Market Minute from BlackRock Fundamental Equities

Choosing stocks in a choosier market

Jan 25, 2022

Without the catalysts of a restarting economy and historic earnings surprise, investors may need to dig deeper to unearth winning stocks in 2022. Tony DeSpirito, CIO of U.S. Fundamental Equities, looks across four favored sectors for “hidden” opportunities.

To call 2021 a remarkable year is probably an understatement. We’d venture to say that 2022 could be more “normal.” At a minimum, the market backdrop may be more balanced than the prior two years, which were marked by pandemic-related anomalies and massive monetary stimulus.

Without a rising tide to lift all boats. we see 2022 as a year for deep thinking and active selection. Separating potential winners and losers may entail questioning some common instincts and looking in less obvious places for opportunities.

Generally speaking, we like pairing cyclical value exposures (e.g., financials and energy) with long-term structural growers (e.g., technology and healthcare). Within that broad construct, we’d think outside the box:

Financials

Financials have been unloved since the global financial crisis (GFC). But we see a lot to like. For one, the need for excess return in a lower-return world sets the stage for growth in alternative asset managers. Yet current pricing suggests markets are skeptical, with some of these high-growth-potential alternative managers priced like value stocks.

Then there are the banks. Falling rates were long seen as limiting bank profitability, yet we find many are in their best fiscal shape since the GFC while valuations remain attractive. Banks are one of few areas that benefit from rising rates and inflation. We calculated the potential impact of a 100-basis-point lift in interest rates across the yield curve on the earnings of the five largest U.S. banks and found earnings growth potential as high as 45% (see chart below). Selectivity is key, as rate sensitivity is just one consideration and will vary significantly by bank.

Where higher rates help
Earnings sensitivity to a 1% shift in rates

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Source: BlackRock Fundamental Equities, November 2021. The analysis is conducted for the five largest U.S. banks/capital markets companies by market capitalization, and seeks to estimate the percentage change in earnings per share (EPS) assuming a +100-basis-point parallel shift across the yield curve.

Energy

The energy sector was a top S&P 500 performer in 2021, returning 54.6% versus the broad index’s 28.7%. Many may have shunned traditional energy on fears of its demise in a more ESG-centric world, but environmental, social and governance (ESG) issues actually helped to move the price up ― a dynamic likely to prevail in the intermediate term.

Oil companies, hurt by low oil prices since late 2014 and anticipating a future peak in demand, have been hesitant to invest. Yet there is still a significant need for traditional energy as the world transitions to cleaner solutions, and those needs were magnified as the world reopened in the past year. In this interim period ― amid robust demand, hesitancy to increase supply, and renewables still far from filling the gap ― we can expect higher prices to linger. We would focus on areas with opportunity for growth, such as exploration and production companies, rather than places where growth is limited, such as service providers.

Technology

The fast and steady pace of disruption creates an abundance of growth opportunities in technology. Often, the key is identifying those that others may be misreading or underappreciating. One view is that companies spent big on tech upgrades during COVID and will pull back from here. We believe spending will continue as companies need to keep both home and office systems running in the new hybrid work environment.

The rollout of 5G is also creating opportunity: Telecom companies will need to spend on upgrades and create use cases for stimulating demand for new 5G-powered technologies. Another theme we see is technology as a labor-saving or labor-arbitrage device. The intuitive thinking is that as wages go up, the smart buy is industrials (think robotics and mechanical solutions). Less intuitive is to buy technology as labor costs rise. This, we believe, is where more companies will create efficiencies. One example: Call centers, historically a labor-intensive business, using software and artificial intelligence to replace people with chat bots.

Healthcare

The unprecedented speed with which a COVID-19 vaccine formula was identified and developed demonstrates the ingenuity and innovation that is powering the healthcare sector. Yet valuations are well below the broad market, as shown below. We see an understated opportunity in the medical devices industry, which has been temporarily hampered by COVID closures and labor shortages. Earnings for many of these companies are modestly depressed as elective procedures had to be delayed. As these come back online, we see plenty of ground to be made up.

We continue to like quality stocks, which have attractive valuations and, we believe, add a dose of portfolio resilience. Healthcare is a sector where we see many quality opportunities, but we encourage investors to be conscious of short- versus long-term quality. Some of the COVID healthcare beneficiaries may have strong near-term fundamentals but may not hold a quality bid across time. This is where deep fundamental research can make a difference in identifying those well-priced stocks with the greatest long-term potential.

Healthcare: Quality at a discount
Healthcare sector valuations vs. broad market, 2011-2021

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Source: BlackRock, with data from Bloomberg, as of Oct. 31, 2021. Relative valuation is a ratio of the forward P/E (next 12 months) of the S&P 500 Health Care Index versus the broad S&P 500 Index. It is not possible to invest directly in an index.

Navigating the road to “normal”

The transition toward “normalization” will not be without bumps. Our latest market outlook assesses the landscape. We advocate a focus on quality and selectivity across sectors and individual stocks to actively navigate the evolving dynamics, while keeping an eye on some of those places that may present underappreciated or misunderstood opportunity

Tony DeSpirito
Tony DeSpirito
BlackRock Fundamental Active Equity Investment Team
Antonio (Tony) DeSpirito, Managing Director, is Chief Investment Officer of U.S. Fundamental Active Equity. He is also lead portfolio manager of the BlackRock Equity ...