Buy stocks with these 3 qualities to hedge against short-term volatility, according to the head of equities at a firm that manages $141 billion in assets

In fact, there's an "unusually wide" disconnect between economists' often pessimistic top-down forecasts and a bottom-up view that suggests firms have "incredibly strong" order books, said Anik Sen, the global equities head at PineBridge Investments, in a recent interview with Insider.

Though Sen and his colleagues at PineBridge, which manages $141.1 billion in assets, aren't certain that the US will avoid a recession as the economy continues to contract on a GDP basis, he said that stock fundamentals should stay "relatively strong" despite the big selloff this year.

"When I look at stock prices today, they are trading as if we're going to get a recession," Sen told Insider. "So I think that's very much baked into these prices. So we are actually taking this opportunity in our portfolios to buy into those kinds of companies that are world-class companies that have been sold off aggressively."

Inflation's likely peak, strong job growth outweigh market risks

Sen believes that price growth has peaked and the job market is truly as strong as it appears to be. Inflation will recede, in Sen's view, because the supply-side issues that have plagued companies since the pandemic began and worsened early in the year are now healing.

"You could argue that it's because of global recession concerns, but generally speaking, people in all industries are saying that the supply chains are beginning to feel a lot better," Sen said.

Even though price growth should start to decline, as Sen has been predicting for months, inflation isn't yet an issue that investors can ignore. Slowing inflation means that prices are still increasing, albeit at a slower rate, and it's also worth noting that the consumer price index (CPI) may merely fall month-over-month because it's starting to lap higher year-over-year marks.

Although consumers may be disappointed that goods and services aren't getting cheaper yet, it would be encouraging to see evidence later this week that inflation isn't spiraling out of control.

While a soft inflation report would be unequivocally positive for both stocks and the economy, investors were less sure that the remarkably robust jobs data released last Friday is a tailwind for equities. There's a sense in markets that the shocking display of economic strength will encourage the Federal Reserve to keep rapidly raising interest rates, which could hurt economic activity and end up causing a recession.

But Sen is taking the glass-half-full view of the July jobs report. Unemployment is near a 53-year low, and there were nearly twice as many available jobs as there are unemployed people, the equities head noted — a gap that he said is "historically, the highest ever."

"Looking at unemployment — not just as an average, but also unemployment in certain demographic groups of the population — that number, obviously, is trending down," Sen said. "By all accounts, the economy is in reasonably strong shape."

And while that economic strength could lead to wage inflation and give the US central bank a green light to hike rates to a level that hurts stocks, neither possibility is overly worrying to Sen.

"I don't think that the jobs report per se is a cause for concern from a Fed standpoint," Sen said.

Sen made clear that there are still serious risks for stocks, including that some companies will lose pricing power as they sell goods at a discount after over-ordering inventory. Another far-more-frightening threat is that the Russia-Ukraine war escalates or that the relationship between China and Taiwan gets hostile.

How to hedge against near-term risk

The fate of stocks depends on unpredictable inflation data, Federal Reserve policy choices, unemployment reports, and geopolitical developments.

Investors can't possibly know what's coming next, but they can protect their portfolios by hedging against short-term risk, said Sen, who co-manages the PineBridge Global Focus Equity Fund. The mutual fund had a tough start to the year but rebounded strongly in July, data from Morningstar shows. Sen's fund trounced its benchmark in both 2021 and 2020.

Sen's strategy is a bottom-up approach that focuses on several key attributes of companies regardless of what sector they're in. He then chooses 40 "world-class companies" that he said have three qualities: "extremely strong" leadership and governance, pricing power, and healthy financials.

The former trait is easy to understand but difficult to find. Companies with capable management tend to nail the small details, which can have huge consequences. For example, ordering the proper amount of inventory sounds simple, but it hasn't been in recent years. Under-ordering goods hurts revenue, while over-ordering weighs on margins and can sink a company entirely.

Effective pricing power can come from having the right amount of inventory, but Sen said that it can also stem from having "tremendous scale or tremendous technology" — or both. 

Lastly, companies that are financially healthy with either very low net debt levels or even a net cash level, Sen said. That attribute is especially relevant during periods of economic stress.

While Sen didn't speak on his favorite stocks due to compliance reasons, there's a publicly available list of his fund's top 10 holdings, as of June 30, on its website. Those names are as follows: Alphabet (GOOGL), LPL Financial Holdings (LPLA), Allegion Public Limited Company (ALLE), TE Connectivity (TEL), Walmart (WMT), Otis Worldwide (OTIS), Honeywell International (HON), Motorola Solutions (MSI), State Street Corporation (STT), and Centene Corporation (CNC).