Create a watchlist of quality shares

  • Quality stocks with negative momentum are worth watching
  • Some defensive games highlighted for the interim

Further market turmoil looks likely as investors struggle to judge the timing and severity of recessions in the real economy. We are in an inflationary bear market, which is very difficult to judge. There will likely be more declines in stock prices, but the stock market will bottom out before the economy does. The important thing for investors now is not to get sucked into buying too early in what are only relief rallies and also to have an eye out for quality stocks that they may soon have an opportunity to hold at exceptionally good value.

Our UK large-cap quality screen shows a mix of tactical defensive plays and some quality longer-term stalwarts. The former group, including the tobacco companies Imperial Marks (IMB) and British American Tobacco (BATS) have done well overall this year, as stable earnings point to them as a sort of hedge against stagflation. This last group, which includes nouns like drink group Diageo (DGE)engineering group IMI (IMI) and software company Sage (SGE) have seen more negative stock price performance in recent months, largely because stocks with the return on equity and margin characteristics we seek have been so expensive. The timing isn’t necessarily the right one right now, but these are worth keeping on a watch list.

Long-lived assets, such as stocks of US companies with strong market positions and reliable cash flows, have been claimed at extremely high valuations due to low interest rates. The aggressive hike the Federal Reserve has undertaken to fight inflation has been very bad for these expensive companies but, as our screen shows, they are companies with enduring quality characteristics. Investors should hold on for now, as there are likely more selloffs to come, but the opportunities around the corner are tempting.

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