Quality is a virtue
Global Head of Portfolio Construction and Strategy Adam Hetts explains why, given the unique nature of this year’s sell-off and subsequent recovery, sector and style decisions should not be based on a traditional recovery playbook.
Sep 7, 2022
3 minute read
3 minute read
This article is part of the latest Trends and Opportunities report, which seeks to provide therapy for recent market shocks by offering long-term perspective and potential solutions.
The unique nature of this year’s sell-off is giving rise to an equally unique recovery environment.
YTD Recap
- As widely expected, rising rates and inflation have taken the largest toll on growth (down -23.2% YTD), which has shown roughly twice the downside of value (-9.8%).
- At a sector level, that same pressure on growth shows in the underperformance of Communication Services (-31%) and Information Technology (-22%), and with Consumer Discretionary (-24%) also suffering due to its particular sensitivity to economic conditions.
- Even in the face of slowing growth, classically cyclical sectors have performed relatively well (e.g., Energy +49%, Industrials -11%, Financials -15%, Materials -16%)
U.S. Equity Style, Size, and Sector Returns
| Value | Core | Growth | |
|---|---|---|---|
|
Large
|
-9.8% | -16.9% | -23.2% |
|
Mid
|
-11.8% | -16.5% | -25.1% |
|
Small
|
-12.2% | -17.2% | -22.3% |
Source: Morningstar, YTD returns through 8/31/22; Style/size table based on Russell indices, sector chart based on GICS sectors of S&P 500 Index.
Outlook
- As multiple compression now gives way to a focus on earnings as the key determinant of stock performance, investors need to be mindful that not all earnings are created equal: the composition of earnings will carry significant forward-looking implications as companies battle global supply chains, financing costs, fickle consumer demand, and other headwinds.
- Earnings forecasts do not fully reflect company-level challenges ahead, and focus should turn to idiosyncratic risks and opportunities.
- With so much bad news priced into equities, there is proportionately more upside opportunity than downside risk remaining.
PCS Perspective
The Quality Equity MOAT: A framework to battle stagflation
| Key Risk | Defense | |
|---|---|---|
| Margins | Inflation | Wide margins, pricing power |
| Ownership | Slowing Growth | Nimble management to navigate a downturn |
| Advantages | Slowing Growth | Competitive advantages and durable growth opportunities |
| Tenacity | Rate Volatility | Low leverage and/or long-term financing |
- The unique nature of this year’s sell-off is giving rise to an equally unique recovery environment, marked by many fits and starts, where sector and style decisions shouldn’t be made according to a typical recovery playbook.
- Those typical playbooks depend on superficial categories – e.g., growth vs. value, cyclical vs. defensive – which are losing relevance for this unique recovery.
- Instead, think mechanically and map today’s biggest risks to the moving parts of individual companies: e.g., margins, leverage, competitive landscape, management strategy.
- To simplify this extremely complex task, our MOAT framework for quality equity investing identifies individual stocks which mitigate – and even capitalize on – today’s biggest risks so that investors can defend against stagflation and be prepared for the subsequent upside.
Sep 7, 2022
3 minute read
3 minute read
