Explore Our investment Outlook
Explore Our investment Outlook
U.S. stocks have proven to be resilient regardless of which political party controls the White House or Congress. We don’t favor a candidate or a party, but we try to gauge how a candidate’s priorities might affect the companies in which we invest.
Taxation is an issue that’s up for debate in almost every election cycle. The 2017 Tax Cuts and Jobs Act cut the corporate tax rate from 35% to 21%, which has been positive for corporate profits and stock prices. We’d expect continued downward pressure on taxes in a second term for President Trump. Joe Biden, on the other hand, has proposed raising the corporate tax rate to 28%. Democrats would likely need to control both houses of Congress and muster considerable political will to make this happen.
The candidates also differ in their views on regulating businesses. In the value investment universe, regulatory pressure and tax policy significantly affect the financials sector, particularly banks. The Trump administration has eased some regulations, but banks would likely face more regulatory pressure under a Biden presidency. Likewise, Trump supports less regulation of energy companies while Biden would likely be tougher on fossil fuels but more supportive of alternative energy initiatives.
The health care sector is in the political crosshairs as well. A Biden presidency would likely provide stronger support of the Affordable Care Act (ACA) while a second term for Trump could continue to weaken it. Health care facilities and providers benefit from the expanded coverage of the ACA while health insurers come under pressure anytime there is talk of moving to a single-payer health care system. Meanwhile, pharmaceutical executives can’t rest easy regardless of November’s outcome because drug prices tend to be an ongoing target of both parties. Drug companies are getting additional attention as they seek treatments and vaccines for COVID-19.
As we learned in 2016, election outcomes can be unpredictable. Therefore, we expect volatility in the coming weeks as some investors attempt to buy and sell based on shifting political winds. Rather than betting on the election results, we view this as an opportunity to find quality companies trading at valuations that don’t reflect their underlying value or upside potential.
During election season, it’s important to avoid letting your political views cloud your investment decisions.
The market’s rebound to historic highs in recent months is highly unusual. For one, the rally has occurred in a remarkably narrow segment of the market. In the broad Russell 1000® Index, the number of stocks outperforming the index this year is as small as it has been since the technology bubble of 1998-1999.
Sector and style performance reflect the narrowness. From a sector perspective, consumer discretionary and information technology have beaten the market by a wide margin. While from a style perspective, our analysis of financial market data indicates high growth, profitability and momentum are virtually the only factor groups to outperform the broad market so far this year as of Aug. 31, 2020. To put an even finer point on it, the difference in performance between high- and low-growth companies is as wide as it has been since 1999. The spread between high and low profitability and expensive and cheap stocks is the widest in the 25 years we’ve been tracking the data. And, high and low momentum spread is the largest since 2008.
We believe this has important implications going forward. Mean reversion is real— historically, these relationships have tended to reverse or return to “normal” over time. With the market so stretched, we believe actively managing downside risk is a key challenge because these reversals can be sharp and sudden.
We believe market risk is elevated and index-based strategies could be overconcentrated in richly valued stocks trading at historic extremes.
Investors may be paying too much for large-cap technology stocks that have risen to historically high levels. Despite sharp declines in March and April amid COVID-19 lockdowns, the Russell 1000® Growth Index was up more than 30% year to date as of August 31.
Technology stocks have helped drive growth’s advance. The result is an extreme valuation disparity with large growth stocks trading at more than 32x earnings compared to just over 18x for large value stocks. As Satish alluded to in his comments, this price trajectory is reminiscent of the technology bubble and financial crisis—events that didn’t end well for many investors.
Beyond valuation, large technology companies face regulatory risks. In the U.S. and Europe, Big Tech companies face antitrust concerns, issues related to user privacy protection and the spread of disinformation.
Taxes also loom large. Many multinational companies have legally avoided taxes using “transfer pricing” strategies. They set, or transfer, prices of transactions among subsidiaries to register profits in low-tax countries. This tax avoidance may change as developed countries collaborate in addressing some of the most flagrant tax-avoidance strategies.
Highly concentrated portfolios are more vulnerable to swings in performance. Owning a diversified mix of small-, mid- and large-cap stocks reduces the risk of holding a high concentration of large tech stocks. A mix of growth and value exposures may also benefit performance as the long period of growth’s outperformance could reverse in the future. Diversification doesn’t guarantee a profit or prevent a loss, but offers the potential to manage volatility, improve risk-return characteristics and help mitigate risk.
As value investors, we believe holding a high concentration of stocks from a handful of large tech companies poses downside risks.
Discussions about whether investor portfolios should tilt toward growth versus value or whether certain corners of the stock market are too expensive frequently overlook a key point: Traditional growth sectors contain many of the companies redefining markets and business models.
Growth stocks have outperformed value stocks this year, and investors will have to decide whether they think the outperformance is justified. Earnings growth in the growth universe also continues to outpace that of the value universe. Further, this earnings growth isn’t restricted to a small number of companies.
Some have compared today’s market conditions with the dot-com era of the late 1990s through early 2001. We disagree with this comparison, especially when we talk about large-cap growth stocks. Dot-com era leadership came from companies with negative cash flows. Today, leadership comes from companies whose free cash flow metrics are comparable to businesses in consumer staples, a sector noted for stable cash flows.
In our view, the investment challenge in today’s growth market is divining the duration and defensibility of cash flow growth even as businesses change. Our research efforts take the long view. Multiple investment themes in health care and technology have the power to transform—cloud computing, 5G telecommunications networks, advances in cancer treatments and innovations in drug discovery tools, to name a few. Growth strategies may help you gain exposure to these breakthrough developments.
Sectors and investment styles have rotated in and out of favor over time. We don’t let near-term concerns about these shifts stand in the way of having long-term exposure to companies that are redefining markets and business models.
References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
International investing involves special risk considerations, including economic and political conditions, inflation rates and currency fluctuations.
Alternative mutual funds that hold a variety of non-traditional investments also often employ more complex trading strategies than traditional mutual funds. Each of these different alternative asset classes and investment strategies have unique risks making them more suitable for investors with an above average tolerance for risk.
Diversification does not assure a profit nor does it protect against loss of principal.
Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.
Mutual fund investing involves market risk. Investment return and fund share value will fluctuate. It is possible to lose money by investing in mutual funds.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
No offer of any security is made hereby. This material is provided for informational purposes only and does not constitute a recommendation of any investment strategy or product described herein. This material is directed to professional/institutional clients only and should not be relied upon by retail investors or the public. The content of this document has not been reviewed by any regulatory authority.
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