Looking for Growth (In All the Right Places)
Large-cap growth equities, as measured by the Russell 1000 Growth Index, have been market leaders in 2017, gaining more than 25% through the end of October. Investor risk appetite has generally been robust against a backdrop of better-than-expected global growth and strong corporate earnings. So, where do equity markets go from here? To learn more, we spoke with Portfolio Manager, Justin Kelly, CFA, who also serves as the Chief Executive Officer and Chief Investment Officer at Winslow Capital Management.
An Equity Market Regime Change
From 2009 to 2016, the equity market’s ascent was primarily driven by price-to-earnings (P/E) multiple expansion—accounting for roughly 80% of the market’s rise. Thus far in 2017, we have experienced a rapid regime change, as investors once again (and finally) reward companies with superior fundamentals. Case in point: Among the S&P 500 companies that had reported third-quarter earnings by the end of October, three-quarters had exceeded expectations. According to FactSet, this represents close to a 4.5% earnings growth rate (year-over-year). Under this new market cycle, we believe equity returns will continue to advance, fueled primarily by earnings growth. In an expensive world, growth equities are particularly attractive, given their ability to compound above average earnings growth.
The Case for Active Growth
Who Will Lead the Charge Going Forward?
So far this year, U.S. equities have experienced double-digit returns across large-, mid-, and small-cap companies. Among the best performers has been large-cap, high growth companies that recovered from depressed valuations. At this stage, is there room for further upside? We think so—provided you know where to look. In the current slow-growth environment, we believe relative outperformance will come from quality growth companies who are industry leaders/market share gainers with seasoned management teams and improving fundamentals (including accelerating earnings and free cash flow growth).
The Benefits of Diversifying across Different Types of Growth
Looking ahead to the U.S. Federal Reserve’s unwind of quantitative easing, equity markets will likely become more fundamentally driven. Focusing on companies with sustainable competitive advantages can potentially help drive value-added performance. A valuation discipline is critically important as well as diversification across different types of earnings growth potential: Consistent Growth, Dynamic Growth, and Cyclical Growth. This approach offers greater investment flexibility, enhances diversification (by business dynamic and risk profile), and may provide more consistent performance results across different market cycles.
- Consistent Growth – Companies with earnings-per-share (EPS) growth greater than the market and demonstrated acyclicality.
- Dynamic Growth – Companies in dynamic positions with superior competitive advantages, generating revenue growth at or above 10%.
- Cyclical Growth – Companies exposed to product, industry, regulatory, or economic cyclicality with prospects for superior earnings growth in the forward 24 months.
Choose Wisely – Fundamentals Matter!
In our view, given current valuations and the market’s extended bull run (nine years and counting), the low fruit has largely been picked. In a post-QE (quantitative easing) era, we see compelling opportunities to generate alpha through fundamental stock selection — if you look in all the right places. Such a backdrop, with distinctive winners and losers, could be ideal for active management. In particular, the key to absolute and relative performance in this moderately expensive and evolving backdrop will be microeconomics. We believe this calls for choosing companies with strong and sustainable competitive advantages that can continue to demonstrate higher earnings and a higher terminal value.
Opinions expressed are current opinions as of the date appearing in this material only. The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results.
All investments are subject to market risk, including possible loss of principal. There is no assurance that the investment objectives mentioned will be met. Diversification cannot assure a profit or protect against loss in a declining market.
Alpha measures a fund’s risk-adjusted performance and is expressed as an annualized percentage.
Earnings-per-share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock.
Free cash flow is the amount of cash a company is able to generate after making required investments in the existing business, such as for new machinery and to pay for supplies.
Large cap (sometimes “big cap”) refers to a company with a market capitalization value of more than $5 billion. Large cap is a shortened version of the term “large market capitalization.” Market capitalization is calculated by multiplying the number of a company’s shares outstanding by its stock price per share. The dollar amounts used for the classifications “large cap,” mid cap” or “small cap” are only approximations that change over time.
The Price-to-Earnings to Growth (PEG) ratio is a valuation metric for determining the relative trade-off between the price of a stock, the earnings generated per share (EPS), and the company’s expected growth.
P/E Ratio (price‐to‐earnings) denotes the weighted average of all the P/Es of the securities in the fund’s portfolio.
Russell 1000 Growth Index refers to a composite that includes large and mid-cap companies located in the United States that also exhibit a growth probability. Russell 1000 Growth Index refers to a composite that includes large and mid-cap companies located in the United States that also exhibit a value probability. Both are subsets of the Russell 1000 Index.
The S&P 500 Index is an unmanaged index and is widely regarded as the standard for measuring large-cap U.S. stock-market performance. Index results assume the reinvestment of all capital gain and dividend distributions. An investment cannot be made directly into an index.
Small cap is a term used to classify companies with a relatively small market capitalization. A company’s market capitalization is the market value of its outstanding shares.
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New York Life Investment Management LLC engages the services of federally registered advisors. Winslow Capital Management, LLC is unaffiliated with New York Life Investments.
MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, New Jersey 07302.