperform larger companies.

To that effect, the bank believes that small-cap value stocks should finally have their day in the sun after years of substantial underperformance by large-cap growth stocks.

“We are resisting buying the downside of battered growth stocks. $100 of small-cap value in 1926 is worth $36 million today versus $0.8 million for large-cap growth,” said BofA.

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