In its mid-year market outlook, analysts from Julius Baer believe investors should remain invested in equities in the current environment.
Amid the higher volatility in the markets, lower growth and higher uncertainty, investors should explore equities with a more defensive bias, say analysts Bhaskar Laxminarayan and Mark Matthews, who have indicated their preference for the healthcare sector, Swiss equities and high-dividend stocks.
Laxminarayan is Julius Baer’s chief investment officer (CIO) and head of investment management, Asia Pacific (APAC) while Matthews is its head of research for the APAC region.
“Stocks in the healthcare sector tend to have very strong balance sheets, mid-to high-single-digit sales growth, and relatively low sensitivity to inflation,” the analysts write.
“We favour large-cap pharmaceutical and biotechnology companies due to their earnings stability and solid pipeline,” they add, highlighting digital health as a long-term theme within the healthcare sector.
Further to their presentation, the analysts are expecting Swiss equities to continue to outperform amid an uncertain environment.
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“This is due to the market’s heavy tilt towards the defensive sectors relative to the cyclical sectors,” they say, adding that the Swiss equity market is one of the “best-quality and most-defensive equity markets in the world”.
Finally, high-dividend stocks are deemed attractive.
“[This is] due to their high balance-sheet quality and attractive valuations, and companies expected to offer share buy‑backs. This type of capital return to investors is seen as a positive, as it shows that the company generates plenty of cash,” the analysts say.
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The food and drugs, as well as personal and household goods as demand for such goods are constant, whether the economy is expanding or not.
“Looking back at previous periods of sharp inflation, we see that demand in these sectors tends to hold up well, in contrast to spending on consumer discretionary goods, for example,” the analysts write.
Valuations ‘reasonable’ for IT stocks
Further to their presentation, the analysts deem valuations for IT stocks are currently “reasonable”.
“Higher interest-rate headwinds should be more than offset by market-leading earnings growth. Compared to the dot-com bubble in 2000, free-cashflow generation is high for the large and profitable firms in the IT sector,” they write.
The sector currently remains in a “secular bull market”, offering investors “promising growth perspectives”.
“We focus on profitable companies with strong cash flows instead of early-stage technology names. Relative to the market, IT stocks trade at a slight premium due to their attractive growth perspectives and above-average balance sheet quality,” the analysts add, highlighting their preference for semiconductors and software over hardware companies.
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Investing in an inflationary environment
While the analysts see inflation normalising in 2023 to 3.8%, high inflation remains a top concern this year. The analysts are forecasting global inflation to reach 7.9% in 2022, which is attributable mostly to the first half of the year, and easing in the second half of the year.
With that, the analysts have identified six ways to invest amid an inflationary environment.
In their presentation, they are recommending investors put money into real estate investment trusts (REITs), which are a “natural hedge against inflation”. They are also seen as a “good investment choice”.
“Physical property values and rents typically grow in tandem with inflation, supporting positive distribution growth while providing a steady income stream,” the analysts write. “The peaking of hawkishness and the easing of inflationary pressures, both widely anticipated in 2H2022, will increase investor interest in REITs.”
“The muted price performance of the asset class year to date, and the more reasonable valuations that some of the REITs are now trading at, should also provide near-term support for the asset class,” they add.
Companies with a higher-than-average scope for price increases will, too, benefit in an environment of rising prices.
Third, value stocks. Such counters, which outperformed the overall equity market in the first few months of 2022, tend to “do well do well in an environment of higher inflation and rising interest rates”, note the analysts.
Value stocks are also considered to be “an essential part” of their present barbell strategy approach of balancing both growth and value stocks.
Fourth, commodities and commodity-exposed markets are another way to invest in the current environment. Commodities have outperformed other asset classes since the beginning of 2022, even if commodity prices have partially corrected since their extreme highs.
“High commodity prices have been a positive for commodity companies – some of which have been among the best performers so far this year – and for commodity-exposed markets, such as Canada. These are markets heavily exposed to companies producing or trading hard assets, such as oil and industrial metals,” the analysts say.
Fifth, gold, which is traditionally seen as a safe-haven asset, is seen as a “suitable hedge in times of severe recession or growing systemic risks in financial markets”.
However, the link between gold and inflation isn’t as simple anymore as longer-term inflation expectations remain “confined”.
Finally, macro hedge fund strategies are another way for investors to hedge against inflation. Global macro funds are “uniquely positioned to navigate the current market gyrations and could thus be considered as part of a diversified portfolio”, the analysts say.
“Fund selection is key, as the difference in return among individual hedge funds tends to be larger than is the case for more traditional strategies,” they add.
Sectors to look out for in the Hong Kong and Chinese markets
During the Q&A session with journalists, Richard Tang, China strategist and head of research Hong Kong, Bank Julius Baer, said that the Chinese economy is “fairly likely” to see a trough following the Covid-19 lockdowns that took place in April and May.
“We do expect that as the economy gradually reopens from the previous lockdown and with the policy stimulus from the China govt, we think there’ll be a fairly strong recovery in the second half of 2022 for the Chinese economy. How strong that would be, would heavily depend on the stimulus,” says Tang in response to a question on the bank’s views on the Chinese economy.
“We think the direction is up cyclically,” he adds.
On the country’s property sector, Tang reveals that the bank is still cautious on the sector, although it will focus on state-owned enterprises (SOEs) and remain careful about picking private developers.
With residential properties in China, Tang thinks the worst is over, with home sales plunging 59% y-o-y in May.
Within the Hong Kong markets, Tang has expressed his preference for the financial sector, particularly the banks and insurance.
“We think the sector will benefit from the high rates environment ([with the Fed [raising] rates a number of times), we expect the rate hike to be seen in Hong Kong, as the region will follow the US’s monetary cycle,” he says.
With counters in Mainland China, Tang likes three themes: environment, consumption and high-end manufacturing.
“[The] environment [sector] has been doing quite well in 2022. The theme refers to electric vehicles (EVs) and renewables,” he says. “The arguments are basically laid out when Mark talked about new energy, [where the sector is pushed by competitive prices and supportive policies]. The same arguments can be applied to China, with one additional point: the government is still very supportive in energy transition in the country.”
The second theme within Chinese stocks, is consumption.
“Consumer sentiment hasn’t been good, but we think that it’ll improve especially once [the country’s] pandemic policy normalises,” says Tang, who adds that within the consumption sector itself, he will be focusing on mass consumption, which includes beverages, milk, beer, even sportswear or household appliances. This is on the back of the Chinese government placing an emphasis on raising the purchasing power in rural areas in its 14th five-year plan.
Finally, the high-end manufacturing sector.
“Industrial tech is now a buzzword, especially with Mainland investors in the last 12 months”, says Tang. “We’ve seen a clear shift in policy focus from the Chinese government, especially when you look into and read into policy documents of Chinese officials,” he adds. “The focus is now on hard tech than soft tech, which has been well developed.”
“Hard tech, which includes automation, industrial, internet of things (IoT) and robots, all these still have a distance or are lagging behind [China’s] Japanese, German and European peers. It’s the priority of the Chinese government to ramp up this sector. That’s why we would expect a lot of policy tailwinds into the sector,” he continues.
