Traditionally, when considering the topic of investments in stocks of public companies, we focus on the trends of the American stock market, as the largest and liquid market in the world. It is a key arena for investors due to its wide diversification, technological innovation and strict regulation.

Since the beginning of 2024, the US economy and the stock market continue to show mixed signals, which affects the strategies of investors. Despite steady growth in some indices, such as the S&P 500 and Russell 2000, the market has seen increased concentration of stocks. In the first quarter, roughly 40 companies drove 100% of the S&P 500’s gains, while just 10 companies dominated the Russell 2000. There have been no corrections of more than 2% for more than 250 days. This is unusual for the market and may indicate artificial maintenance of market prices, which increases the likelihood of a sharp correction in the future.

What should an investor pay attention to in order to navigate the current market conditions and adjust the strategy?

Main economic indicators

Among the main economic indicators, an investor should pay attention to the slowdown in business activity in the USA confirmed by the indices for the real and service sectors of the economy, which have remained at low levels for the past three years. Rising wages, shrinking real demand and falling new orders raise the risk of a recession. Retail sales are decreasing; small businesses are pessimistic. All this foretells further deterioration of the economic environment.

Inflation remains a significant problem

Despite the decrease in commodity inflation, service inflation continues to grow. This is mainly due to the increase in wages, which affects pricing in the service sector of the economy. International conflicts, in turn, affect the cost of goods. This factor also causes inflation.

Current investment strategies

In our opinion, the bulk of the US equity portfolio should be held in companies that generate stable cash flow. In the current situation, they objectively deserve more attention than dividend-paying companies or a broader stock market, where the share of a few large IT companies account for more than 30%. This is dangerous both because of the concentration of risks and because of the lack of a normal diversification strategy, which is a necessary element of a long-term growth and balance of the investment portfolio.

Investment-attractive companies share several fundamental characteristics:

1. Low beta (less than 1). This coefficient indicates that the stocks do not change more than the market.

2. High FCF (free cash flow) Yield over the last 12 months compared to the sector of a specific stock.

3. The FCF CAGR, which shows how quickly the company has grown its free cash flow over the past five years, should be higher than the market average.

4. The high cost of reviewing EPS (earnings per share) by analysts over the last 3 months compared to the market.

5. High cost of free cash in relation to the company’s total assets.

Now, companies from the financial, energy, IT and healthcare sectors meet the listed criteria. Here are some of them: Arch Capital, Progressive, Assurant, Kinder Morgan, CBOE Global Markets, FOX Corp., Everest Group, Marathon Petroleum, Lowe’s.

It is worth considering that the overall portfolio effect is achieved not so much due to the concentration of specific companies, but due to the selection of stocks that have the specified characteristics. This reduces the risks of individual companies during the period of corporate reporting and after it.

Why do we recommend choosing companies that generate large amounts of net cash flow? A historically high rate of cash flow profitability shows better results of dynamics throughout the business cycle, and especially at the stage of the economy’s transition from growth to recession. We are probably now in that stage of the cycle where companies with stable financial health have better history dynamics. Investors pay more attention to the FCF multiplier (one of the indicators of the quality of the company’s financial condition) than to the categorical characteristics of the business. Companies with high FCF also historically grow more strongly during turning points in the Federal Reserve’s interest rate policy. This indicates their ability to adapt to changes in the economic environment and maintain resilience even during periods of market uncertainty.

With the current dynamics of inflation and monetary policy, investors are interested in companies that can benefit from difficult market conditions. For example, the companies from the consumer goods and services sector can quickly adapt to changes in consumer demand and have a flexible pricing policy.

In addition, it is important to take into account the financial health and strategic vision of the companies. Companies with strong balance sheets, low debt and clear strategies for sustainable growth are less exposed to market fluctuations, which makes them attractive to investors seeking to minimize risk.

Therefore, investing in modern conditions requires a balanced approach and a careful study of both the economic context and the individual characteristics of each company. Economic instability calls for an enhanced analysis and a strategic approach to identify the most promising assets capable of ensuring long-term growth and stability of the investment portfolio.