2023-10-10 07:25:58
Selecting stocks in a difficult stock market situation
The stock market mood depends on major topics such as interest rates, the economic situation or important events. How to choose stocks with this in mind.
The New York Stock Exchange provides the most important impulses for the financial markets.
Bild: Michael Nagle/Bloomberg
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In a current outlook on the stock markets, the name of the American central bank Federal Reserve, or Fed for short, will most likely appear – sooner rather than later. The key interest rates that the Fed sets have a major influence on the stock markets.
Since March 2022, the Fed has increased the key interest rate from 0.25 to 5.5%. In doing so, it wants to counteract the enormous increase in the price of goods, inflation. The key interest rate influences the price of money that banks borrow from the central bank. This also influences the costs of loans. When loans become more expensive, this slows down economic performance. As a result, prices rise less again.
Economy, inflation, interest rates
The key interest rate also indirectly influences the bond markets, i.e. trading in the debt securities of states and companies. If they pay a lot of interest, professional investors tend to choose more bonds and fewer stocks for their portfolio. As a result, prices on the stock markets fall.
Bond interest rates are high at the moment. But because the key interest rate and thus the cost of borrowed money are also high – and may be raised further in November – the economic downturn that has already been observed may be more severe than desired.
If, in this complex interaction, the Fed manages to use interest rates to reduce inflation and at the same time prevent excessive economic damage, this is the so-called soft landing. But if there are problems in the economy, there will be a hard landing.
Clouded prospects
Because there is a lot of uncertainty around this issue, the stock market outlook is clouded at the moment. The stock markets don’t like uncertainty. In addition, bonds currently definitely offer an alternative to stocks. Political crises such as the violence in the Middle East and the ongoing war in Ukraine are also dampening the mood.
But why are Fed interest rates always highlighted? The answer is very simple: What happens in the USA affects stock markets around the world. This is illustrated by the price development of the S&P 500 stock index, which contains the 500 most important companies on the US stock exchange (see graphic).
By the end of the summer, the mood was better – it was expected that key interest rates could be reduced as early as the first half of 2024. And people were more optimistic about a soft landing than they are now. By the year’s high at the end of July, the S&`P 500 had risen 20%. Since then the price has fallen by around 6%.
However, the situation has different consequences for the price prospects of individual stocks. If the economic outlook is clouded, defensive securities tend to benefit. This refers to the titles of companies that offer fundamentally important goods or services.
The pharmaceutical companies Roche and Novartis as well as the food multinational Nestlé are always mentioned first on the Swiss stock exchange: medicine and food are always needed. In addition to Nestlé, other food companies such as Lindt & Sprüngli, Bell, Orior and Emmi can also be listed.
Stocks with a clearly defensive profile that can be invested in in the FuW stock market game include the insurance groups Zurich, Swiss Life, Helvetia, Baloise and Swiss Re. Real estate stocks such as Swiss Prime Site, PSP Swiss Property or Allreal are also considered very stable as long as the real estate market does not show any serious problems.
Winners and losers in the economic situation
The disadvantage of defensive stocks in the two-month FuW stock market game is likely to be that their prices will move rather slowly. “Defensive” often also means “leisurely”. Although there are always surprises. A defensive classic where prices are moving faster is the number one in the Swiss telecom market, Swisscom.
Cyclical stocks are more affected by an economic downturn. This includes almost all industrial stocks on the Swiss stock exchange. Such companies risk that demand for their products will decline in a crisis. On the stock market, it is enough that this possibility is expected for prices to fall.
Stock pickers, i.e. the people who select stocks, look particularly closely at the different characteristics of companies. Can a cement company like Holcim manage to sell enough building materials despite the slowing economic performance? Will the car industry be worse off than before, and what does this mean for companies like Autoneum, Komax or Georg Fischer, which produce special parts and supply them to car manufacturers?
Experts now recommend buying shares in companies that are relatively exposed to the ups and downs of the economic situation. Omar Brem, who heads the analyst department at Zürcher Kantonalbank, for example, expects a positive surprise from Holcim currently favors cyclicals such as the lift manufacturer Schindler or the turbocharger manufacturer Accelleron.
Interest rates influence stock prices
In addition to the economic situation, high interest rates also influence share prices – and not only, because they strengthen the “equity competition” of bonds. High interest rates are generally good for banks because they can earn a lot by cleverly exploiting the difference between the interest they pay themselves and the interest they charge.
The so-called growth stocks are left behind. Particularly when it comes to companies in future industries, investors also “buy” successes that will only really materialize in the future. In other words: You are betting that these technology companies will make significantly more profits than they do today. However, these profit prospects become cloudy when analysts use higher interest rates in their forecast models.
Typical growth stocks on the Swiss stock exchange are the computer accessories specialist Logitech, the pharmaceutical contract manufacturer Lonza or the chip industry suppliers VAT, Comet and Inficon. Before it became clear at the beginning of 2022 that interest rates would rise, they had been rising for years.
Rising interest rates are taking a toll on stocks. Only a new euphoria surrounding technology stocks, mainly thanks to the markets’ enthusiasm for artificial intelligence, turned the tide. This can be seen very clearly in the course of Inficon’s share price (see graphic).
Even if the stock market situation for cyclicals and growth stocks is not particularly good at the moment, stock pickers still choose them if the other conditions are good for the company.
Regardless of the general stock market assessment, share prices could react positively when companies present their third quarter results. Prices often react positively when management credibly presents an optimistic outlook – despite an uncertain economic situation.
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