To Capitalize on Disruption, Try the ‘3 Vs’

2017/11/17
To Capitalize on Disruption Try the ‘3 Vs’

Summary

Disruption today takes the form of more than just FANG stocks: US shale, health care, and even Janet Yellen and the Fed are disruptors, too. The challenge lies in harnessing these forces to benefit portfolios – and for that, we suggest investors consider the “3 V” approach.


Key takeaways

  • The Fed’s “great unwinding” of its bond holdings will be a disruptive force that removes liquidity from the system
  • As the Fed normalizes policy, keep an eye on value stocks, which have lagged since the financial crisis, while avoiding “value traps”
  • The shrinking number of publicly listed companies underscores the need for investors to pursue the victors of disruption
  • A potential correction or positive upside shocks could boost volatility – all the more reason to consider active management

The “Amazon effect” on the US retail sector might be one of the best-known examples of the disruption phenomenon, but disruptive forces are emerging in all parts of the US economy – from the energy sector to the US government. To prepare your portfolio, consider a long-term strategy centred on the “3 Vs”: shifting to value stocks, focusing on victors and preparing for volatility to rise.

The FANG effect

Facebook, Amazon, Netflix and Google – the so-called FANGs – have been among the biggest drivers and beneficiaries of disruptive technology – and for good reason. They have proven business models that keep strengthening as they widen their user bases and shake up competing sectors. Just witness Amazon’s recent push into the world of grocery stores and home delivery.

Interestingly, however, FANG stocks’ robust earnings have translated into valuations that have kept steady or even declined over the past five years. At the same time, “value traps” have emerged in companies that have become less relevant due to significant industry change. For example, retail department-store chains have been disrupted as people increasingly shop online, and we could see their multiples move lower to reflect this secular shift.

Booming US energy

Disruption is creating opportunities elsewhere too. The emergence of the US energy sector on the global stage has significantly disrupted the global energy market. Today’s low energy valuations reflect a seemingly boundless supply of US energy – shale in particular, even though US shale makes up only 8 per cent of global energy supply. Even though oil prices have declined dramatically and may remain range-bound in the near term, we believe US energy stocks are generally oversold. Investors would be wise to look for emerging catalysts that could reverse this extreme negative sentiment.

Disruption from D.C.

While governments are seldom considered fast-movers, Washington D.C.’s efforts to disrupt certain segments of the economy could have widespread implications.

Reforming US health care
Little progress has been made by the Trump administration to “repeal and replace” Obamacare, yet this sector remains ripe for disruption. US health-care outcomes are lower than most of the developed world while costs continue to rise – the US health-care system could make up 28 per cent of US GDP by 2028. We believe investors should continue to seek out health-care innovators with proven outcomes – as they could be tomorrow’s winners – and avoiding avoid firms with overlapping products.

Janet Yellen, the financial disruptor
The US Federal Reserve under Chair Yellen has just begun unwinding 10 years of balance-sheet growth, potentially cutting its USD 4.5 trillion balance in half over the next 3-5 years. This will remove liquidity from the financial system, which could cause financial conditions to tighten in the US economy.

Investment implications: Watch the “3 Vs”

As disruptive forces transform entire industries, US equity markets continue to approach all-time highs – benefiting also from a low interest-rate, high-liquidity regime that has lasted nearly 10 years. However, a new regime is likely beginning, marked by rising rates and potentially lower liquidity, which could make the “3 Vs” worth watching:

Value stocks

As the Fed normalizes its balance sheet and interest rates, we will keep an eye on value stocks, which have lagged since the financial crisis. Within the value universe, we recommend remaining selective – avoiding “value traps” in particular. We would consider sectors such as energy, where we see a long-term fundamentals story, and US banks, which stand to benefit from a steepening yield curve and decreasing regulation.

Victors of disruption

The ubiquity of disruptive technology means there will be winners and losers that emerge in all sectors – and the FANGs have clearly shown how investing in disruptive winners can generate alpha. A “winner-take-all” trend is emerging, underscored by the shrinking number of US publicly listed companies – from more than 8,000 in 1996 to around 4,400 in 2016. We believe it is imperative for investors to align themselves with the future victors of disruption. For our part, we will continue to rely on our global in-house research teams – including our proprietary Grassroots℠ investigative research division – to help us seek a fundamental information advantage.

Volatility

The US equity market has not seen a 10 per cent correction in almost two years, and the VIX – the well-known “fear index” gauge of market volatility – remains near all-time lows. With peak central-bank liquidity likely behind us, we expect more volatility ahead – and an increased chance of a market correction. We may also see upside shocks in the US market if tax reform passes or if hurricane relief efforts translate into increased infrastructure spending. While these events would clearly fuel the markets, the associated volatility would require investors to reposition portfolios – another reason for investors to consider active management to navigate the final phase of the US economic cycle.

FANGs Not Fuelled Solely by Multiple Expansion
Average forward P/Es have dropped for the FANGs. Earnings growth remains fairly robust, and valuations aren’t as stretched as they were in the ’90s tech boom.


Source: Bloomberg based on forward price-to-earnings (P/E) multiples. Data from 31 December 2012 and 30 September 2017.

Will Growth and Value Flip As the Fed Shifts Direction?
In the last 10 years, US growth stocks grew 108 per cent while value names increased only 31 per cent. Will the Fed’s “great unwinding” alter this dynamic?


Source: Bloomberg. Chart shows indexed monthly data. Data from 31 August 2007 to 30 September 2017.

Some of all the securities identified and described may represent securities purchased in client accounts.The reader should not assume that an investment in the securities identified was or will be profitable. The securities or companies identified do not represent all of the securities purchased, sold, or recommended for advisory clients. Actual holdings will vary for each client. FANG is an acronym widely used on Wall Street and among many investors; it stands for four high-performing large-cap technology companies - Facebook, Amazon, Netflix and Google (now Alphabet) - that are also household names. 

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Survey of US Consumers Sheds Light on ‘Generation Z’

2017/11/17
Survey of US Consumers Sheds Light on ‘Generation Z’

Summary

More than 840 people recently spoke to our Grassroots Research team about their spending habits, financial goals and more. Among them were members of generation Z – a young demographic that, at least for now, places a much greater emphasis on lifestyle experiences over retirement savings.


Key takeaways

  • Grassroots study results: 58% of boomers and 22% of generation Z are married; 74% of boomers and 39% of generation Z own property
  • In our new survey, retirement is currently the top financial priority of only 36% of boomers and 4% of generation Z
  • Generation Z is much more focused on having life experiences (27%) and paying down student debt (18%) than saving for retirement