As Wall Street turns bearish on the U.S., here's where the pros say to invest

Published Mon, Apr 3 20238:45 PM EDT

The S & P 500 notched an impressive performance in the first quarter, gaining 7% despite turmoil in the banking sector and a series of interest rate hikes. But Wall Street strategists appear unconvinced that U.S. stocks are the best place to be looking ahead, citing tighter financial conditions, declining corporate earnings, and relatively high valuations among other factors. Graham Day, chief investment officer at Innovator ETFs, said in notes to CNBC last week that a recession looks very likely in the next six to 12 months, with "cracks starting to form" in the economy. Risk assets are underestimating the prospect of a recession, with equities still priced at 22% above typical recessionary valuations, he added. There's also the possibility that markets could be wrong about the possibility of a rate cut by the Federal Reserve. "The futures market thinks the damage [from the banking crisis] will be severe enough to warrant a serious about-face. They're all in," Daniel Gerard, senior multi-asset strategist at State Street Global Markets, said. "That seems a bit rich given the wide diversity of potential outcomes and the risk right now is that the market has gone too far with cut expectations." The bearishness on Wall Street is palpable, with nearly 70% of respondents in a CNBC Delivering Alpha investor survey saying the S & P 500 could see declines ahead. Where to put money Against this backdrop, where should investors put their money? Some strategists believe Europe's the place to be. Goldman Sachs ' Chief Global Equity Strategist Peter Oppenheimer said the U.S. equity market remains "expensive relative to history" and believes European stocks are set to outperform their U.S. peers. Within Europe, Goldman prefers companies in value sectors that pay dividends , as well as select defensive and growth stocks in the market. It also expects companies with stronger balance sheets to fare better. UBS also sees "select opportunities" in Europe. Valuations of German stocks look "attractive," the bank said in its second-quarter outlook report on Mar. 23, while European consumer stocks, particularly those in the luxury space, should also perform well on the back of China's recovery. Emerging markets Several Wall Street analysts are putting their money on emerging markets, with most bullish on China, the world's second-largest economy. "We see low-teens total returns from emerging market stocks over the remainder of the year, powered by strong earnings growth, China's recovery, and relatively cheap valuations," UBS said. While the bank expects just 1% earnings growth for emerging market stocks, it said the sector's valuation looks attractive at a 23% discount to global peers. Within this space, UBS is bullish on Asian semiconductor names, with the bank anticipating a recovery in margins in the second half of the year. The bank also named Chinese stocks among its preferred areas, saying current valuations and a 7% expected earnings growth provided a "solid platform" for further uplift. Moreover, Beijing's supportive policy stance and the expected earnings recovery in Chinese stocks have yet to be fully factored into valuations, the bank added. John Lin, a China-focused portfolio manager at AllianceBernstein, is also staying long on Chinese stocks, with a preference for domestic A-shares given their higher exposure to the domestic economy and lower exposure to geopolitical risks. "Beyond consumer cyclicals, we have been finding opportunities in industrial cyclicals as well as parts of upstream commodities. For example, machinery names such as truck engine makers, bus makers, forklift manufacturers, chemical refiners, etc. – after an extraordinarily tough 2022, these companies are poised to see robust recovery in earnings in 2023, and possible beyond as well," Lin said. Philip Blancato, CEO at Ladenburg Thalmann Asset Management, is also bullish on emerging markets. He said its outlook is improving amid softening inflation, U.S. regional banking woes and slowing growth in the developed world. He added that the case for adding to emerging market allocations is growing, particularly given the "near guarantee" of a softer dollar in the short- to medium-term. Bonds Market pros are divided on whether investors should allocate to fixed income. Blancato is a fan of the asset class, citing a favorable environment for long-term fixed income securities. He said higher bond yields, which he believes are likely to prevail in the years to come, allow investors to tap into "sources of resilient income" that have been hard to come by for years, while investors tend to flock to "safer" assets such longer-duration bonds during recessionary times. Audrey Goh, head of asset allocation and thematic strategy at Standard Chartered , has also turned defensive in her investment stance, favoring high-grade developed market government bonds and U.S-dollar-denominated Asia bonds, which she said are likely to be "more resilient." But Innovator ETFs' Day said investors chasing higher yields could "pay a big price" if relying on bonds alone for income or risk management. Still likes U.S. stocks Some analysts, however, remain bullish on U.S. stocks. Citi's analysts, led by Beata Manthey, wrote in a Mar. 31 note that they were upgrading U.S. stocks to overweight as further downgrades to consensus earnings per share (EPS) forecasts remain likely in the bank's view. "The U.S. tends to perform more defensively than other markets during EPS recessions," the analysts said. And while past performance is not necessarily an indicator of future results, investors can also potentially take comfort from historical trends. CNBC Pro's analysis of S & P 500 index data on FactSet dating back to 1928 showed that if there is a rebound in the first quarter following a down year for S & P 500, the index rises 78% of the time in April. That suggests there could be more upside ahead for U.S. stocks after a winning first quarter. — CNBC's Yun Li and Ganesh Rao contributed to reporting