- Major indexes are losing gains as the election-fueled rally fades, with the S&P 500 down 5% in 2023.
- Uncertainty and lack of clarity from the administration impact investor confidence and earnings.
- Investors should focus on high-quality stocks with strong balance sheets amid market volatility.
The election-fueled rally is running out of fuel as major indexes give back their gains.
The S&P 500 is down almost 5% so far this year and below its pre-election level. The tech-heavy Nasdaq plunged further by almost 10% as of Tuesday as investors moved away from risky bets they had crowded.
So, where do we go from here? At this point, economists and strategists usually come to the rescue with their economic models and projections. But right now, it’s all about the uncertainty.
“I come to the office in the morning, I see one thing, and then halfway through the day, something has been retracted or replaced or paused,” said Rich Drage, a senior portfolio manager at RBC Global Asset Management, in an interview on March 10. It has been hard for long-term investors to position their portfolios under these circumstances.
“You’re starting to see some of them just capitulate and throw their arms up, not being able to get that long-term visibility that you would need,” he added.
Earnings growth largely drives stock prices. However, since companies don’t have enough certanty around tariffs, even they’re having difficulty projecting their outlooks. As a result, earnings estimates are declining, Drage said.
It’s hitting areas like consumer discretionary, with the S&P 500 Consumer Discretionary index down by over 14% this year. Industrials are also struggling, with smaller caps being hit hard despite an expectation that they’d do better since they’re more US-based. But at this point, investors are looking at the potential for higher-for-longer interest rates, inflationary pressures, and weakening demand, all of which hurt domestic companies too, he added.
“The administration doesn’t seem to be offering much clarity, and it even admitted that there may be some hiccups in the economy, and they’re not paying attention to the stock market,” Drage said. “There’s probably a little room for some more risk-off, to be fair.”
The macro environment isn’t helping. September brought a trough for US inflation, with the consumer price index at 2.4% before it climbed back to 3% in January, with the possibility that tariffs may aggravate it further to the upside.
While the unemployment rate remains steady at 4.1%, concerns over an economic slowdown and what that means for corporate spending may cause a hiring slowdown. Former Fed economist Julia Coronado told Business Insider she expects the job market to go from an average of 175,000 jobs created monthly to below 100,000. Drage added that it’s just another rub that will lead people to hit the pause button on spending.
It’s a tough market to navigate because almost all sectors, including those traditionally seen as defensives, could be on the chopping board.
“A lot of companies that we have been speaking with have said we’ve been through this before during the last administration, so we already have playbooks to handle it,” Drage said. But the difference this time is tariffs are targeting a broader array of products, and investors are more worried about that, he added.
Investing in high-quality stocks
Despite all the uncertainty, Drage’s task is to find long-term stocks that have the best business models able to navigate through the course of the full market cycle. That said, this time around, it’s all about leaning into high-quality stocks with robust balance sheets over speculation and risk.
Below, Drage shares a few key characteristics for this type of play.
First, as long as inflation is a concern and interest rates either remain at the current level or increase, investors should focus on companies with self-funding business models. In other words, they don’t need debt, and they don’t need to issue equity to fund their operations.
Next, that means avoiding companies with higher debt exposure. To quantify this a bit further, companies that are three times levered are riskier now. This can be measured by a company’s debt-to-earnings before interest, taxes, depreciation, and amortization (EBITDA). Investors can look at the trailing 12-month EBITDA and compare that to the forward-looking EBITDA-to-debt to determine if there will be a significant shift.
“I’ve been doing this for 30-plus years. It seems to be a more conservative number when I see debt at less than three times,” Drage said. “When I see it over three, the company’s financials get too subject to changes in interest rates, and you have to worry about cashflow being able to satisfy the debt needs.”
This also means looking for companies with above-average profit margins relative to their sector and industry peers.
And finally, look into their management teams and whether they have good execution over the years.