The worst may be over in markets, so what's the next move for portfolios?

Pick forward-looking equities with companies that have good pricing power, says veteran

The worst may be over in markets, so what's the next move for portfolios?

There are signs that the worst of the market downturn is over, says one veteran who has seen lots of them before, but is still cautiously urging cautious stock picks during the current uncertainty.

“There’s a whole bunch going on, but we’re in such a unique environment that the pieces don’t fit together like they used to,” Don Stuart, executive vice-president of the Vancouver-based Dixon Mitchell Investment Counsel told Wealth Professional, citing the runaway inflation plus rising interest rates, and debate as to whether we’re now in a slowdown or recession.

“When investor mood is at its worst, it’s often also the case that selling has been largely exhausted. At the same time, lower valuations make the math of equity ownership more compelling and tend to bring bargain hunters and fresh capital the market.”

Dixon noted that, in June, the S&P 500 posted its worst performance since 1940, a decline that caused both equity fundamentals and investor sentiment to significantly reset. Net bullishness was then lower than during the worst of the pandemic and just barely above the worst of the 2008-2009 financial crisis.

Stock valuations also quickly compressed, which mirrored the retrenchments of the bottom of past bear markets.

Stuart now is watching earning records, but also what management says about future cost pressures, demand, and ability to raise prices. But he noted that inflation isn’t necessarily bad for companies can raise their prices as fast as their input costs, though he warned about artificial spreads between sale price and cost.

“The other thing we want to be careful about owning is companies that don’t have price elasticity,” he said, such as breakfast cereals where there are cheaper options.

Stuart said Dixon Mitchell doesn’t own a lot of commodity companies or companies that don’t have product pricing power. It’s also been repositioning its allocations from 60% U.S. and global and 40% Canada toward being slightly overweighted with Canada, which it hasn’t done in awhile.

“We’d rather own companies that are price setters instead of price takers,” he said. “We’ve also done very well in the past half decade by being more oriented to growth companies in the U.S. But, if we look at it now, Canada looks relatively cheap compared to the U.S. because we’ve been left behind. Now, some of the companies up here are more attractive than they’ve been in the past. So, we’re interested in global. But, if we look at Canada as a market relative to the world, and its valuation, it’s probably a better time than it has been in the last little bit. So, it’s good to look at home a little bit more.”

Stuart is encouraging advisors to cull their portfolios and clean out companies that have already peaked and don’t have much bounce-back power, and check for companies with pricing power that will be more essential to the world in the next three to five years.

Consider quality names, particularly those that recently reworked their balance sheets with low interest rate debt, so they’re now well-positioned to take advantage of those that aren't.

“You want to look at who’s financially in a strong position and companies that have a runway to grow that are temporarily being ignored by the market,” said Stuart, noting that companies like Zoom may have topped out, but Apple’s clients will continue to renew their iPhone.

“Be careful about not abandoning the right asset mix for them on the equity side because where people tend to make mistakes is when they make long-term decisions based on short-term movements in the market and a dramatic short-term headline,” he said. “Just use a little common sense as you’re going through them. It’s not really crystal balling.”