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Here's why investors should stick with value stocks

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Jill Carey Hall, Head of US SMID-Cap Strategy at BofA Global Research joins Yahoo Finance to discuss how markets are faring as earning season kicks off this week.

Video Transcript

MYLES UDLAND: All right, welcome back to Yahoo Finance Live on this Wednesday morning. Big banks unofficially kicking off first quarter earnings season. But of course, the teeth of this reporting period still to come. Wall Street analysts are still trying to fine tune their expectations. Joining us now to talk about how those have changed over the last couple of months is Jill Carey Hall. She's head of US mid cap strategy over at Bank of America Global research. So Jill, if we look at what we saw from the banks today, analysts are still quite below where we saw those results come in, and backing out any oddities within the banking sector, you guys also think the street, just broadly, looking at the S&P, still has a ways to go to get up to where you expect first quarter earnings to come in.

JILL CAREY HALL: That's right. For financials and banks, financials overall is one sector that we've been favorable on, both in our overall large cap US equity strategy work, as well as within small caps, it's a sector that's screened well going into earnings season, as well as just with the overall backdrop of GDP growth accelerating, and with rotation into value that we expect to continue or resume.

I think that's a sector that we recommend you wanting to own, but the overall earnings backdrop, as you suggested, we think analysts are still too low. We've seen big upward revisions heading into this earnings season, much bigger than what we typically see, but we don't think that's over, so we're forecasting that earnings should be, expectations in this quarter by about 6%.

Analysts' expectations right now are not too far above the two year ago, pre-COVID earnings, so we think there's more to go, but that a big beat this quarter might not necessarily translate into big market gains, just given the sentiment we've seen within the market.

BRIAN SOZZI: Jill, outside of the banks, where else are you seeing some big earnings estimate revisions right now?

JILL CAREY HALL: Overall, I think numbers have generally been coming up broadly. The sectors that have screened well, short term, going into earnings season in our work have been financials, materials, so some of these cyclical areas, communication services, which is a sector that we're more cautious on. It did screen well going into earnings season.

But overall, financials is a big one. I think when you think about full year, 2021 earnings expectations, that's where we're expecting that some of the cyclical Capex and GDP tethered areas should be where we see some of the better growth, relative to what consensus is expecting. So that's one thing we'll be watching for this earnings season, is Capex spending going to continue to pick up? There's a lot of favorable tailwinds for that, whether it be from just the cyclical rebound in the US, potential infrastructure spending, restoring of US manufacturing, et cetera. So I think that's an area that can support some of the industrials, materials, energy stocks, earnings as well.

MYLES UDLAND: And then Jill, on style, obviously, value has just had a huge couple of quarters. How much more do you guys see that running, and then I'd also ask, related to style, is small and mid-cap favorability, is that a style in itself? Because I know that they kind of get lumped together. Small caps or value, and it's not always true across the board. But as you see those two trades working in tandem, where does it feel like we're at in that cycle playing out?

JILL CAREY HALL: Right. We've definitely tried to evaluate both of those individually, and they're both styles that we like right now. So both value stocks and preferring small caps over large caps. With value versus growth, we found one of the best signals for when you want to own one versus the other is the profit cycle, so when profits growth is accelerating, as it is right now, and what we expect for the next few quarters, is you want to own value stocks, you don't need to pay up for expensive growth stocks if growth in the overall market is broadening out.

So we say stick with value until profits growth peaks, which on a trailing, four quarter basis won't be until later this year. And then on size, even though you've seen a big run in in small caps, they've obviously now started to lag large caps a bit over the past month. But we do expect for the year that small will continue to beat large. The small cap size segment is more tethered to the above consensus outlook we have for US economic growth. They're more oriented to services spending, where we see a lot of pent up demand, they're more domestic, so benefiting from the economic recovery.

And we're seeing fund managers are still underexposed to small caps, the big inflows we've seen into small caps haven't eclipsed the outflows we saw over a number of years. So that's a side segment that we still see more room to run, and it typically, historically, outperforms when you're in this mid cycle environment, transitioning from that initial bounce off the bottom into mid cycle.

BRIAN SOZZI: So Jill, if you see profits peaking later this year, do you expect the markets, they'll be more volatile in the six months before that happens?

JILL CAREY HALL: So overall, our outlook on the S&P 500, we have a year end target of 3,800, so even though we've been constructive on the US economy and on earnings, and then on areas within the market that are more tethered to that economic, cyclical recovery, like value like small caps, we do see potential for volatility and for risks within the overall large cap US equity market, and our measure of Wall Street equity sentiment is getting closer to suggesting equity euphoria.

We saw last quarter within the S&P 500 stocks that beat on earnings did not outperform, and the only other time you didn't see a positive reaction for beats was around when the market peaked in March of 2000.

So we're not expecting a bear market, the bear market sign posts that we track are not ringing any alarm bells yet. But we are more relatively cautious on the overall large cap equity market relative to some of the other areas that I mentioned, just given where valuations and sentiment are today. So the good quarter for earnings just might not translate super strongly into the market.

MYLES UDLAND: All right, Jill Carey Hall, head of US mid cap strategy at Bank of America Global Research. Jill, really appreciate you jumping on this morning, take some time to talk us through the outlook for first quarter earnings.

JILL CAREY HALL: Thanks.