Strong stock market 'is all about corporate profits': Bank of America investment strategist

Marci McGregor, Bank of America Merrill Lynch managing director and senior investment strategist, joins Yahoo Finance Live to discuss the state of the stock market and what's ahead over the next couple of years.

Video Transcript

ALEXIS CHRISTOFOROUS: I want to get to more on the markets and bring in Marci McGregor, managing director and senior investment strategist at Bank of America Merrill Lynch. Marci, thanks so much for being with us. So I know you believe this market's going to grind higher into 2022. What do you think is going to get us there? What will be some of the key drivers?

MARCI MCGREGOR: Thanks for having me on, Alexis. You know, when I take a step back and look at the big picture of this market, I still think it's all about corporate profits. You know, I know a lot of my peers are concerned that peak earnings growth is behind us. But I think peak earnings isn't even a 2022 story. We're seeing solid consumer demand, a strong US economy. And I think we're going to have a Capex cycle in 2022. And I think that's all a positive for corporate profits. And that underpins this market, in my view.

ALEXIS CHRISTOFOROUS: So right now, how are you positioning US portfolios over at Bank of America Merrill Lynch? Are you overweight equities? And if so, where?

MARCI MCGREGOR: Yeah, so we're overweight equities relative to fixed income. And that's a pretty easy call for us. But when you kind of go to that next level down, it's a preference for US equities over the rest of the world. And it's both large and small caps. But we're really positioning for cyclicals to lead this market higher.

So think about energy, financials, industrial materials. I wouldn't abandon tech, right? Because innovation is not going to stop. But I think we're going to see this market rotation resume and continue as we look ahead into 2022. And it's going to be cyclicals and value that lead the way in the equity side.

ALEXIS CHRISTOFOROUS: Well, what about some of the possible headwinds here, like higher inflation, like interest rates rising from the Federal Reserve? And if we continue to see these supply chain issues, many in the industry are saying they can see them well into 2022, accompanied by these labor shortages. How do you build the portfolio around all of those concerns, Marci?

MARCI MCGREGOR: You know, and I would agree that these supply chain issues are likely to linger. So are the labor shortages as we head into the new year. All of this at the end of the day is driven by a demand surge. I think we're entering a new regime. In the old world, you had an economy with plenty of supply, and demand struggled to keep up and inflation was in check.

I think in the new regime that we're looking forward to, it's going to be a world where demand outstrips supply, and you have to position for higher inflation. The good news is one of the key takeaways, I think, from third quarter earnings is, you know, the operating leverage and the pricing power that companies are seeing is simply outweighing the input costs and the higher wages that I do think are likely to persist.

So right now, it's still a positive inflation dynamic. I just don't see it waning because it's really driven by demand. And we both know there's so much cash still out there. And with wages rising, I think that's another support for the consumer.

ALEXIS CHRISTOFOROUS: You know, how much is the virus-- which continues to be, of course, the backdrop to everything that we're doing. How much does coronavirus play into the market and play into expectations for growth going forward?

MARCI MCGREGOR: Yeah, it's a fantastic question. And I think what we've seen since the start of this pandemic is each subsequent wave of the virus seems to be having a smaller and smaller impact on both the economy and the markets. Now, without a doubt, the delta variant caused a significant moderation in growth in Q3. I think what we're seeing now is delta's waning here in the US, at least, almost this mini economic reopening. Consumers are becoming more mobile. Spending has picked up significantly. I think that leads to strong growth in Q4. But we have to continue to acknowledge the virus is a risk.

That said, I think the positive developments on treatments can really take us a step forward, and again, continue to allow the virus to have a smaller and smaller impact on both the markets and the economy. But right now, I think it's a mini reopening story, as we look to fourth quarter into the new year.

ALEXIS CHRISTOFOROUS: And what about expectations-- I mean, we're still in earnings season. But what are your expectations for companies' earnings in Q4 and the early part of next year? You know, I'm wondering if these supply chain issues and labor shortages are going to start squeezing corporate America's margins in a more meaningful way.

MARCI MCGREGOR: So, you know, it's interesting because we're still seeing margins hung in really strong in third quarter. You know, I know it depends on who you talk to about whether we're seeing peak, especially transportation, bottleneck right now, as Christmas demand was almost pulled forward a full month. So as we get past the holidays, I think some of that will ease. But like we discussed, I think many of these supply chain issues will linger.

I think it goes back to the significant operating leverage that we've seen built up in a number of industries because the cost cutting of 2020 throughout the crisis was structural on the corporate side. I think the biggest story of 2022 on the corporate side is how much cash they have. And I think it's going to be about Capex. It's going to be about dividends as well, and maybe a lesser extent, share buybacks.

But I think you're going to see this cash put to work. And I think that's going to be the important story for investors to pay attention to, even if these bottlenecks and wage issues. So the pressure is going to stay on wages. I do think they continue into 2022, but US corporations are resilient. And I'm still not sure we're giving them enough credit for it.

ALEXIS CHRISTOFOROUS: All right, Marci McGregor, we're going to have to leave it there, managing director and senior investment strategist at Bank of America Merrill Lynch. Thanks for your time today.