Portfolio managers Scott Davis and Shilpee Raina from the U.S. Equity team explain how they are approaching slowing growth, and where they take selective risks based on their investing philosophy.
What are you hearing from corporate managers about a potential recession?
Our team conducts thousands of company meetings each year, asking management how they are reacting to the economic environment. Specifically, how are they controlling costs and still investing for the future? The common theme we are hearing is that management teams are pulling back on discretionary spending where they can, but being careful not to overreact, given their healthy profit base.
Can companies sustain those healthy profits if the economy goes into recession?
Yes, we think so. Remember the context: A recession might mean year-over-year declines in a company’s profits, but the starting point is profits near record highs. Therefore, even if profits decline, it will likely not be to unhealthy levels.
As such, what we are not hearing in these meetings are plans for broad-based employee layoffs, when companies are still healthy in an absolute sense – from a profit margins and earnings perspective.
Managers are resistant to making dramatic layoffs when it took two years to hire employees following the pandemic. Management is also not canceling strategic capital expenditure plans. This informs our base case – if companies are not cutting to the bone, a recession is likely to be mild and not require a multi-year recovery period.
What are some of the most important things you’re looking for as you manage a blend portfolio in an uncertain economic environment?
The macro environment is uncertain and not where we are compensated for taking risk. It is helpful, though, to understand the economic backdrop. We use our insights, working closely with our analyst partners, to ensure that both our near-term and long-term earnings forecasts appropriately reflect cyclical risks. Being prepared allows us take advantage of volatility because we have conviction in our long-term forecasts.
The portfolio is cyclically balanced, and our focus is on the risks we are being compensated for taking, namely, idiosyncratic stock selection. We want to invest in companies where we have insight, conviction and where there is valuation support. Identifying those opportunities is only possible when you have the right people focused on the right things: our research analysts focused on each company’s long-term fundamental earnings power.
We utilize the outputs from our proprietary research process – one that has been time-tested over 30 years – to build a high-conviction portfolio of stocks that is style-agnostic: the best of value, growth and blend. This is what drives the portfolio: stock selection wherever the opportunity lies and bringing it together into a core balanced portfolio.
We want to invest in companies where we have insight, conviction and where there is valuation support.
Where are you finding opportunity today, with that style-agnostic approach?
Consistent with our approach, the portfolio today is balanced. It’s overweight in defensive areas like health care, cyclical areas like financials and, most notably, in technology after last year’s sell-off. We have also found opportunities to selectively add to both growth and value names.
Can you give us examples of recent growth and value additions?
In growth, we initiated a position in Uber (UBER) last year after the sell-off, driven by a valuation that reflected an attractive entry point. The company’s U.S. mobility trips are, at present, around 80% of pre-pandemic levels. This lack of a full recovery is not related to lost market share; rather, it’s that travel and commuting have not yet returned to pre-pandemic norms.
Uber’s management has resolved the company’s labor issues pertaining to driver shortages and is poised to capitalize on the broader travel market recovery. Uber is the largest player in the rideshare oligopoly, and we believe it is well positioned to continue to grow its market share.
And what have you added in value?
We added a classic industrial company, Trane Technologies (TT), a leading provider of commercial HVAC solutions. In the immediate aftermath of the pandemic, air filtration was a big focus – but in addition to that theme, energy efficiency is now front and center as offices, hospitals and schools look to reduce their carbon footprints and energy costs. We think TT can benefit from these strong secular tailwinds and is trading at an attractive valuation.
Active vs. passive is hotly debated, especially in the S&P 500 arena. How much does the index play into your portfolio construction?
As a style-agnostic core strategy, we need to be aware of index positioning, but our active bets are not anchored in yesterday’s winners. It pays to be selective. Of the top 10 names in the S&P 500, we don’t own four, we’re underweight two and we’re overweight the remaining four.
We are seeing ample opportunity in underappreciated names in the benchmark that we believe could be the household names of tomorrow. In semiconductors, we like NXPI (NXP), the leader in semiconductor chips for the entire auto industry. The chip content in electric vehicles is multiple times greater than in internal combustion engine vehicles. NXPI should benefit regardless of which automaker wins the electric vehicle race.
In e-commerce, an underappreciated name where we see opportunity is Prologis (PLD), a dominant player in warehouse REITs that provides fulfillment centers to e-commerce giants like Amazon and also to a broader array of retailers such as Walmart and Target. Last-mile fulfillment needs, close to the end customer, are only becoming more important as companies look to reduce fulfillment speeds and save distribution costs.
This is how we seek to beat the index: By using fundamental research to be very selective among the household names driving the index, and finding what we think are the unappreciated winners of tomorrow – a combination of high conviction and taking what we judge to be the right risks.
The companies mentioned herein are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell and is in no way an endorsement for J.P. Morgan Asset Management investment management services.