Hot stocks in peril as inflation restarts

Hot concept stocks are likely to come under the most pressure this year, according to Bell Asset Management’s chief investment officer Ned Bell.

Ned Bell is investment officer and portfolio manager at Bell Asset Management. Picture: Hollie Adams

Rising inflation will intensify volatility in markets through the rest of the year, with the “hot” concept stocks likely to come under the most pressure, according to Bell Asset Management’s chief investment officer Ned Bell.

But there are big risks at both ends of the growth/value seesaw, he warned.

“We’ve just come out of US earnings season, which was unbelievably strong. What markets are now trying to come to terms with is the pick-up in inflation that comes with the inevitable bounce in the US economy,” Mr Bell told The Australian.

“The reality is we’ve not seen inflation for years and years, so there’s clearly some digestion going on and that’s causing a lot of volatility.

The riskiest, from our perspective, are these really expensive concept-type stocks, the high-growth stocks, which have been incredible performers of late but are now starting to come under a bit of pressure.”

A surprise spike in US inflation last week sent jitters through markets as investors mulled sooner-than-expected interest rate rises in the world’s biggest economy.

The Dow and S&P 500 each fell more than 2 per cent on Wednesday after data showed US inflation was climbing at the fastest pace since 2008.

Consumer prices rose 4.2 per cent over the 12 months through to April, up from 2.6 per cent in March and well above the 3.6 per cent the market had been expecting.

After posting their steepest three-day declines in seven months early in the week, both indices bounced on Thursday and Friday, paring some of the losses.

Rising inflation will mean more frequent corrections for certain parts of the market but not necessarily the US stockmarket as a whole, Mr Bell said.

“The big stocks like Tesla, Nvidia, Netflix, Salesforce, these types of names, they’re so overowned, and they trade on these nosebleed earnings multiples. And frankly, I don’t see who the marginal buyer is.

“So those are the names, those extremely expensive names, are the ones that typically derate the most in a rising interest rate environment. And that’s what we’re expecting to see.”

Growth stocks are not the only ones at risk, he warned.

“A huge part of the market has probably got too much leverage. For the last three to four years, a lot of companies have been happily borrowing money (to) buy back shares.

“That’s all great until interest rates go up. And that’s where that value end of the market is probably a bit more vulnerable to a prolonged period of inflation and rising interest rates,” Mr Bell said.

These companies could be hit with the “double whammy” of not having pricing power, while holding too much leverage, taking a hit to their earnings, he added.

While floods of money flow into the “hot” parts of the market, Mr Bell is still finding value in the small and mid-cap sector, away from the crowds.

Around 40 per cent of Bell’s global core equity portfolio is invested in small and mid-cap stocks.

This part of the market is like the “last unopened Christmas present” under the tree, according to the veteran investment manager.

“Small and mid-cap stocks have lagged in the last couple of years. They had big earnings drawdowns last year as an asset class. But they always recover very, very strongly in the subsequent periods after these big earnings drawdowns.”

Stocks Bell favours at the moment include pool equipment supplier Poolcorp, farm equipment supplier Tractor Supply, and outdoor recreational product-maker Yeti.

In the five years post the dotcom boom and the GFC, the global small and mid cap sector returned 221 per cent and 230 per cent, respectively.

The sector is still in the first inning of the recovery post 2020, Mr Bell said.

“A lot of these small and mid cap stocks, they’ve cut their cost base back quite sharply through COVID-19. Time and time again we’ve heard a lot of companies say they have had three years of efficiency gains that they’ve put into place over six or 12 months. So when stimulus comes and the economy starts firing again, the revenue drops to a much lower cost base, which means the earnings leverage is huge.”

“That particular aspect of the small to mid cap stocks is not that well understood and still has quite a way to play out.”