Why the bear market has triggered 'back-to-basics' investment strategies

Traders and investors unnerved by the sell-off that has hit stocks and bonds are looking for a safe refuge, increasing the appeal of “back-to-basics” investments that offer reliable returns, such as shares that pay steady dividends, according to financial experts.

The market rout, which has seen global stocks enter a bear market and so-called risk-free Treasuries slump, is forcing investors to get creative. They are looking at assets such as high-dividend shares, investment-grade bonds and Chinese stocks, they say.

Investors are hoping the assets they buy will withstand any fallout from an expected accelerated pace of interest rate hikes by the US Federal Reserve to tame inflation that’s climbing at the fastest pace in four decades.

“We are arguing for adjusting the portfolio to get those exposures that make sense in the current environment,” says Peter Garnry, head of equity strategy at Saxo Bank.

“These themes are commodities, defence, logistics, cyber security and mega caps.”

Meanwhile, Karim Chedid, head of BlackRock's investment strategy team and senior strategist for iShares EMEA, says they prefer stocks that can navigate persistent inflation and more difficult margins, such as health care and tech, and generally defensive sectors with consumer price inelasticity.

Here are some of the other assets that are attracting investors’ attention during the bear market:

Free cash flow stocks

The era of easy money with very low or negative real rates is clearly over, according to Ellen Hazen, chief market strategist and portfolio manager at FLPutnam Investment Management.

“It’s clear all that stuff we learn during our CFA [chartered financial analyst] exams and in business schools about how you value companies and this kind of cash flow, that matters again. And what that means is you want to own companies that are generating free cash flow,” Ms Hazen says during an interview on Bloomberg Television.

Health care, insurance and a few technology and software stocks in the S&P index generate a lot of free cash flow, which make them look appealing for FLPutnam, she says.

Dividend yield

Some investors are tweaking their dividend strategies.

High-dividend yielding stocks are the best place to hide, along with commodities and large caps, says Marija Veitmane, senior strategist at State Street Global Markets.

Central banks will keep raising rates as consumers and companies continue to have a lot of cash and access to still-cheap borrowing, she says. “This is a very negative outlook for stocks, so we would be sellers of any rally.”

Sat Duhra of Janus Henderson Investors has been adding to positions in mainland Chinese shares, including in the renewable energy infrastructure and water sectors, on attractive valuations as they will be paying out dividends in June and July.

The Singapore-based portfolio manager is investing in Asian companies with dividend yields of around 6 per cent to 8 per cent.

It “is a decent spread over bond yields and provides some protection in a period of heightened volatility”, he says.

Pricing power

HSBC Holdings has a list of stocks that tend to do well even in a weak macroeconomic environment, says Herald van der Linde, head of the lender's APAC equity strategy.

“These stocks can do that because their businesses have pricing power, or they operate in a special niche or are key players in highly concentrated markets.”

Meanwhile, now that Asian economies are reopening, JP Morgan Asset Management sees the outlook for domestic demand improving in the region.

Current earnings forecasts for Asian equities seem “too conservative for 2022 and valuation is also attractive once market sentiment improves”, Tai Hui, Asia chief market strategist at JP Morgan Asset Management, wrote in a recent note.

Investors can also find opportunities in stocks with pricing power, such as Sika, Geberit and Givaudan, says John Plassard, a director at Mirabaud & Cie, a Switzerland-based bank and wealth manager.

“With equity returns essentially bimodal and largely recession dependent, we focus on relative value opportunities and reassess our preferred themes and related screens,” UBS Group AG strategists, including Keith Parker, wrote in a note.

They are focusing on pricing power, stocks with higher and improving quality, as well as shares exposed to high-income consumers.

“Some of the consumer staples companies are holding up given price elasticity for the strong brands,” says Louise Dudley, portfolio manager at Federated Hermes, an investment management company in the US.

Stocks with stable dividend policies are havens and there’s value in health care and energy, she says.

Fabio Caldato, a partner at Olympia Wealth Management, also “built a decent bulk of healthcare companies and we are still buyers of the sector, with a strong focus on big European pharma” like GSK and Sanofi.

Meanwhile, Wells Fargo strategists, including Christopher Harvey, said in a recent note that they had screened for long ideas, using history as a guide for a recession portfolio that includes names such as Comcast, Coca-Cola and IBM.

China’s stocks

Now is a good time to buy so-called new economy stocks in China, including tech, despite the regulatory risk there, says Banny Lam, head of research at CEB International Investment Corporation.

“Lots of people one year ago thought this thing would be pushed like a more backward cycle for all the tech stocks,” says Mr Lam. “I am really positive about this sector, and in the second half of this year.”

Goldman Sachs, meanwhile, remains bullish on China stocks as the government is easing overall policies. The nation’s internet shares are still trading below their intrinsic value, Goldman Sachs strategist Kinger Lau wrote in a note.

Pictet Asset Management recently sold its China positions again because the zero Covid-19 policy is “too risky” and is underweight equities across the board right now in terms of geographies, says Frederic Rollin, senior investment adviser at the company.

Investment-grade bonds

High-rated bonds strike a good balance between income generation and resilience against slowdown concerns, according to JPMorgan’s Mr Hui.

While a short-term challenge for fixed income is risk from duration — a measure of debt price’s sensitivity to interest-rate moves, income generated from government and corporate notes offers a better cushion to offset price volatility from rising rates.

“Now is the time to start rebuilding fixed income exposure” as central bank tightening anchors long-term inflation expectations, says Nannette Hechler-Fayd’herbe, chief investment officer of international wealth management and global head economics and research at Credit Suisse.

“Core government bonds and high grade corporate credits are offering decent yields now and emerging market hard currency bonds [for example in USD] are outright attractive,” she says.