How fund managers hunt for bargains during stock market declines

Thursday brought more negative news from the labor market, with jobless claims rising 14,000 in the week ending July 27 from the previous week to 249,000. On Friday, the July jobs report showed the unemployment rate rising to 4.3% from 4.1%, the highest level since October 2021.

Investment executives and top strategists are saying the market is overreacting to last week’s weak data and they are using it as a buying opportunity.

“As markets sell off, other things being equal, the return outlook has become more favorable, so we’re slowly but surely adding back some of the equity risk that we were underweight before the sell-off,” said Philip Straehl, chief investment officer for the Americas at Morningstar Wealth.

What the economic data really says

The good news is that the jobs reading may not be a new trend, but rather a passing one, according to an Aug. 4 note from Goldman Sachs equity strategists. Led by Jan Hatzius, they highlighted one key point: 70% of the increase in unemployment in July was due to temporary layoffs.

Likewise, production data is not as promising as it might seem at first glance.

“The ISM number has been weak for about two years and hasn’t affected the broader U.S. economy, as nearly two-thirds of U.S. GDP comes from services consumption,” said Alicia Levine, head of investment strategy and equities at BNY Wealth. “However, the ISM manufacturing data can be a leading indicator of S&P earnings, particularly new orders.”

Levine maintains that the stock market is overreacting. He calls the sell-off a “growth without recession scare.” The S&P 500 remains in good shape. The index is down 12% per year on average; it’s still up 9% year to date. Meanwhile, August and September are historically slower months for stocks.

Still, she is bracing for increased volatility as economic data continues to trickle in. So what has changed? Mainly, the expectation of more rate cuts. Levine is forecasting three rate cuts by year-end, each by 25 basis points in September, November and December, for a total of 75 basis points. If the jobs report weakens significantly or comes in at fewer than 100,000 jobs, we could see a cut of as much as 100 basis points, with 50 basis points in September, she said.

Buying opportunities

Levine’s strategy is to wait for a further downturn before using the crisis as an opportunity to invest capital.

Morningstar’s Straehl already has an idea of ​​where his team will hunt for opportunities. He’s interested in two key areas this round: U.S. large-cap and Japanese stocks.

The broad market wasn’t looking great before Thursday, but the sell-off has created an opportunity to return to U.S. large-cap and growth stocks. Straehl is also eyeing buying opportunities in the Japanese market, where there has been a lot of selling due to the yen’s surge. He had previously sold positions in the Japanese market. But the price action has forced him to rethink that strategy, with the biggest opportunities in hard-hit sectors like export-oriented companies and banks.

For Simeon Hyman, global investment strategist at ProShares, everything is cheap right now, except for the Magnificent Seven. For the big tech heavyweights, the sell-off is only putting a small dent in their valuations. The question for him is how do you tell what’s been left for a good reason from what’s been left for no reason at all? There are many ways to answer that question, but his suggestion is to stick to dividend stocks. That way, you’re using this as an opportunity to buy high-quality stocks, not just those in the sell-off bin.

“If you’re looking for companies that are more likely to have a good chance of maintaining their fundamentals, why not just look at what the companies are telling you,” Hyman said. “When a company buys back stock, like a lot of tech companies have, it’s telling you they had a good year last year. But when a company increases their dividend, like these dividend aristocrats, it’s telling you they’re confident about the future because it’s a commitment to the future.”

Hyman refers to growers as those that have increased their dividends for at least 25 consecutive years. Their long history means they have increased their dividends in extremely difficult environments, including the Great Financial Crisis and the pandemic. The only way they were able to do that was by having various dimensions of quality, including cash flow, earnings growth and an overall strong balance sheet, he noted.

If you’re not a fan of dividend stocks but enjoy digging into the data, Donald Calcagni’s approach may be more your speed. The Mercer Advisors chief investment officer says it’s a good time to hunt for value and quality gains, focusing on the higher numbers on a company’s income statement.

In short, investors need to move away from looking at simple price-to-earnings ratios and look at a company’s revenue and operating profitability to determine how healthy its core business is. When you move down the income statement and factor in items like administrative expenses and non-cash items like depreciation, there’s more room for manipulation, he noted.

He added that the approach can also be used to find large-cap stocks in developed markets.

“If you look at non-U.S. stocks and their valuations, they’re trading at about 13 times earnings,” Calcagni said. “So I would argue that investors should be cautious about their allocation to non-U.S. stocks right now, especially given the fact that the dollar has been quite strong.”