Global equity markets have bounced back strongly after a down year in 2018. What is your outlook on equities going forward?
We are still constructive on equities in the medium term. Currently, the S&P 500 Index’s forward PE multiple is just under 17, which translates into an earnings yield of about 6% and current dividend yield of nearly 2%.1 When you compare that against the backdrop of more than US$15 trillion worth of negative-yielding bonds in the global market, the equity market valuation looks rather attractive on a medium- term basis versus other asset classes.2
There is a lot of bifurcation within the equity market, however. Growth stocks have meaningfully outperformed value stocks over the last decade, driven in large part by real cashflow growth and real earnings growth as opposed to valuation multiples re- rating. Importantly, this is different from the dot-com bubble when valuations for growth stocks were coming just from multiples being re-rated to reflect potential future earnings improvement.
As you say, growth stocks have performed well in the past decade on the back of improving fundamentals. Do you think this is a structural change that will continue?
We do believe it is something that is quite structural. When you think about structurally what is actually happening within the growth segment of an index and the value segment, a lot of the growth stocks are actually disrupting the value stocks. Just look at a stock like Amazon disrupting traditional retail businesses or fintech disrupting banks to see how this is occurring today.
Over the last decade Amazon's total sales have grown more than eight-fold.3 During that period, many retail stocks in the S&P 500 Index have actually had flat sales growth. To understand why Amazon performed so well as a stock, you have to look at how the operating performance of Amazon appears to have been much, much better than the average retail stock in the U.S. That is a structural change and our view is that it is here to stay.
Having said that, growth stocks are often painted with just one brush, and that ignores the fact that there are also a lot of growth cyclicals in the market. So stocks in industrial automation and robotics that are linked to the industrial cycle, for example, have actually sold off meaningfully in the past year to the point where we see a lot of value.
It’s also worth noting that there are still several undiscovered growth stocks that in our view are ripe for significant expansion in the coming years. This includes stocks like e-commerce providers Mercardo Libre in Latin America and Sea in Asia and payment processer Stone in Brazil.
The U.S.-China trade dispute has had a major impact on financial markets across asset classes. What is your view on the situation and how are you positioned for a potential outcome?
The U.S.-China trade dispute has clearly had a significant impact on investor sentiment dating back to 2018. Where the situation goes from here in terms of getting to a resolution or whether there is further escalation really depends on politics and the rhetoric from both the U.S. and China.
As investors, we do not want to position our portfolio for just one outcome in such a binary event because of the inherent uncertainty of the situation. Instead, we are staying true to our investment process and are investing in durable, quality growth stocks at a reasonable price. We do recognise that the trade dispute could increase volatility in the near term, however, and have lowered our portfolio beta down from around 1.07 to be closer to 0.99.4
If we are to enter a world of heightened volatility amid rising geo-political concerns and slowing global economic growth, what is your approach to managing risk in the portfolio?
We use beta as one key indicator when we look at risk and are quite dynamic about it when thinking about portfolio positioning. For instance, we reduced the portfolio beta in 2018 and that served us really well during the fourth quarter when the market sold off. At that point, we started to see more attractive valuations and dialed the risk back up again, which helped our performance through most of 2019 to date, particularly during the first quarter. We have since lowered the beta again because we believe the market may be too complacent regarding the risks of the trade dispute.
While we have scaled back some risk, we have also not gone overly defensive, as we still think equities represent good value over the medium-term, especially versus other asset classes, in the context of trillions of dollars of bonds in negative yielding territory.
The comprehensive research platform at T. Rowe Price enables you to oversee a very large investment universe that includes growth stocks which may still be relatively unknown to global investors. With that in mind, what are some of the key stocks that you are monitoring?
There are still plenty of opportunities in the growth space, in part because so many stocks are either uncovered or not covered well by the broader market. By virtue of having nearly 160 equity research professionals worldwide,
T. Rowe Price has the luxury of actually covering a great number of these stocks in depth.5
One of the stocks we really like in the health care space is WuXi Biologics. This is a leading contract research and development organisation in the emerging field of biologics, which sources pharmaceutical drugs from components of living organisms rather than synthetic materials. WuXi Biologics has benefited from the shift toward biologics, and the beauty of a stock like this is that you are not betting on the success of a single pipeline. Based in China, the company also has access to a pool of talented scientists who can potentially unlock new areas of innovation.
Another stock we are positive on is Hexagon, a Sweden-based technology solutions provider. Hexagon provides measurement systems and productivity solutions to several industrial manufacturing companies and government agencies. We like the stock because of this deep market penetration angle along with Hexagon having a very capable management team that has grown the business through several successful acquisitions.
To share a final example, we are also constructive on HDFC Bank. The India- based lender benefits from the rising wealth effect in the growing economy together with a low credit penetration rate in the country. We also believe emerging markets (EM) have become more attractive, particularly given the low-to-negative economic growth seen in developed markets. While EM stocks have been hit by volatility amid appreciation in the U.S. dollar, we embraced this as an opportunity and added to our position in HDFC Bank.
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1 S&P 500 Index, data as of September 25, 2019.
2 Bloomberg Barclays Global Aggregated Bond Index, data as of September 25, 2019.
3 Source: Bloomberg, as of September 25, 2019.
4 Portfolio data; period under review: September 30, 2018 - September 30, 2019.
5 T. Rowe Price’s equity research team included 10 Sector Portfolio Managers, 94 Investment Analysts, 40 Associate Research Analysts, 7 Quantitative Analysts, and 8 Specialty Analysts as of June 30, 2019.