Be selective within equities

Stocks are well above their lows, and market pricing has become less indiscriminate as the path to recovery has gotten clearer.

At a glance

Stocks are well above their lows, and market pricing has become less indiscriminate as the path to recovery has gotten clearer. Investors with excess cash, or those looking to increase equity exposure, should be careful about how and where they invest. In our central scenario for the coronavirus, we expect more stable and defensive areas to perform well, such as healthcare and consumer staples, quality stocks, and dividend-paying stocks. For investors who can implement options, this period of elevated volatility could enhance the value of put-writing strategies, which can reduce the opportunity cost and timing risk of an averaging-in strategy.

How long will markets remain volatile?

Markets have risen from their March lows as investors have dared to look beyond the peak of the pandemic. In our central scenario, we would expect economic functioning to normalize sustainably from December 2020. Although we expect a recovery in 2021, we don’t think corporate profits will recover levels reached in 2019 until 2022.

Our central scenario is already broadly priced in by equity markets, but this does not mean that there are no opportunities in the equity space. Now is the time look at in sectors/stocks whose earnings growth trends are less likely to be negatively impacted by the coronavirus outbreak.

Resilient. Consumer staples and healthcare companies meet the criteria of more resilient growth trends. Their products are consumed daily, consumption is growing while demand is very much independent from economic cycles. Elevated equity market volatility should support companies with stable earnings and cash flows. Meanwhile, as lockdowns are lifted, loose monetary policy and fiscal stimulus support should also drive consumer spending. Well-positioned consumer brands should benefit from increased consumption and/or strong pricing power if inflation rises.

Dividend-paying. Dividend payments, which are an important part of shareholder returns, are still attractive at current levels, particularly compared to government bond yields. While we expect dividend cuts as a result of COVID-19 (more so in Europe than the US), history has shown that dividend-paying stocks tend to have defensive characteristics. We recommend using a selective approach that identifies companies with attractive dividends that our analysts expect to be sustainable.

High-quality. We also see value in global quality stocks across the US, Europe, Switzerland, and Asia. We expect high-quality stocks to offer another year of excess returns and lower risks than the broader market. Quality tends to perform better than the overall market when the economy grows below trend or slows down.

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In addition, US-China tensions have started to ramp up again, and rhetoric is likely to remain heated into the presidential election in November. As a result, we also favor US "Campaign Warriors" – stocks that should experience less election-related volatility because their businesses are relatively insulated from the policy changes at stake in this election.

Talking points:

  • Markets have risen sharply as investors have dared to look beyond the peak of the pandemic and focus on exit strategies.
  • Our central scenario is already broadly priced in by stocks. This does not mean that there are no opportunities in the equity space, but we do recommend a selective approach.
  • To weather an uncertain and likely choppy recovery period, we recommend focusing on resilient, dividend-paying, and high-quality stocks.

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