- Tech giants offering “secure returns” could be de-throned by cyclicals
- Biotech valuations look attractive after year of underperformance
- Many financials have rallied too far on rate hike hopes
Secure growth companies could be forced out of the limelight by turnaround stories in US equity markets following a period of significant gains for online retailers and other internet stocks, according to Legg Mason affiliate ClearBridge Investments.
Margaret Vitrano, a manager with ClearBridge, says the dearth of economic growth in the US in recent years has caused investors to focus on ‘secure growth’ names.
However, she believes better opportunities to access higher growth rates have emerged in unloved sectors experiencing reversals in their fortunes.
“There is a dearth of growth and this explains why high-flying internet companies performed well in 2015 and 2016,” she said. “There has been a focus on secure return and a very low appetite for turnaround stories because of market nervousness.”
As a result, Vitrano argues that opportunities have arisen in cyclical sectors, with valuations too attractive to ignore. “Energy is a good example, as in a cyclical recovery we think companies in this sector have a lot of earnings growth ahead,” she says. “It has also had less focus recently from investors so you can find value there.”
As well as energy names, Vitrano is unearthing opportunities in the healthcare space, where valuations have lagged the wider market. “We have a very broad definition of growth – it is not just revenue growth, it can be margin expansion, and some of those diamonds in the rough look attractive to us,” she says.
“Healthcare and biotech in particular look really interesting right now. In the case of biotech stocks, they underperformed substantially last year so valuations are attractive.” Looking at broad market levels, Vitrano says that, although indices such as the Dow Jones are close to hitting all-time highs, valuations are only approaching “fair value” given the backdrop of record low rates and quantitative easing.
However, she cautions that financials appear expensive on current valuations, with the risk growing that too many rate hikes have been priced-in to forecasts for the sector. “Yes, rates are probably heading higher, but if there is one thing we have learned about what this Fed is doing, it is incorporating multiple data points – not just here but outside the US,” she says. “So I would caution that between here and 2018 a lot could happen to change the shape of the interest rate curve.”
Vitrano is avoiding large financial stocks such as money centre banks because, as a growth investor, such stocks cannot deliver the requisite rates of growth. However, she does see value in specific companies in the sector.
“We don’t own big financials as we think we can find better growth elsewhere, outside of the large money centre banks, but we are now entering a period where you may have a double whammy of potentially higher interest rates and less regulation, or even a triple whammy if we get tax cuts,” she says.
“The fundamental landscape has improved for the whole financials sector, and we do like Schwab, for example, as we see it as a secular growth opportunity which will also be a beneficiary of higher rates.”