From increasingly hawkish central banks to worries about a war that could exacerbate an inflationary spiral, risks for stocks are piling up.
Equity markets have reeled on signs that central banks will tighten policy far more aggressively than previously expected, disrupting a rally that had braved successive flare-ups of a once-in-a-century pandemic. They’re now contending with the uncertainty of a potential military conflict, although Russia has repeatedly denied it plans to invade Ukraine.
While too many moving parts cloud the outlook for markets, some key themes are beginning to emerge: First, the era of an indiscriminate rally fueled by abundant liquidity is coming to an end. And second, investors may need to steer clear of lower quality stocks that are vulnerable to a less forgiving macroeconomic backdrop.
Here are the basic outlines of a stock trader’s playbook for this new era based on conversations with investment managers and strategists and notes to clients from major brokers.
Pick Quality
“Investors need to focus on higher quality, rather than more speculative investments that have benefited from low interest rates and high liquidity,” says Carin Pai, executive vice president and head of portfolio management at Fiduciary Trust International. They should seek out companies with “more stability and more predictability in earnings,” she said in an interview.
Those include cheaper, so-called value stocks, and also more expensive companies, Pai said. This earnings season saw markets reward some of the most expensive companies in the S&P 500 index for solid earnings, while severely punishing the misses.
The era of looking for returns in “just one market, factor or particular sector,” might well be over, Goldman Sachs Group Inc. strategists led by Peter Oppenheimer wrote in a note. “This should mean a return to Alpha,” selecting stocks based on potential growth relative to price, they said.
Ukraine Risk
The case for quality is reinforced by the return of geopolitical risk. With the U.S warning that a Russian invasion of Ukraine may be imminent, Morgan Stanley’s chief U.S equity strategist Mike Wilson advised investors to maintain a defensive bias and seek haven in quality stocks.
While most strategists expect the impact of a potential conflict to be brief, volatility is expected in the near term. UBS Global Wealth Management advised clients on Monday to manage downside risks while preparing for a rebound later in the year.
“Sectors like energy and financials, value stocks, and commodities are both positioned to benefit from robust economic growth and are relatively well insulated from the primary market risks,” the strategists led by Mark Haefele wrote in a note.