A domestic focus mitigates tariff risks

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Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves. 

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Murdo MacLean, client investment manager at Walter Scott & Partners 

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The question about what factors are impacting global equities is an interesting one, given the fact that, really, up until the end of 2024, it was largely, I would suggest, artificial intelligence trends, excitement around which companies are benefiting from the significant capital expenditures on data centres, and other infrastructure driven to support the rollout of artificial intelligence. Really, since the end of last year, we’ve seen markets pivot towards non-U.S. securities in light of their more favourable valuations, as well as some other sectors. And so there’s been a bit of a broadening out in markets since the end of last year, it feels like. 

And then, obviously, in the last several weeks, in the run up to the so-called Liberation Day, we’ve seen investors — given the level of uncertainty around the tariff picture, and even on Liberation Day, I think there are probably more questions than answers — I think investors are now trying to ascertain the winners and the losers from the initial picture that’s been provided by the White House. 

So at this stage, and for the last couple of weeks, I would suggest that it’s largely been potential tariffs that have been dominating the short-term narrative in markets. 

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So, how best to mitigate risks in portfolios really depends on, I suppose, your time horizon. 

So, certainly in the short term, if you’re trying to mitigate potential risks coming from the rollout of tariffs, you may look to position around companies that don’t have a significant exposure to outside of the U.S., potentially in certain sectors as well, which tend to be more domestic focused. However, that may not be necessarily the best way to position for the long term, and I think that’s, as ever, a challenge that faces investors. The short term may be more easy to position for, but actually, in the long term, that’s what will really matter. 

From our perspective, I think our portfolios are positioned towards companies and sectors where we believe the bulk of earnings growth will be coming from. These are sectors, in many cases, such as technology and healthcare and industrials, and indeed some areas of the consumer space where we think that these companies have a long runway for growth, that because of the fact they occupy dominant positions in certain growth markets, they will be able to extract a significant amount of earnings and revenue growth. So, as I say, it depends on your time horizon.  

I think the other way that you would look to mitigate risk is by knowing your companies that you are invested in extremely well, understanding how they plan to deal with potential pot holes in the road, if you will, whether or not they have pricing power, which will allow them the flexibility to pass on additional costs due to tariffs and other sort of factors.  

And, so, really knowing your companies very well, engaging with management to make sure that management have a good grasp of the outlook, and then, obviously, the fundamentals of those companies. So businesses, as I’ve mentioned, that have strong pricing power, but also companies with the financial robustness, the balance sheet and cash-flow dynamics, which will allow them to take decisions relatively quickly, and that you can still sleep well at night, safe in the knowledge that these companies are not going to run into significant financial difficulties. 

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So, in terms of which stocks or sectors we think are undervalued and therefore could provide opportunities for investors, I think what we’ve been saying since the end of last year is within the technology space, companies that we believe have an excellent position, longer term, to capitalize upon the rollout of artificial intelligence, and that may not have necessarily been the top-performing stocks in the most recent period of strength, but longer term, we assume will do well, I think is an obvious space. They’ve not necessarily participated in the strong rally that we saw in the narrow market that we saw last year.  

So companies like Adobe, that whilst the market continues to be rather circumspect about their prospects, when you look at the fact that they have a long history of rolling out software packages, that they have the distribution, the customer or user base, provided Adobe is able to develop good software — it doesn’t have to be the best software, but good software in that space — the overall distribution infrastructure that they have should allow them to capitalize quite well on opportunities there.  

I think in healthcare, it’s an obvious area that has not performed particularly well since the pandemic. There’s been a lot of overhang from the Covid pandemic, overinvestment in the supply chains for vaccines, only to discover that the demand for vaccines was not as great or as long in duration as some had hoped. And, therefore, there has been a period of overhang in inventories of a lot of these equipment that needs to be worked through.

And you could look at companies in the area of life sciences.  We would suggest companies like West Pharmaceutical Services that has had a bit of a bumpy quarter, but longer term, their core business certainly looks like one that’s well-positioned in the supply chain for injectable drugs. 

Indeed, companies such as Roche — the Swiss pharmaceutical business that isn’t really being priced at the moment for any growth at all — it’s trading on, really, multi-year, if not multi-decade, lows, and really only requires a small amount of pipeline success to get that stock moving. I think that looks particularly attractive.  

At the same time, I think investors should be careful attributing cheap stocks to longer-term opportunities, or indeed to low risk. We’ve seen of late, a rally in financials and some potentially lower-quality areas of the market. However, typically stocks that trade on discounts to the market over long stretches do so for a reason. Their businesses tend to be quite cyclical. They tend to lack pricing power, lack the balance sheet strength that you might expect would help them in periods of stress. And so, I think we continue to believe that although some of those areas may be cheap optically, they don’t necessarily possess the defensive qualities that one may need should we enter a period of extended volatility.  

So indeed, undervalued is very much a sort of subjective view, if you will. But I think companies that have not participated in strength of late is an obvious space.  

U.S. industrials — a sector or a part of the portfolio well represented through companies like Fastenal, Ferguson, Copart, Old Dominion Freight Line, to name a few — are all companies that we are very bullish on long term. [They] have seen many cycles, will be probably beneficiaries of a more U.S.-centric economic policy from the White House, have all been going through a bit of a prolonged slump in their end-markets. When those end-markets begin to normalize, the valuations on these stocks provide very good entry points. 

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The outlook for global equities in the current environment is, I think, still somewhat uncertain. We’ve just come off the back of two exceptionally strong years, particularly in 2024. And the beginning of the year so far has been optically quite different from what we saw last year and the year before that. The excitement around AI, whilst still there, I think the market has switched to looking for more returns on investment, and a little bit concerned about whether companies have overinvested. So it may be that the hitherto beneficiaries, according to the market, go through a period where perhaps the market’s looking for a little bit more in terms of returns, a little bit more clarity on how these things will be deployed in the actual real economy. So there could be a period of slower or lower returns from some of those sectors. 

At the same time, I think the market is looking to other sectors that are trading on lower valuations, but recognize that they have been good businesses, and looking for evidence that cycles are turning, and that certain economic levers that have been pulled by governments around the world are beginning to work. So, I think that would be not a surprise to see those companies, those sectors, potentially benefiting, I think, from investors being slightly more cautious on tech or AI, shall we say. 

I think the word that comes to mind is that of volatility. We’ve seen heightened volatility, really, through the first four months of the year. And as long as there’s not perfect clarity about tariffs, and the shape of potentially, the U.S. and global economy over the sort of short to medium term, then volatility is likely to persist. 

That can be not necessarily a negative. If you are an active manager, if you have a long-term perspective like Walter Scott does, if you are sensitive to valuations, then there are plenty opportunities that will come along amidst volatile periods.  

And so, I think volatility is likely to continue; a lot of noise in markets is basically a constant feature. And so being able to keep a cool head, focus on fundamentals and focus on the long term is the way that we believe will lead to the best investor returns over time.

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