Finding the Middle Path in Extreme Equity Markets

Equity markets were jolted in January amid growing concerns about macroeconomic threats. For investors seeking more stable equity allocations, stocks “in the middle,” with high-quality features and reasonable valuations, can help portfolios cope with volatility.

With inflation rising, fears that policymakers could tip economies into recession have eroded enthusiasm for stocks after three strong years. Hypergrowth names at the most expensive extreme of the US market were hit hardest. We believe these trends reinforce the need for defensive equity strategies to help reduce risk in a downturn and capture recovery potential.

In good times and bad, predicting macroeconomic and policy trends isn’t a prudent strategy for equity investors, in our view. Instead, investors can seek to build a macro-resilient portfolio by investing in companies with features that are likely to withstand the key risks to equity markets. Today, those risks are interest rates/inflation, valuation and a decelerating growth outlook.

Position for Heightened Inflation

Inflation and interest rates are the biggest source of uncertainty today. While the US Federal Reserve and Bank of England have signaled plans for aggressive rate hikes, the European Central Bank has taken a more moderate stance. Market volatility is being fueled by a tension between concerns about monetary policy and signs of solid corporate earnings.

In this environment, equity investors must distinguish between businesses that are more likely to do well in an inflationary environment and those more vulnerable to higher prices. Defensive portfolios should also aim to identify companies with fundamentals that are more likely to hold firm if efforts to combat inflation trigger a worse-than-expected economic slowdown.