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July 2022

Managing Risks While Staying Focused on Quality Companies

Key Points

• High-quality stocks have historically outperformed the broad market over the long term

• Quality companies are becoming increasingly attractive

• Blue chip companies are better able to withstand economic weakness

For many months, our advice for investors has been to keep your seat belts fastened. After declining another -16% in the second quarter, the S&P 500 is off to one of its worst starts in history and is now down -20% year to date. Other indices have experienced even greater declines.

With the Russell 2000 down -24% and the NASDAQ down 30%, there have been very few places in equities to hide. Even quality stocks are down -23%, a level that approximates the returns for Core Equity stocks so far this year. However, the underperformance in quality stocks is coming after many years of strong returns and does not change the appeal of these stocks.

As chart 1 shows, quality stocks have solidly outperformed the S&P 500 over the long term, although not every year. In some years, or over shorter periods of time, quality stocks can lag the broader market by a fair amount, as they have so far in 2022. Still, while not calling a near-term bottom, we believe these stocks are becoming increasingly attractive. Blue chip companies, with strong management teams and durable franchises, can grow nicely if economic growth continues, and will come out in better shape on the other side should a recession occur. A nice blend of offense and defense, if you will.

Over the last decade, our primary and preferred approach has been to invest in quality companies for the long term. It’s the best way to be tax efficient and create long-term wealth. This strategy has served us well and we are sticking with our focus here.

So, what is a quality company? We have a proprietary approach, evaluating revenue and earnings stability, balance sheet and cash flow strength and return on equity. On a weighted average basis, we estimate that our Core Equity Strategy has a 10-15% higher quality rank than the S&P 500. We are also continuing to avoid highly speculative tech stocks and crypto-related investments. Other conscious and proactive steps we are taking this year have included reducing exposure to certain stocks with above-average exposure to Europe and, most recently, stocks in cyclical industries that have greater downside earnings potential should recession risks increase.

More from the Quarterly Update

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