Helen Jewell, deputy co-chief investment officer of BlackRock Fundamental Equities, outlines how further volatility is expected as higher interest rates impact economies. The key to resilience in this volatile market is careful stock selection based on strong fundamentals.

Quality companies can support returns, but quality differs across sectors, Helen Jewell, deputy co-chief investment officer of BlackRock Fundamental Equities, said last week. 

“We see a clear end to the cheap-money era that followed the global financial crisis. For equity markets, this means fewer returns from “beta” – or overall market gains – and a greater share of performance via “alpha” – or above-market returns. Market fluctuations offer potential opportunities for active, long-term investors to pick up quality companies at a discount,” she continued.

“Quality doesn’t just mean high profit margins, stable earnings, low debt levels and return on capital. Quality can mean different things across different sectors, and it can be hard to find at the right price,” she added.

Here are some sectors that Jewell is looking at now.

Financials 
Recent events have put financials in focus and reinforced the need for selectivity. The move away from negative interest rates has been transformational for European banks. “We believe they are in a strong position to profit from higher rates – interest received on front-book new business is far higher than on back-book old business – and high levels of liquid assets mean they are more resilient than they were during the GFC,” she said. 

Consumer 
Wage pressures and continued supply chain dislocation are challenges for this sector. Quality companies here combine operational execution and supply chain excellence, with the right products in the right place when consumers want to buy. On the flip side, companies must be conscious of avoiding inventory build-ups as demand wanes.

“But it’s important to be choosy. Companies with a strong brand, constrained supply, a stable footing in the US and Europe, as well as exposure to Chinese consumers, are best positioned to pass on higher costs and maintain healthy profit margins,” she continued.

Tech 
“After last year’s sharp valuation reset, attractive entry points across the sector have now opened up. Quality companies in this area have management teams capable of leading in a new era of artificial intelligence while also controlling costs now that cheap money isn’t readily available to finance growth,” she said.

Enormous computing power is needed for the advancement of AI. In the more immediate term, semis are essential for cloud infrastructure, electrification of the automobile industry, renewable power, factory automation, the internet of things and 5G penetration. “The quality companies in this space have unique products, supply chain dominance and a crucial role in the need for smaller, more powerful chips,” she said.

Energy
“We are cautious on near-term returns as a warm winter has reduced physical demand for oil and gas. Over the medium term, we see supply remaining tight and expect some of the European oil majors to generate impressive amounts of cash – while currently trading at a discount to U peers,” she said. Quality companies should be able to use their free cash flow to offer attractive dividends and buybacks, pay off debt, buy smaller companies to bolster market position, and allocate substantial investment towards renewable energy.

Healthcare 
Healthcare earnings have historically been resilient during recessions as spending on health can be seen as an essential expense. But not all healthcare is the same, and there can be widespread dispersion of performance within the sector. “We look for opportunities for growth tied to expanding healthcare needs such as Alzheimer’s, diabetes and obesity. Given the technical nature of the industry, having a deep understanding of the science behind each company is key when looking to invest,” she continued.

Quality “discounts” – take a regional view
Europe: attractive earnings and valuations: Company earnings in Europe have been better than feared as lower energy prices and renewed demand from China boosted the economy, yet European equities remain at a discount compared with US counterparts. However, especially, if there is not an economic contraction in H2 2023, the European Central Bank may tighten monetary policy further to bring down inflation. If inflation eases faster than expected, this could prompt the US Federal Reserve to cut interest rates, which could benefit US growth stocks at the expense of European equities.

Emerging markets; positive on rates: Emerging market stock valuations remain at a discount versus their 10-year history on a price-to-earnings basis, and EM equities should also continue to benefit from China’s reopening. EM central banks are better positioned to cut interest rates to boost economies. “We are favorable on certain Latin American and Eastern European countries for this reason,” she said.

The impact of rising rates and geopolitical fortune: "This market rotation from growth toward value has benefited Europe versus the US. This trend may continue if inflation stays higher for longer. The reopening of China’s economy has also been a boost to Europe. Meanwhile, energy prices in Europe have plunged from their highs last summer, benefiting both European companies and consumers," she concluded.