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Why quality matters more than ever: Bell AM

Defining quality and why it is more important than ever as stocks fall

Markets are falling, interest rates are rising alongside inflation, the US dollar is appreciating along with bond yields and money is moving away from risk. While the crisis in Ukraine still plays out, it certainly has exacerbated risks surrounding growth and inflation.

Ned Bell, Chief Investment Officer at Bell Asset Management discusses the current market outlook and performance of global equities. He says a huge rotation from growth to value has occurred, especially in some of the big US tech stocks. “When we think about the likes of “Netflix, Meta, Alibaba, Tencent, Nvidia, those names are down on average 39 percent year to date.”

The magnitude of these drawdowns is huge. Bell says, “there’s really two factors that are instigating these drawdowns. The first one being that the magnitude of earnings growth is flattening quite substantially.” Looking at the PE ratio chart of the Australian market, it was sitting on a whopping 80x. This has dropped dramatically back to its average, currently on 25x.

  • Bell says “this is what you would expect when interest rates start moving higher. What we’re seeing is a change in where the momentum is, in terms of the various style buckets within markets. Interestingly quality stocks as a whole have lagged, by a bit over 3 percent in the first quarter of this year. That is somewhat of an anomaly.”

    Quality stocks have only done a little better than growth but worse than value.

    So, what is a quality company? Bell defines a quality company as one that is consistently very profitable and has pricing power with little to no debt.

    Over the last few years, consistent profits haven’t been rewarded. The market has rewarded companies for their forward growth metrics. Bell says, “So companies with pricing power, and a lack of interest rate leverage, are perfectly positioned for this environment.” To highlight the factors in this environment, “you’ve got inflation at a 40 year high. It ticked over 8 percent recently. It’s coming from energy, food, employment, housing and from transportation.”

    And so the environment is favourable for quality stocks. In the past, it has been growth at any price or reasonable price, is what has worked.

    Growth is slowing pretty meaningfully together with the composition with growth.

    Taking a three-to-five-year view, Bell concludes by saying, “this is a great time for active management… Buying momentum, and the market as a whole has definitely got some flaws. Being nimble and agile is really important.” By taking a bottom-up perspective, there are opportunities to find quality stocks at discount valuations.

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