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Rotation, the Growth Debate, and the Cyclical Fade

David J. Eiswert , Portfolio Manager

2017 is turning out to be just as full of surprises as 2016. Well, not in one respect: The data have largely met expectations, with earnings growth and economic activity trending upward. With volatility low and global political fears easing, this has provided a robust backdrop for equity sentiment and also for global equity returns. For a short period of time, the wall of worry seems to have been put to one side and replaced with some old fashioned animal spirits.


Strong returns, but greater dispersion

However, low headline volatility disguises some big return spreads and a meaningful shift in the market fabric. One of the biggest surprises to consensus can be observed by looking at market leadership, with the “Trump trade” face-planting in spectacular fashion. Policy rhetoric has proved to be very different from policy reality, and the net effect has largely been a lack of policy implementation. This has realigned expectations surrounding the impact of stimulus and deregulation on key sectors—including materials, energy, and financials—holding back the performance of cyclicals and value compared with secular winners and growth stocks.

 

Looking at the swing in sentiment and the move by the market back to growth, this may appear somewhat contradictory with good time sentiment. Markets are moving upward, but the market is also questioning whether broad-based and late-cycle themes of accelerating growth, inflation, and commodity strength will follow through.

 

To us, this shift is rational and reflects a repricing of the impact that Republicans’/Donald Trump’s policy may have on stock fundamentals. It is also an indication that inflation and growth data in this particular cycle may not follow the pattern that economic historians suggest. This is especially true of inflation, where the outlook is likely subdued versus history given some powerful and embedded secular changes occurring within demographics, technology, and supply/demand fundamentals in energy and many commodity markets (we remain bearish). If broad-based cyclical trends do not accelerate as expected, then the reality is that earnings delivery and secular winners are likely to command a premium.

 

Positive drivers could maintain this bull market

This backdrop has created somewhat of a perfect and positive storm for equities involving easy monetary policy, improving stock and economic fundamentals, and few attractive alternative uses of capital. Effectively, this has lengthened the equity cycle versus other bull markets. The key for us is to keep picking stocks where the market has the wrong estimate of growth and improvement while being conscious that an extended bull market entails new risks, driven both by fundamentals and by complacency.

 

Our underweight positions (Figure 2) continue to reflect where we are struggling to find stock-specific ideas or fundamental change, combined with valuations that offer us a conviction entry point. Industrials appear expensive to us on average, as do many consumer staples stocks. Our structural views on energy and commodities are borne out in underweight positions at the sector and industry level.

 

How are we positioned?

Despite a strong first half of the year for markets (see below), we remain constructive on the outlook for equities. We also remain active and have been sifting through the poor performance of the U.S. retail sector for specific stock ideas that are, by definition, contrarian but where we believe we have specific insights regarding durability and fundamental improvement. We have also added to our health care positions where quiet outperformance reflects fears of U.S. pricing regulation easing, given the challenges in agreeing on reform.

 

We remain overweight in technology, more specifically, those stocks that are innovating faster and monetizing their advantage more rapidly than the market anticipates. When combining these secular winners with our positions in product cycle-driven technology stocks, the aggregate position is a conviction overweight in the sector. Importantly, while valuations clearly are not cheap, we believe we are some way from bubble territory. When and if we do see bubbles emerging, we would expect to sell and trim, as we have done in the past.

 

Figure 1: Global Focused Growth Equity Composite Performance

As of June 30, 2017. Figures shown and/or calculated in U.S. Dollar.

Past performance cannot guarantee future results.

1Net-of-fees performance reflects the deduction of the highest applicable management fee (Model Net Fee) that would be charged based on the fee schedule appropriate to you for this mandate, without the benefit of breakpoints. Please be advised that the composite may include other investment products that are subject to management fees that are inapplicable to you but are in excess of the Model Net Fee. Therefore, the actual performance of all the portfolios in the composite on a net-fee basis will be different and may be lower than the Model Net Fee performance. However, such Model Net Fee performance is intended to provide the most appropriate example of the impact management fees would have by applying management fees relevant to you to the gross performance of the composite.

2Returns shown with gross dividends reinvested.

3The Value Added is shown as Global Focused Growth Equity Composite (Gross of Fees) minus MSCI All Country World Index.

4The Value Added is shown as Global Focused Growth Equity Composite (Gross of Fees) minus MSCI World Index.

5Effective September 30, 2012, David Eiswert assumed portfolio management responsibility for the strategy.
Source for MSCI data: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.

 

 

Figure 2: Global Focused Growth Equity Representative Portfolio Versus MSCI All Country World Index

Relative sector weights, as of June 30, 2017.

The representative portfolio is an account we believe most closely reflects current portfolio management style for the strategy.

Performance is not a consideration in the selection of the representative portfolio. The characteristics of the representative portfolio shown may differ from those of other accounts in the strategy. Information regarding the representative portfolio and the other accounts in the strategy is available upon request.

Sources: MSCI and FactSet, MSCI/S&P Global Industry Classification Standard (GICS) sectors; analysis by T. Rowe Price Associates, Inc.
T. Rowe Price uses the MSCI/S&P GICS for sector and industry reporting. Each year, MSCI and S&P review the GICS structure. The last change occurred on 31 August 2016. T. Rowe Price will adhere to all future updates to GICS for prospective reporting.

Source for MSCI data: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.

 

 

201708-231239

 

IMPORTANT INFORMATION

This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.  

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Concentrating high conviction positions in leading global investment prospects.
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