The Outlook For Value
Is value dead? Value investing has struggled for most of the past decade—now, read our outlook for what to expect next in the short and longer terms.
Events in 2020’s final quarter capped off a remarkable year for markets. Approval of two vaccines to inoculate against COVID-19 marked a watershed in the fight against the pandemic and sparked a broader rally in equities, notably benefitting shares of companies most exposed to the negative economic effects of the virus. The prospects for continued investor confidence and economic recovery in 2021 look promising. However, the pandemic continues to pose significant headwinds, and the incoming Biden administration will face early challenges in dealing with record infection rates and executing an effective vaccine distribution and administration program.
Though by slim margins, Democrats now control both chambers of Congress which bodes well for additional near-term fiscal stimulus. We expect that monetary and fiscal stimulus will gradually support a return to endogenous positive nominal economic growth. The broadening of equity market gains suggests that investors expect a widening range of companies to begin to recover. As social and economic activity return to pre-pandemic levels, U.S. GDP growth is likely to revert to its prior low-single-digit growth trend.
The pandemic has accelerated the adoption of digital technologies by several years, and many of these changes will be permanent. Companies are understanding that to remain competitive in this new environment they must value technology’s strategic importance as a critical component of business, not just as a source of cost efficiencies. As a result, businesses are making the kinds of investments that are likely to ensure the trend’s perpetuation. This can be seen across multiple fronts: technology-heavy capital expenditures; e-commerce strategies; the enterprise transition to the cloud; direct-to-consumer business models; and software applications that extend across businesses.
Consumers have adapted even more rapidly, with consumption behaviors shifting dramatically over the past year toward digital. Jennison believes this mass adoption and new baseline will be the foundation for continued superior growth for the right companies. They believe large, global-oriented total addressable markets provide an ample runway for long-duration top- and bottom-line growth, with many disruptive trends expected to double over the next 3-5 years. Historically, earlier stages of mass adoption have spurred more innovation, greater ease of use, and an expansion of the ecosystem, which in turn has kept the virtuous cycle spinning with yet greater adoption.
Jennison Associates’ Growth team expects that corporate profits in 2020 will end up being better than feared earlier in the year, when the ramifications of the pandemic were first becoming evident. Earnings for the S&P 500 could recover significantly from 2020’s decline and could possibly eclipse the level achieved in 2019 if vaccines are distributed broadly and rapidly.
Throughout 2020, many companies benefited from trends that were in place before the pandemic and that received a further boost once the realities of lockdowns, social-distancing requirements, and work-from-home protocols began to take shape. Productivity-enhancing products and services, such as ecommerce, cloud computing, streaming entertainment, and electronic payments were increasingly in demand throughout 2020. Full-year revenue growth and profits for companies in these businesses may very well come in above forecasts.
The valuations of many of these companies expanded meaningfully in 2020, given the distinction of their fundamentals in a time of scarce growth. Although the team anticipates a pause in the share-price appreciation of these companies as the market digests their gains, they expect that their above-average rates of revenue and earnings growth will support continued, long-term share price appreciation.
The market broadened out in the fourth quarter with sectors that underperformed for most of the year posting the largest gains. Cyclical sectors like energy, financials, and industrials performed the best. Materials and the defensive consumer staples, utilities, and health care sectors underperformed in the quarter. Information technology and consumer discretionary maintain their leadership positions for the one-, three-, five-, and trailing ten-years. Despite outperformance in the fourth quarter, energy continues to be the weakest sector for all longer time-periods. Cyclical and defensive sectors also lag for periods one year and longer.
In 2020’s fourth quarter, the health care sector of the S&P 500 Index rose 8.0%, underperforming the overall index, which advanced 12.2%. Over the full year, health care rose 13.4% compared to the index’s 18.4% gain. Jennison believes the pandemic could have a permanent and salutary impact on the health care sector. The past several months have highlighted inefficiencies within the system and the serious implications of administrative mismanagement. At the same time, there has been phenomenal speed of discovery and multiple modalities available within the biotechnology, life sciences, and health care technology industries to address unmet medical needs. As a result, many companies may be able to penetrate their total addressable markets at accelerated rates.
The S&P 500 Index’s financial sector lagged the overall market and is one of the worse performing sectors. In 2020, the sector returned -3.1% versus +17.7% for the S&P 500 after gaining 21.5% in the fourth quarter as the second best performing (behind energy) sector. Despite the recent strong 4Q performance, it is not certain whether or not the sector’s rally will continue into 2021. Many of the macro concerns that plagued the sector earlier this year are still in place, the Fed has signaled that interest rates will remain at depressed levels for the foreseeable future, and there is still no certainty around sustainable economic growth. The result is that continued headwinds are working against traditional fundamentals and market sentiment, which will continue to put downward pressure on P/Es for financial stocks.
After flatlining in the third quarter, midstream infrastructure jolted back to life in the fourth quarter as the beaten down energy sector (including midstream) rallied on positive vaccine progress, an improving macro environment, and the hope of returning to normalized levels of supply and demand in a post-pandemic world. The most beaten-down MLP stocks rallied the hardest, with the Alerian MLP Index up 32.45%, while the Alerian Midstream Energy Index gained 20.15%. As economic activity begins to slowly ramp up, the short-term benefit to the midstream group should finally catch-up to the long-term positive benefits from the significant transformational corporate reform that has occurred over the past few years. With the incoming Biden administration unlikely to make permitting easier for new pipeline projects, the value of existing infrastructure should increase. It wouldn’t be surprising to see M&A and industry consolidation occur over the next 12 to 18 months.
Utilities lagged the broader market for the majority of the year, but gained 6.54% in the fourth quarter and posted a full year return of 0.48%. Investors now appear to be more bullish on the sector given the incoming Biden administration’s policies that could potentially extend renewable tax credits, further stimulating the development of renewables. The discrepancy between utility fundamentals and performance in 2020 may underscore the attractive absolute and relative opportunity heading into 2021. In fact, the group currently trades at an approximate 20% discount to the S&P 500 Index on a 2022 P/E basis. The sector looks appealing based on its predictable fundamentals and attractive relative entry point in the ultra-low bond rate environment.
The Alerian Midstream Energy Index is a broad-based composite of North American energy infrastructure companies. The capped, float-adjusted, capitalization-weighted index constituents earn the majority of their cash flow from midstream activities involving energy commodities. The Alerian MLP Index is an unmanaged index and the leading gauge of energy master limited partnerships (MLPs). The capped, float-adjusted, capitalization-weighted index constituents represent approximately 85% of total float-adjusted market capitalization. The S&P 500 Index is an unmanaged index of 500 common stocks of large U.S. companies, weighted by market capitalization. It gives a broad look at how U.S. stock prices have performed.
The views expressed herein are those of Jennison Associates investment professionals at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice. Neither the information contained herein nor any opinion expressed shall be construed to constitute investment advice or an offer to sell or a solicitation to buy any securities mentioned herein. Neither Prudential Financial, its affiliates, nor their licensed sales professionals render tax or legal advice. Clients should consult with their attorney, accountant, and/or tax professional for advice concerning their particular situation.
Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy.
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