Friday January 27th, 2017
In the weeks following the U.S. elections, the S&P 500 Index has surpassed record highs reached in August last year, and in a marked reversal of fortunes, U.S. value stocks outperformed their growth counterparts for a substantial part of 2016.
Value and growth: reversal of fortunes
Growth stocks led the market in 2015, but with growing expectations for a U.S. interest rate hike, the value trend reasserted itself in 2016, starting with a broad market rotation out of defensive sectors into beaten-up cyclicals.
Calendar Year Returns
|Russell 1000 Value Index (USD)||15.51%||0.39%||17.51%||32.53%||13.45%||-3.83%||17.33%||1.66%|
|Russell 1000 Growth Index (USD)||16.71%||2.64%||15.26%||33.48%||13.05%||5.67%||7.07%||3.99%|
Although Growth has a head start so far this year, we think the broad rotation into Value will continue. Why?
- The broad equity market is expensive: The S&P 500 P/E is trading at 21.3x vs. the 10-year average of ~16.9x and growth stocks are even pricier, at 22.7x. Against this backdrop, value stocks, at a P/E of 18.6x look attractive right now. Even more compelling, the portfolios of our two U.S. value-oriented funds – Purpose Tactical Hedged Equity Fund (PHE/PHE.B) and Purpose Enhanced US Equity Fund (PEU/PEU.B) – are trading at an average 16.7x2.
- The election of Donald Trump is widely seen as positive for small- and mid-cap U.S. value stocks. As long as he follows through on his pro-market, pro-business policies (likely, given his plan for his first 100 days in office and Republican control of both the House and Senate), we believe value will continue to outperform growth over the next few quarters.
- Trump’s plans to cut the corporate tax rate from 35% to 15% is very beneficial for U.S. businesses. Domestic U.S. companies are currently subject to some of the highest corporate tax rates in the developed world.
- Over the last five years, regulatory headwinds have caused financials to become under-owned and undervalued. Plans for a scale-back of financial regulations, including elimination of the Volcker Rule and reductions in capital and liquidity requirements, are likely to generate significant additional revenue and free up unproductive capital.
We believe a secular shift to Value is just beginning, and can persist over multiple quarters–much like it did coming out of 2000.
Where are we seeing the best opportunities?
- This is still the region with the most room to grow; we could see the substantial rally continue, led by value.
Industrials and Materials
- Trump’s infrastructure plans should be beneficial to these sectors.
- Financials began 2016 significantly undervalued and under-owned, but rallied considerably in the second half of the year, particularly following the U.S. election.
- This year, there could be some consolidation in the sector, but the rally still has legs; banks should benefit substantially from planned deregulation and the Fed’s plans to increase rates another three times this year–and the consequent improvement in their net interest margins.
- Energy continues to be the cheapest sector right now, but faces continued headwinds. In keeping with our disciplined approach and equally weighted portfolios, we will never have extreme exposure to the sector.
Ideas with Purpose: Our value proposition
Over the long term, relative value and quality are two factors that have historically outperformed. Given our favourable outlook, now is the time to re-focus on Purpose’s value solutions:
- Purpose Tactical Hedged Equity Fund/ETF – FX-hedged (PHE) / non-FX-hedged (PHE.B) -Conservative investors looking for a risk-managed way to participate should consider PHE, a portfolio of high-quality U.S. value stocks that tactically hedges market risk based on momentum trends of the S&P 500 Index. For more details on our outlook for PHE, see the latest fund update. A non-FX-hedged version – PHE.B – is also available for clients who expect continued weakening of the Canadian dollar and want exposure to currency returns.
- Purpose Enhanced US Equity Fund/ETF – FX-hedged (PEU) / non-FX-hedged (PEU.B) – With its ability to invest up to 130% of its NAV in U.S. value stocks while maintaining market-level risk, PEU is an excellent choice for investors looking for an enhanced way to participate in the U.S. value rally. A non-FX-hedged version – PEU.B – is also available for clients who expect continued weakening of the Canadian dollar and want exposure to currency returns.
How We Stack Up1
|PHE/PEU||S&P 500 Index|
|Price to Earnings ratio||16.65x||21.29x|
|Price to Cash Flow ratio||5.92x||12.66x|
|Price to Book Value||1.33x||2.98x|
|Dividend Yield (Gross)||2.31%||2.04%|
1Source: Bloomberg L.P., as at January 26, 2017.
2Source: Bloomberg L.P.; all data as at January 26, 2017. Value stocks as measured by the Russell 1000 Value Index (USD); growth stocks as measured by the Russell 1000 Growth Index (USD).