Finding Quality on Sale in an Uncertain Market

The Fed does not have control over shortages related to supply-chain problems. It will continue to struggle to rein in costs for energy, materials, food, shelter and labor. Food and energy combine for over one-fifth of the consumer’s wallet share, while shelter costs represent roughly one-third. With widespread job availability and negative annualized productivity growth, wages are continuing to rise in tandem.

Sectors to Watch in a Choppy Market

We are currently favoring companies with strong pricing power and free cash flow in an environment where we believe inflation will remain elevated and supply chains will continue to be challenged. Areas on our radar screen are energy, which has been a favorite for almost a year, and companies exposed to improved efficiencies in agriculture and the necessary capex cycle to address shortages.

We are being selective across all sectors where we invest. In the choppy market, we find low-beta defensive sectors — health care, staples and utilities — to be attractive. Meanwhile, the significant pullback in valuations for high-quality discretionary, communication services and technology names offer opportunities to buy quality on sale. In financials, rising rates support higher interest income, and while investment banking activity has slowed, trading operations have been in high demand amid the volatility.

We advocate for a barbell approach that captures a variety of potential catalysts amid a choppy market. We also advocate for investors to remain calm, focused and stay invested. In each of the past four Fed tightening cycles, the S&P 500 ended higher one year later, with the S&P 500 median return +6.2%.

The Fed projects its target rate to be 3.4% by year-end, indicating roughly 175 basis points further in rate hikes this year. This rising-rate environment has negatively impacted the broad fixed-income and equity markets, but especially longer-duration growth assets. Growth names, particularly non-earners, tend to be more impacted by rising rates and higher labor costs. We’ve advocated for investors to remain short duration, avoiding exposure to leveraged, long-horizon growth names, and capturing current income growth from companies with healthy balance sheets, pricing power and attractive shareholder return programs.

Reminding clients to stay focused on the long term is critical when the market turns bearish. According to Hartford Funds, stocks lose on average 36% in a bear market and, by contrast, gain 114% during a bull market. Further, the length of a bear market tends to be just 9.6 months, while a bull market, on average, lasts 2.7 years. Bear markets have occurred roughly every 5.4 years. It’s important to stay invested during these bear markets because half of the S&P 500’s strongest days in the last 20 years occurred during a bear market, while 34% of the market’s best days took place in the first two months of a bull market. Timing the market is difficult and often unfavorable, since missing out on these best days is likely to have destructive effects on long-term compounded returns.

2022 has been challenging. At current valuations and with the prospect for greater economic clarity, now is the time to block out emotion, stay focused and seek opportunity.

Stephanie Link is chief investment strategist and portfolio manager at the national wealth management firm Hightower Advisors LLC. She leads the firm’s Investment Solutions Group, which specializes in outsourced chief investment officer services, model portfolios, separately managed accounts, investment research and due diligence for Hightower Advisors LLC. Follow Stephanie on LinkedIn and Twitter @Stephanie_Link. Read her regular market insights here.