• Wei Li remains constructive on US stocks this year.
• However, she warned the risk of the Fed tightening too much is growing.
• She shared with Insider where she thinks investors can find the best opportunities.

Wei Li believes some in the investing community are looking at Federal Reserve rate hikes the wrong way.

Instead of focusing on the pace and severity of hikes in the near-term, the BlackRock global chief investment strategist said investors should be paying attention to the terminal federal funds rate, or its eventual peak.

How high the fed funds rate eventually climbs is much more significant in terms of its impact on stocks than how much the Fed hikes rates by at meetings in the months ahead, she said.

That's because saying the Fed raising rates above the neutral rate would come at too high a cost for the earnings and the labor market, according to her statistical model, Li told Insider in an April 22 interview.

The pace of rate hikes in the meantime until rates are at their neutral level won't have as much of an impact, she said.

Li's projected neutral rate for the fed funds rate is 2.25-2.5%. 

Li said the risk of the Fed raising rates above the neutral rate has risen since the start of the year. This is because inflation has consistently risen above expectations for longer than expected — the Consumer Price Index now sits at 8.5% year-over-year, the highest in 41 years — and the Fed now needs to respond aggressively to cool off rising prices. 

Her base case is that the Fed will be able to conduct a so-called soft landing and not send the economy into recession. One reason for that is because she expects high inflation to start to dissipate.

But the proverbial runway has gotten smaller, she said, with risk on one side of tightening too harshly and risk on the other of not being able to slow down inflation and losing credibility and investor confidence. The Fed's credibility is already seemingly on thin ice, as many investors already think they've made a policy error by not starting to tighten sooner.

Others on Wall Street see the Fed inducing a recession because of its tightening regime ahead.

Deutsche Bank has a target of 2.6% for the fed funds rate peak in 2022, and they said in recent weeks that they see a recession coming in late 2023. Credit Suisse's Jonathan Golub also told Insider in April that he sees a recession coming around Q1 2024.

The bond market also signaled a recession ahead when the 2-year Treasury yield rose higher than the 10-year Treasury yield, inverting the yield curve. An inverted yield curve has preceded every recession since the 1950s, though the inversion usually occurs many months in advance of a downturn.

4 areas where Li sees opportunities

Given that Li's base case is for the economic expansion to continue, she said her first recommendation would be to stay invested broadly in US stocks despite heightened risk.

Another reason she likes stocks more broadly is because of still-unattractive real interest rates. Even though bond yields are rising, they are not rising fast enough to keep pace with inflation. 

She said it's important to stay invested in the market despite the feeling of higher risk compared to 2021.

The Vanguard S&P 500 ETF (VOO) offers exposure to US stocks. 

More granularly, Li said she likes a barbell approach of investing equal weight in value stocks on one side and tech and healthcare stocks on the other. She likes healthcare and tech on a longer-term basis of multiple years. 

Tech is attractive because of its ability to drive innovation and grow explosively despite what macroeconomic trends might be, and healthcare is appealing in part because of the growing focus on healthcare after the pandemic, she said.

Value stocks, meanwhile, have outperformed over the last year — and continue to do so — as investors anticipate higher interest rates, which are typically harmful to longer-duration growth stocks. 

The Technology Select Sector SPDR Fund (XLK) and the Healthcare Select Sector SPDR Fund (XLV) offer diversified exposure to the above sectors. 

The iShares Core S&P US Value ETF (IUSV) offers exposure to US value stocks. 

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