Bill McMahon, a Schwab chief investment officer, says active investing will soon make a comeback versus indexing.
With the year winding down, you may be wondering what’s in store for stocks next year.
Bill McMahon, chief investment officer of active equity strategies for Schwab Asset Management, sees a narrow trading range in 2023.
He expects economic weakness to cap any rallies. McMahon favors dividend and other high-quality stocks. Consumer-oriented European stocks also represent a buying opportunity, he said.
McMahon likes Nike, Diageo and Arthur J. Gallagher. And he thinks active investing will make a comeback in an environment of high interest rates and inflation.
TheStreet: What’s your outlook for stocks next year?
McMahon: It will be a tricky year, with a pivot of concern from inflation to recession. We should see weaker earnings growth. Earnings estimates are coming down.
Stocks still aren’t really cheap. For the first time in years, we’re getting better yields, [making bonds a more attractive investment]. The stock market could be range-bound next year — muted, if not flat, returns.
TheStreet: Where do you think the best buying opportunities are?
McMahon: Look outside the largest names. Be more selective. One trend that should continue is the strength of dividend stocks.
This is a good environment for higher quality stocks. That means companies with higher profits, strong free cash flow, solid balance sheets.
Avoid high beta [volatile] companies, high-multiple stocks and companies with weak balance sheets. That especially goes for companies with debt maturing soon, as higher interest rates are expected. Avoid companies that are leveraged to the economic cycle.
TheStreet: What’s your outlook for technology stocks?
McMahon: We’re still a little cautious. There was a pull-forward of demand during the pandemic for personal computers [and other hardware]. And now the same has happened with software.
Companies are rationalizing their budgets, figuring out what isn’t necessary. On the consumer side, the tech sector is dealing with a weaker economy, [which depresses demand].
TheStreet: What’s your outlook for foreign stocks?
McMahon: European equities are getting more interesting. They have lower valuations [than in the U.S.] The U.S. has a long period of outperformance. At some point that will revert to the mean.
We like stable names in Europe, less economically sensitive stocks. Consumer staples and health care, including pharmaceuticals, fit that view.
Bill McMahon, Schwab Asset Management
TheStreet: Can you talk about three stocks that you like?
1. Nike (NKE) – Get Free Report Nike has had a rough period, but I think the brand is still relevant. It has had pricing power for a long time. It will benefit from the loosening of China’s covid policy. It had a big inventory buildup last quarter, but it is taking a lot of marketing action to deal with that. It has a premium multiple, but that is justified.
2. Diageo (DEO) – Get Free Report, [the liquor company that owns Johnnie Walker], has high quality, diversified brands. It has pricing power. There is a trend toward premiumization, with people going upscale. That will normalize next year, [as the economy weakens], but it’s a long-term trend.
3. Arthur J. Gallagher (AJG) – Get Free Report, a mid-market insurance broker, has a scale advantage in a highly fragmented sector. They gave guidance of a mid- to high-single-digit organic-revenue growth for 2023. If they’re at the higher end of that range, profit margins will grow, too. They have inorganic growth opportunities as well — to buy up small firms at a discount. It’s a good stock to withstand the economic slowdown.
TheStreet: Do you think passive investing will continue to take market share from active investing?
It’s changing. When interest rates rise, it’s a better time for active investing [because some companies are more affected by higher rates than others]. It’s not as easy to just buy an index fund and do well.
Individual stocks should be the priority now. Investors have to look outside the FAANG stocks — Meta Platforms, Amazon, Apple, Netflix and Alphabet].
We’re in a different environment [than the one that has prevailed] since the 2008 financial crisis. For most of that time, central banks helped investors [with low interest rates]. Now central banks are turning into a headwind [by raising rates].
You need to find companies that will grow in this environment, that can withstand inflation and higher interest rates.