Stock Investing: Rupal Bhansali on 4 Ls to Watch if You Want to Avoid Adverse Stocks

“It doesn’t matter if you invest in global stocks, US stocks or Indian stocks, junk stocks are going to have problems for the foreseeable future,” says Rupal BhansaliCIO and Portfolio Manager, International and Global Equities, Ariel Investment.

How to deal with the rate-tightening cycle in the world?
Investors need to understand that there is a regime shift underway that may last for many years and not just weeks or quarters and that this specific regime shift is not just about inflation and rising rates, it everyone is watching of course. This is the Fed announcing that it is moving from quantitative easing to quantitative tightening.

In a QE world, the more risk you took, the more you were rewarded and one of the risky asset classes tends to be stocks, which is why they performed so well. On the other hand in a QT world risk is penalized and I would say the biggest thing to avoid and the way to take advantage of this rally is to sell junk bonds and stocks because that’s where the greatest risk tend to be.

Now you might ask me what you mean by junk stocks, because not all stocks are junk. Adverse actions are characterized by the four Ls. Number one is very loss-making companies. This is where the biggest pain has been, as you’ve seen, especially in the new IPO market where many companies that aren’t making money have collapsed. The second L stands for high leverage companies.

Financial leverage, balance sheet risk is something you don’t want to take in this QT environment. The third L is companies whose stock prices have very high valuations, because growth will disappoint. In fact, we could have recession stocks priced well below future expectations and vulnerable. So be wary of high valuations.

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And the last L is stocks that I think have ridiculous expectations and that would be a lot of growth companies that are overhyped and overvalued. So those are the four Ls that I call undesirable actions. It doesn’t matter if you invest in global stocks, US stocks or Indian stocks, junk stocks are going to have problems for the foreseeable future.

Since you’ve talked about Fed tightening and how the US Fed bull cycle is going, do you expect that hawkish stance to continue or given that over the last two quarters we’ve seen a negative figure arrive in terms of GDP for the United States, it is a bit of an expectation that there might be a bit of a change. Can a slightly more dovish tone come from the US Fed in the future?
That was certainly the market’s assessment yesterday, but that’s going to start to change because throughout today many other Fed members on the board have started backtracking on what the The Fed was trying to broadcast that they were far from done, as the top of the yield curve is around 3-3.5%, which means markets seem to be looking at a peak.

They’re very much in data watch mode, meaning if inflation continues to stay high, they’re going to be extremely vigilant and they’re going to raise rates well ahead of what the market is expecting today. I disagree with the market assessment that we are late in the cycle, we may actually be very early in the innings.

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