Markets & Economy
Amid Policy Shifts, a Focus on Finding Innovative CompaniesMarch 13, 2017
- Although valuations are less attractive, stronger economic growth and corporate tax reform could drive further market gains in 2017.
- Our positive view on the financials sector is partially based on our expectation that the new administration will scale back regulations.
- We continue to focus on companies that are on the right side of major and lasting changes, such as the emergence of cloud computing.
- We believe the coming market environment will favor active managers as policy changes are likely to result in distinct winners and losers.
After the strong results in late 2016, what is your perspective on valuations in the U.S. equity market?
With the rally in the fourth quarter followed by solid results in January, it is beginning to get harder to find attractive new investment opportunities as the market has started to price in an improved outlook. Two factors that we believe are key for the market in 2017 are the potential for a pickup in economic growth and the passage of corporate tax reform. If both happen, we could see strong performance. If neither occurs, we would look for muted returns, and if we get one and not the other, we will likely end up somewhere in the middle. The year has gotten off to a good start with generally positive fourth-quarter earnings reports.
“Two factors that we believe are key for the market in 2017 are the potential for a pickup in economic growth and the passage of corporate tax reform.”
What is your view on value versus growth among U.S. large-caps?
Large-cap growth companies are looking more attractive relative to value stocks. Growth is coming off a period of significant underperformance versus value in 2016 that was driven by changes in sentiment more than by fundamental factors. Many growth companies are fundamentally stronger than they were a year ago while also looking more attractive relative to their value counterparts.
Do you expect much volatility going forward?
It seems likely that market volatility will increase given the combination of political and policy uncertainty as we move through the latter stages of the business cycle. We believe the coming market environment will favor active managers as potential policy changes likely result in distinct winners and losers. Indeed, we believe that speculation has played a role in the market’s postelection rally and are mindful of the importance of not attempting to chase performance.
Among the many uncertainties investors face are the impact of the UK’s decision to leave the European Union, the upcoming European elections, and the potential for a disruption in established trade agreements. This could spur further volatility in foreign exchange rates. The nature and extent to which regulations will be unwound in the U.S. health care and financial services sectors are also at the center of our focus, as is the future of U.S. tax reform.
Have you repositioned the portfolio since the U.S. presidential election?
No. If you look at the top names in the portfolio, we are pretty consistent with where we were six months ago. We continue to favor secular growth companies, which were a drag on our performance in the first half of 2016 but provided a strong advantage later in the year. We believe the current environment should benefit our focus on higher-quality companies with durable growth and sustainable competitive advantages. We remain committed to a bottom-up approach, so fundamentals are going to drive our portfolio decisions more than macro factors.
Financials have had quite a run since the U.S. election. What’s your view of the sector?
Before the election, we had a slight overweight based on our perspective that we were reaching a regulatory plateau after a lengthy period of increasing oversight. Many companies in the sector had successfully realigned their businesses to meet the regulatory challenges, and we saw opportunities for increased earnings growth. After the election, we saw that outlook get even better—rather than just refraining from creating new regulations, the new administration is likely to begin scaling them back—and we increased our weighting in the sector. Also, interest rates are starting to rise, which will benefit many companies in the sector.
What are some other sectors where you are finding opportunities?
Information technology is our largest sector in absolute terms, making up nearly a third of the portfolio, and we have a modest overweight relative to the benchmark. While many large Internet-related companies lagged late in 2016 following the election, fundamentals remained solid, and we maintained our favorable outlook. The negative sentiment the sector was facing allowed us to add to some of our preferred investment ideas, such as companies that we believe will continue to benefit from the global shift to digital payments.
We are also overweight consumer discretionary, which is our second-largest sector in absolute terms. Our long-held positions in Amazon.com and Priceline make up a substantial portion of our investments in the sector. Amazon.com has the potential for durable growth in both its retail business as well as its cloud computing operations. Priceline, meanwhile, continues to take market share from its competition, and its international expansion and move into non-hotel properties also present attractive opportunities for long-term growth. On a macro level, we are also seeing some tailwinds for the sector. The U.S. economy appears healthy, and we could see pent-up demand from consumers who are starting to see wage gains in a tightening labor market.
Sector weights are a byproduct of our bottom-up stock selection process. As it happens, technology, consumer discretionary, and health care tend to be the most fertile sectors for growth. We also find these areas to be ripe for innovation and disruptive technologies.
How can you illustrate the strategy's approach towards disruptive technologies?
One stock that typifies our approach is Red Hat, a software company that distributes the Linux® operating system. While Red Hat’s opportunities in the cloud are less obvious than some other companies whose businesses are entirely cloud-based, we think it is focusing its efforts on promising areas. In particular, open-source software is likely to remain much more prominent in the cloud than it is in corporate data centers, and the vast majority of cloud computing is already done in Linux—albeit mostly in free Linux alternatives, against which Red Hat has always competed. We anticipate that the value of this strategy will become clearer as companies increasingly run more critical computing processes in the cloud.
What is your strategic approach to constructing the portfolio?
In constructing the portfolio, our philosophy is to look for companies offering sustainable earnings and cash flow growth. We use a variety of quantitative screens to help narrow our universe, and we have a talented team of analysts who provide us with comprehensive research on individual companies. We focus on companies that are on the right side of major and lasting change. Those changes currently include the broadening appeal of
e-commerce, the shift of advertising dollars from print and broadcast media to digital and social media, and the emergence of software-as-a-service and cloud computing. Finally, artificial intelligence/machine learning is the newest trend that we believe will provide significant investment opportunities over time.
As a health care analyst, portfolio manager, and sector team leader, I have worked closely with the large-cap growth portfolio management team for more than a decade, and I identified successful investment ideas that have been owned in the large-cap growth portfolios. Health care previously made up as much as 30% of the portfolio and was the top alpha-generating sector for several years. During the past six months, however, I have continued to selectively reduce our health care exposure in favor of better opportunities in other areas of the market.
Since joining the strategy in mid-2016, I have met with the managements of nearly all of our holdings, a process that largely supported our current portfolio positioning. We have also spent considerable time evaluating new portfolio ideas and have identified some potential opportunities for inclusion in the portfolio.
|Top 10 holdings as of December 31, 2016, based on percentage of total assets|
These above holdings represent 41.4% of total fund net assets.
|Top purchaces for the 3-month period ended December 31, 2016|
|Crown Castle International|
|Philip Morris International|
The specific securities identified and described do not represent all of the securities purchased, sold, or redeemed for clients in the fund and no assumption should be made that the securities identified and discussed were or will be profitable.
Call 1-800-225-5132 to request a prospectus, which includes investment objectives, risks, fees, expenses, and other information you should read and consider carefully before investing.
This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.
The views contained herein are those of the authors as of March 2017 and are subject to change without notice; these views may differ
from those of other T. Rowe Price associates.
This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.
Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.
Past performance cannot guarantee future results. All investments involve risk. All charts and tables are shown for illustrative
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