Insights and Strategies
What’s in Style for U.S. Equities?
Fashion styles can often be described as an expression of one’s true personality and creativity. And with the evolution of time, fashion has also evolved typically over the span of decades to keep up with changes in the environment. However, given the rapid pace of change in the environment that we have all observed over the past year, it feels as though we have transitioned from the simpler times of the 1920s to the fast fashion days of the early 1990s in a matter of only nine months.
Soaring inflation, rapid increases in interest rates/yields, a war brewing in Europe, and lockdowns in China have resulted in a material increase in market volatility globally and the deceleration in global economic growth prospects. At the onset of the year, we were expecting a change from the simpler days of 2021 – most asset classes including stocks, commodities, crypto, etc., ended the year in the green – the current backdrop has been anything but that. That said, one consistent theme we have been reiterating since the beginning of year was for investors to focus on quality stocks. So what does this specifically mean?
The definition of quality is quite subjective and will vary quite extensively from one person to the next. However, given the growth in factor investing over the past +10 years, which to put it simply is an investment approach that involves targeting specific drivers of returns for various asset classes, there has been a lot more consistency in how factors such as quality are defined.
In the world of factor investing, there are six major style factors: growth, value, quality, low volatility, high dividend, and momentum. For each of these factors, there are common metrics used to group stocks into each of these style factor buckets. For example, for the quality style factor, this would include companies that have durable business models, a sustainable competitive advantage, and high profitability. Given the uncertainty of the economic backdrop and our expectation that a recession is on the horizon, companies that meet this definition represent our preference since these companies have historically outperformed during periods of economic contraction.