Q: How do you think about the market, given the economic backdrop? While we have strong earnings on the one hand, we also see growing inflation, the threat of rising rates and, of course, the COVID-19 Delta variant.

Davis: While there are various dynamics at play, overall we’re optimistic about the U.S. equity market today. Quite simply, it looks like this cycle is just getting started. It’s hard to not want to be invested when you see potential earnings power ahead, yet opportunity is not equally distributed across the market. Using our long-standing valuation process, we’re broadly looking for stocks that are constructively geared toward the positive economic backdrop. Quality cyclicals are where we’re finding the most opportunity today.

As for the risks you mentioned, we are certainly keeping an eye on inflation, but it is important to remember that we are starting at very low levels. Thank goodness demand is greater than supply, and thank goodness companies want to hire people again and can actually afford to pay people more. These are generally good problems to have. Productivity is quite strong at the moment. It does not feel like higher rates are going to stop corporations from spending, nor does it feel like they are going to stop consumers from spending. It is difficult to see how inflation that is gradually rising off of a low base would disrupt the economy. But this backdrop does increase the importance of identifying companies that are able to control their profit margins.

What I do worry about is health and safety—including the Delta variant. Psychologically, corporations and consumers alike are taking a blow because masks are being remandated.  But that’s very different from shutting down the economy again.

Q: How do you respond to the growth vs. value debate?

Davis: At the moment, our portfolio is balanced between growth and value. At the same time, the portfolio has a slight cyclical tilt. A year and a half ago, we had a growth tilt. Since then, a lot of the top growth stocks have done really well, so you need to be more selective today. Google still feels very attractive, for example; it’s one of our top holdings. We do not want to abandon growth altogether, but instead, we want to be aware of what is priced in and where there is opportunity to have differentiated insight and conviction relative to the market.

We are also interested in finding growth beyond the household names. For instance, in the emerging electric vehicles space, the first company that may come to mind is Tesla. However, we believe that Tesla is not going to be able to satisfy all of the demand that is coming. How can you invest in the electric vehicle trend, regardless of what vehicle the consumer buys? You can invest in Eaton. Ten years ago, Eaton was seen as a humdrum electrical products and services company. Today, it’s providing innovative charging stations, grid modernization—essentially, everything that is necessary for electric vehicles.

Q: Tell us about your portfolio’s cyclical tilt.

Davis: Our portfolio does have a cyclical tilt, but it’s a high quality cyclical tilt. Quality cyclicals are on sale right now in a way we do not often see. This is partly because the market is singularly focused on reopening. Mastercard and McDonald’s are two quality cyclicals we like. For Mastercard, the migration of cash to card is only advancing. As for McDonald’s, about 20% of restaurants have gone out of business during the pandemic. That’s a lot of market share up for grabs, and we believe that McDonald’s has the brand recognition and infrastructure to capitalize on this opportunity.

Q: What do you think about the mega cap tech stocks?

Davis: The way I think about this question is, how do you manage around the mega cap tech stocks? You simply cannot avoid them, because of their size in the benchmark. Some of them you do not want to avoid, so you need to think about your exposure selectively. Google is one of our largest overweights. We also have a favorable view of Microsoft. The company is in many different verticals, including security and communication. A lot of companies are trading at 40x sales that are supposed to be great at those verticals. Microsoft is usually neck and neck with these companies, yet the stock is trading at a much lower multiple.

Q: How does ESG fit into your investment thinking?

Davis: About two and a half years ago, we fully integrated ESG (environmental, social, governance) into our investment process. At first, we focused primarily on catching the red flags, or the bad actors. In the past year, I have come full circle to really appreciate how ESG analysis can help us identify the positive elements in our fundamental research. Bottom-up stock selection is at the core of everything we do.

The companies/securities above are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell.  J.P. Morgan Asset Management may or may not hold positions on behalf of its clients in any or all of the aforementioned securities. Past performance is not necessarily a reliable indicator for current and future performance.