Top portfolio manager shares his top 3 tips for picking stocks in a challenging market

April 13, 2023, 10:00 AM UTC
Fortune Quarterly Investment Guide 2023 Q2
Top managers tend to have a strong thesis about what will outperform in a difficult market.
Illustration by Jamie Cullen

If you’re sweating it out day after day checking your balances, watching them fluctuate with every gyration of the global economy and utterance from the Fed, imagine this: that it’s not just your retirement savings at stake, it’s your day job to navigate markets. For intel on how a professional is approaching the stock market, we spoke to Jordan Stuart, a client portfolio manager at global asset manager Federated Hermes.

During this period of “macro-induced uncertainty,” investors typically sell growth stocks first and “ask questions later,” said Stuart, who thinks this mentality is wrong. Growth, which refers to stocks with positive business momentum and accelerating fundamentals, will be more resilient if the economy continues to get worse, he said. Small-cap growth stocks are cheaper than large-caps and will likely be the first to recover, Stuart noted. And they are less susceptible to persistent higher rates than large-cap technology stocks, he added.

The nation’s central banks, along with weekly economic data, are driving the broad market rather than the individual stocks themselves, said Stuart, who is part of Federated’s Kaufmann small-, mid-, and large-cap growth equity funds group. On March 22, the Federal Reserve raised interest rates for the ninth time since the beginning of 2022. U.S. employers added just 236,000 jobs last month, while the unemployment rate fell to 3.5%, according to the Labor Department. Economists were expecting a net gain of 239,000 jobs in March and a jobless rate of 3.6%, CNN reported, citing Refinitiv. 

The U.S. economy is slowing, while gross domestic product is decelerating, and the employment picture, while still sound, is slowly getting “less good,” Stuart said. “The Fed is playing catch-up as they should, but it’s at the fastest pace ever seen, so that is throwing an unknown into the market.”

Jordan Stuart, a client portfolio manager at global asset manager Federated Hermes.
Courtesy of Federated Hermes

Don’t give up on growth stocks

Stuart expects growth stocks, specifically biotech, to be first out of the gate when interest rates reflect the negative sentiment in the economy. Biotechs are focused on science, patients, and saving people, he said. These companies don’t care about the economy or oil prices and are only impacted by rising rates when they’re trying to raise capital, he noted. “We believe that biotech is acyclical enough and much more interest rate sensitive that it will be a first mover advantage if the economy gets rocky and rates reflect the new environment,” Stuart said.

In addition to biotech, Stuart also recommends that investors check out health care technology or product companies, in sectors such as diabetes or sleep apnea. “Those markets are ripe for secular growth in our opinion. Both markets are enormous and growing,” he said.

Choose companies that have cash on hand

Whether it’s biotech or health care, investors should target companies that have ample cash on hand, are focused on a large addressable market, and have a scientific advantage over their competitors, Stuart said. This can be a gene therapy or different cell creation that is tough to replicate, he noted. 

While biotechs remain largely independent of rate increases, other sectors are not as lucky. More economically sensitive sectors like retail and industrial typically don’t perform well when there’s a downturn, Stuart said.

Be wary of past winners

The broad market’s concentration in three stocks—Apple, Microsoft, and Google—also makes Stuart uneasy. These companies have each reached, or surpassed, $1 trillion in market capitalization. (Apple actually hit a $3 trillion market cap in January 2022.) While the trio is likely not going away anytime soon, Stuart said the juggernaut reminds him of three companies—Microsoft, Yahoo, and Dell—that were a huge portion of the market 20 years ago. Only one has retained its prominence.

Apple, Microsoft, and Google are so big that it’s rather difficult for them to grow by 10% or 20%. Stuart said he’d rather consider smaller companies that have attained a $10 billion valuation and can jump to $20 billion or $30 billion. For example, Inspire Medical Systems sells an implantable device that is used to treat sleep apnea. 

No doubt a growing market—especially for all those stressed-out investors trying to catch a good night’s sleep.

This article is part of Fortune’s quarterly investment guide for Q2 2023.

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