PRICE
PERSPECTIVE®
April 2016
In-depth analysis and insights
to inform your decision-making.
U.S. Equities:
VOLATILITY—OPPORTUNITY OR
WARNING SIGN?
EXECUTIVE SUMMARY
■■
■■
Helen Ford,
Portfolio Specialist,
U.S. Equities
■■
■■
Top-down macroeconomic news is currently dominating markets, and there has
been a notable pick up in volatility. For patient long-term investors, such uncertainty
typically creates buying opportunities in high-quality companies.
Concerns abound that the U.S. economy will slide into recession in 2016, but that
is not our base-case scenario given that the consumer remains well positioned.
Corporate America remains in good health, and while corporate margins are likely
to plateau around these higher levels, a sharp decline is unlikely.
A combination of reasonable valuations and a fairly supportive U.S. economic
backdrop provides a positive backdrop for the equity market.
MACROECONOMIC HEADLINES
DOMINATE FOR NOW
Eric Papesh,
Portfolio Specialist,
U.S. Equities
In 2015, U.S. equities were what we
would best describe as violently flat.
With uncertainty over the outlook for
the Chinese economy, concerns over
Greece and Europe, tensions in the
Middle East, and continued weakness
in energy and commodity prices, it was
not surprising that anxiety levels rose.
In addition, the intense level of focus in
the lead up to the first Federal Reserve
(Fed) interest rate hike in December
(the first hike in nine years) contributed
to nervousness. To a greater or lesser
degree, these concerns have persisted
so far in 2016, and in the near term
investors have put more weight on
these issues rather than focusing
on the underlying fundamentals of
individual companies.
In this challenging global economic
environment, U.S. dollar price-sensitive
sectors such as energy and metals are
experiencing an earnings recession.
However, it is important to recognize
that we have continued to see relatively
strong corporate results from the health
care and technology sectors, along with
certain areas of the consumer sector. In
addition, we continue to see high levels
of merger and acquisition activity, as well
as ongoing share buybacks supported
by cash-rich balance sheets.
CONUNDRUM FOR THE FED
Given the uncertain backdrop, the pace
and timing of further interest rate rises
remains a hot topic of debate. While
being aware of the global economic
environment, the Fed is also aware
of the continual improvement in the
labor market, moderate increases in
wage inflation, and the steady ongoing
improvement in the housing market.
The U.S. consumer has lower debt
levels than at the beginning of the global
financial crisis and is benefiting from
lower energy prices. Given this, and
For investment professionals only. Not for further distribution.
GROWTH VERSUS VALUE
While growth and value have alternated
leadership over much of the past
decade, during 2015 we saw dramatic
outperformance from growth (Figure 2).
The market narrowed, and a relatively
small number of growth stocks drove
performance. When combined with the
weakness experienced within traditional
“value” sectors (namely energy,
materials, and financials), the result
was a notable outperformance of
growth over value benchmarks.
P R I C E P E R S P E C T I V E®
50
40
30
20
10
0
S&P 500
Russell 1000
Value
Russell 1000
Growth
Russell
Midcap
Russell 2000
Past performance is not a reliable indicator of future results.
Source: FactSet
Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related
to the Russell indexes. Russell® is a trademark of Russell Investment Group.
FIGURE 2: FOLLOWING GLOBAL FINANCIAL CRISIS, GROWTH STOCKS HAVE
MOSTLY OUTPERFORMED
Growth outperforming Value in recent years
As of 31 Jan 2016
40%
Value—Growth
30%
Value Outperforms
20%
10%
0%
Growth Outperforms
-10%
16
20
14
20
15
20
12
13
20
11
20
10
20
20
09
08
20
07
20
06
20
05
20
04
20
20
03
20
02
-20%
01
Weakness seen at the outset of 2016
has been excessive in relation to the
underlying economic backdrop. As
investors have traded broad groups
of stocks somewhat indiscriminately,
based on macro-related concerns, we
have taken advantage of near-term
weakness to add to positions in several
of our higher-conviction names. Given
the market’s pullback, valuations have
also become more attractive and we
view current levels as “reasonable”
considering where we are in the
economic cycle (Figure 1).
Current P/E Ratio
Average P/E Ratio
20
HEIGHTENED VOLATILITY PRESENTS
SELECTIVE OPPORTUNITY
60
00
However, given the Federal Open Market
Committee’s sensitivity to financial
market conditions and the rapidly
decreasing prospect of inflation reaching
its 2% target anytime soon, further rate
hikes are likely to be moderate and
highly data dependent.
Past 20 years, as of 31 Jan 2016
20
While some commentators have
argued that the decline in oil prices
is symptomatic of flagging demand
and possibly even a precursor to more
generalized demand shortfalls that may
lead to a U.S. recession, we would note
that the rapid falls were more to do
with excess supply caused by ongoing
productivity improvements in U.S. shale
oil production.
FIGURE 1: VALUATIONS—CHEAP OR EXPENSIVE?
Market Indices: Forward P/E Ratios
20
notwithstanding the slow GDP growth
reported for the last quarter of 2015, it is
unlikely that a recession is imminent.
Past performance is not a reliable indicator of future results.
Sources: FactSet and Standard & Poor’s
Looking forward, there are reasonable
arguments to support both sides of the
growth versus value debate, and we
would encourage investors to maintain
a U.S. equity portfolio with a balanced
allocation to the full breadth of the market.
AT A COMPANY LEVEL, THE BACKDROP
REMAINS FAVORABLE
The current dividend yield of roughly
2.3% is superior to the yield of U.S.
10-year Treasuries, and the S&P 500 is
trading at a higher earnings yield than
investment-grade corporate bonds. On
balance, the health of corporate America
also remains strong, with balance sheets
in aggregate having been meaningfully
strengthened over the past several years.
While it may be reasonable to expect
recent wage growth to negatively impact
overall levels of corporate profitability, we
do not anticipate a meaningful decline.
FURTHER STRENGTH OF THE
U.S. DOLLAR?
The U.S. dollar has risen strongly on
a trade-weighted basis over the past
several years. Divergent monetary
2
FIGURE 3: POSITIVE BACKDROP FOR CONSUMERS
Unemployment and Non-farm Payrolls
May 2001 to January 2016
Unemployment (%)
10
Unemployment (LHS)
Non-farm Payrolls (RHS)
600
400
200
9
8
0
7
-200
6
-400
5
-600
4
-800
-1000
3
‘01
Change in Nonfarm Payrolls
11
‘02
‘03
‘04
‘05
‘06
‘07
‘08
‘09
‘10
‘11
‘12
‘13
‘14
‘15 ‘16
Sources: FactSet, Bureau of Economic Analysis, Bureau of Labor Statistics, and Federal Reserve
policies and different economic trends
help to explain the dollar’s ascent.
While further appreciation would likely
present challenges to a number of U.S.
multinational companies, the majority of
the dollar strength is likely behind us at
this point. Accordingly, we expect to see
a moderation of the headwinds caused
from currency strength over the second
half of 2016.
WHERE ARE WE FINDING
OPPORTUNITIES?
Health care, technology, and select
consumer-related segments of the market
are providing many attractive options at the
moment. Longer term, we are optimistic
about the potential for future innovation in
health care and expect to see significant
breakthrough developments over the
next decade in the areas of cancer,
gene therapy, and Alzheimer’s disease.
Our research is focused on identifying
companies with strong pipelines,
compelling technology, and a high
likelihood of long-term commercial viability.
P R I C E P E R S P E C T I V E®
Within information technology, over
the past several years we have been
heavily invested in companies benefiting
from the ongoing convergence of
communications and computing. We
continue to find interesting opportunities
related to the continuing shift to public
cloud computing and in companies well
positioned to capitalize on trends in social
media, Internet search and advertising,
and global electronic payments.
We also anticipate that select consumerrelated segments of the market will
continue to offer attractive investment
opportunities. With positive trends in
employment (Figure 3), wage growth, and
inflation, we look for continued strength
from companies offering compelling
goods and services to a strong and
improving consumer-end market.
influencing the market. The bears are
focused on the fact that profit margins
have plateaued and that a strong dollar
and accelerating wage growth are
negatively impacting profitability. The
bulls would note, however, that you
have the opportunity to invest in select
industry-leading companies that are well
positioned to drive earnings growth.
While the timing is uncertain, at some
point the environment for commodity
price and dollar-sensitive companies
will improve. While rising wages have
the potential to negatively impact profit
margins, at the same time, they are a
positive for consumers. Further rate
increases are likely to be moderate,
and monetary policy around the world
remains accommodative. Bull markets
usually end with recession or due to
valuation bubbles—we see no signs
of either.
Given these factors, we remain
reasonably constructive, but returns
are likely to be more modest. As we
have witnessed for the last few years,
sentiment is likely to ebb and flow. This
will again likely provide opportunities to
invest on bouts of stock-specific volatility.
We look to take advantage of these and
to build positions in companies that are
attractive on a risk/reward basis. The
outlook is inherently more stock-specific
than it has been for some time, but
patient investors should be rewarded
over the long term.
WHERE DO WE GO FROM HERE?
In this more challenging market
environment, it is important to be aware
of both the positive and negative factors
3
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