Optimism is high in the US equity market these days, and potential loosening of the regulatory environment and the Fed’s decision to hike interest rates have only added to investor enthusiasm. With the US market firing on all cylinders and optimism priced into valuations, where are the opportunities? We speak to three managers from across the market cap spectrum to find out.
View from US equity expert
Susan Bao - JP Morgan Asset Management
- Fed rate rise was overdue and spurred by improving global data
- US economy still has plenty of room to grow
- Financials will benefit from current positive environment
The Federal Reserve did not surprise anybody by raising rates, especially given all the strong data we’ve been seeing – for example on the job side and the PMI data is in the mid- to high-50s. We’ve also seen strong data coming from Europe and Asia.
I think the Fed did the right thing by raising rates, and it was overdue. From their perspective, in previous speeches they were worried about global growth and China, and I think what triggered them to increase rates this time was they saw both strength in their domestic market and an improvement internationally.
The US market since the election has gone up a lot, and year-to-date it is up more than 6%. When you look at valuations from an absolute perspective, we are trading slightly above long-term fair value based on forward P/E ratios.
But from a relative perspective, given equity versus bond yields, we still have a long way to go because the economy is going to grow, and with interest rates still low this is going to continue giving fuel to the economy.
We went through an earnings recession in 2016, and I think this year we are likely to see double-digit growth in earnings. In my opinion we are still a couple of years away from the next recession in the US.
Everybody is talking about the animal spirit of the US market: consumer confidence is high and sentiment is improving. In terms of sectors, I think the current environment is favorable for banks. I think US banks have the potential to increase dividends and buy back shares.
Valuations are still supportive and they’re trading at 1.5 times book value; these are good value stocks to own. Looking further down the line on a 18-24 month period, we are positive on the outlook for companies that fit in the growth-at-a-reasonable-price stocks, with groups such as Google and United Healthcare.
View from US small/mid cap expert
Justin Tugman - Janus Capital
- Optimism is hitting new highs with both corporations and consumers
- Industrials will benefit from Trump administration’s policies
- Smaller US banks will benefit from new regulatory reforms
The equity market is not cheap in general, and it hasn’t been for a while, but relative to other investment options, such as fixed income or real estate, it’s the best out there.
Small caps are not as highly priced as they’ve been historically. If politicians in Washington DC were to implement everything they talked about, and do it on time, it would improve valuations. We are more defensive in our approach given the current valuations and with much of the potential upside dependent on the policy front in Washington DC.
I was a little surprised that the market took Janet Yellen’s comments in such a dovish fashion. Inflation is creeping up. The Fed said it's approaching the inflation target but there are indicators showing we’re above it. It certainly doesn't want to take away the punch bowl from the equity market and, as Yellen said, it will continue with an accommodative fiscal policy.
Optimism has improved, whether at the business or consumer level. The stock market is up, unemployment is down but when we look at equity markets there are signs that the flows companies are seeing to their order books, and top and bottom lines are not of the same magnitude as the market has priced in as of yet.
We continue to be overweight industrials. We’ve liked this sector for a while as there are some high-quality companies we own. They are not as cheap as they were when we initially bought them in 2015, but it is one area that will benefit from new policies discussed by the Trump administration.
One name we hold is UniFirst, a company that rents workwear apparel, as well as selling cleaning supplies and other facility services that will benefit from increased manufacturing employment.
We are also positive on banks, particularly the smaller banks. Regulatory reform will benefit these banks more than the larger ones, such as JP Morgan or Wells Fargo. We’ve also seen more M&A, particularly smaller banks getting together and mid-size banks buying smaller ones. Among the banks we have in our midcap portfolio is Citizen Financial Group, which we’ve held for a while and will be one of the bigger beneficiaries of rising rates.
View from US mid cap expert
Don Easley - T Rowe Price
- US market returns will be lower going forward
- Mid-cap sector is a fertile ground for growth companies
- Dollar General and Electronic Arts among top stock picks
We focus on bottom-up stock picking and don’t make a broad market call. That said, there are reasons to believe equity returns will be lower going forward versus the historical averages. First, after a long bull market, valuations are fair to full relative to history. Second, there are political uncertainties, with the potentially positive impacts of tax reform and regulatory changes, perhaps offset by an increasing threat of protectionism.
The mid-cap growth space, which is generally in the market-cap range of $3 billion to $25 billion, is an area that, over time, has produced strong returns relative to other asset classes at reasonable levels of risk. It is a fertile field for growth companies that are potentially attractive acquisition candidates for larger companies, and also tends to be somewhat less of an efficient market relative to larger caps.
The core of our portfolio is made up of high-quality, steady growers, which we view as being relatively attractive. One company we like is Dollar General (DG), a dollar store that trades at around 14x calendar year 2018 estimates, a discount to the market. The company has hit a rough patch recently, but we continue to view it as a solid investment with the potential to grow EPS in the low double digits. DG is also somewhat protected from online threat, which is an important consideration for any retail company.
Another company we like is Electronic Arts (EA). EA has gone through a fundamental turnaround over the past three to four years under new management. Operating margins have expanded from 5% to 30% over this time, and we think there is room for further improvement. It has also been very active at buying back its own stock and reducing shares outstanding, which is a metric we pay particularly close attention to. EA also has strong gaming platforms such as the FIFA soccer franchise and the Madden NFL franchise. Considering its strong EPS growth outlook, the stock trades at a reasonable multiple of 18-19x 2018 calendar EPS estimates.
This article was originally published in the April 2017 edition of Citywire Americas magazine. To subscribe and receive the magazine click here