Fundamental Large Cap Core

INVESTMENT PHILOSOPHY

We believe that quality companies with a sustainable competitive advantage and cash flow generation bought at the “right price” should outperform. Patience and a long-term investment horizon allows for the compounding of companies’ cash flows.

 

MARKET COMMENTARY

US Equities

Equity | April 04, 2018

Sandy Sanders, Senior Portfolio Manager, US Equities

Global Intelligence Outlook 2018 - US Equities: The Backdrop Icon

THE BACKDROP

We believe that if consumer and business confidence remains buoyant, capital spending will come through, in turn driving high quality cash flow and earnings.

After a strong start to the year for US equities, the prolonged period of steady optimism inevitably came to an end as volatility roared back to life. We feel it was a healthy correction: it is important to be reminded that volatility, and by extension risk, is never too far away in the marketplace. It is worth noting, however, that while stock prices adjusted during that early February drawdown, we saw no meaningful deterioration in intrinsic values. As this drawdown eclipsed the 10% range that officially qualified it as a ‘correction’, the Core Value team attributed much of the market response to inflation concerns and bond reversals to short-term noise.

While the administration’s trade negotiations – including the new import tariffs on steel and aluminum – may give companies pause as they make capital allocation decisions, we ultimately believe the three key pillars of the economy that we have outlined previously are still in place: banks are in a strong position and housing starts still have significant room to grow before reaching long-term averages. Perhaps most significantly in the current environment, the consumer continues to be under-levered and spending with confidence.1 That naturally has a positive knock-on effect on business confidence. A recent WSJ article noted that CEOs of some of America’s largest corporations raised their spending outlook to the highest levels demonstrated in 15 years2 at the same time that the Small Business Optimism Index rose to its second highest level in 45 years (a higher reading was registered in 1983).3 We believe that if consumer and business confidence remains buoyant, capital spending will come through, in turn driving high quality cash flow and earnings (see chart). The Core Value Team is closely monitoring trade policy moves associated with the ’74 Trade Act’s Sections 232 and 301 (in our view, the more important of the two) to understand whether policy uncertainty may limit capital deployment. Currently we see limited scope for a material change to the healthy US and global economic environment – a view that’s slightly more optimistic than some of our colleagues.

Tight Labor A Catalyst for Capex Recovery

Tight Labor A Catalyst for Capex Recovery
Source: Federal Reserve, Bureau of Labor Statistics, Melius Research, as of March 16, 2018.
 
Global Intelligence Outlook 2018 - US Equities: The Opportunities For Investors Icon

OPPORTUNITIES FOR INVESTORS

Market myopia creates opportunities, particularly in the pharmaceutical and biologics spaces, but taking a long-term investment view in these areas has the potential to deliver real value.

We continue to find opportunities in healthcare. Market myopia creates opportunities, particularly in the pharmaceutical and biologics spaces, but taking a long-term investment view in these areas has the potential to deliver real value.

We are mindful that there is pressure on drug pricing and the recent announcement that three industry-leading companies were joining forces to create a new independent healthcare service business highlights the potential for disruption in that area. For those reasons we have avoided the distribution-oriented names, instead focusing our time on the competitively advantaged biologics and pharmaceutical spaces. Against a backdrop of an aging population, we believe healthcare companies with stable ‘cash cow’ businesses, historically high R&D productivity, and under-appreciated pipelines create opportunities to own businesses with strong, steady cash flow.

Elsewhere, we believe the outlook remains highly favorable for financials. Interest rates and Net Interest Margins (NIMs) have been low but are steadily rising, growth has been improving and the economy has been accelerating. We are now in an environment with a fully-employed consumer with a healthy balance sheet, whose wages are growing, and a housing market that has room to expand. Layer on the likelihood of continued deregulation, and the banking sector appears well-placed for improving Return On Equity and steady earnings growth driven by steady demand for loans at higher margins.

We also continue to be positive on consumer discretionary given the strong position of the consumer (as outlined earlier). The team has been laser focused on the ’Amazon Affect’4 impacting a number of former 'category killers' and related retail models and is very focused on finding companies with defensible competitive moats. We are still finding competitively valued companies that are adding economic value and taking share.

Global Intelligence Outlook 2018 - US Equities: The Risks Icon

RISKS

With the introduction of an import tariff on steel and aluminum there is elevated trade risk and we’re monitoring developments closely.

With the introduction of an import tariff on steel and aluminum there is elevated trade risk and we’re monitoring developments closely. We do feel, however, that this decision is part of a negotiating strategy rather than a declaration of war. We are closely monitoring the NAFTA negotiations as an important bellwether while keeping a watchful eye on all trading partners.

We are disappointed that Gary Cohn has left his position as the Chief Economic Advisor to the White House as he was a committed capitalist. However, his departure is not going to impact the rollback of financial regulation, which is important and ongoing. Overall, we believe the administration is trying to improve the climate for US businesses. However, the sooner we get some clarity around the rules of engagement, the sooner repatriated and tax-driven capital can get to work. We are mindful of inflation accelerating, but do not believe it is going to meaningfully run through Federal Reserve target ranges and should not therefore accelerate the path of interest rate hikes. We are well-positioned for a steady rate hike environment and remain alert to the trajectory steepening and the Fed moving too quickly.

Global Intelligence Outlook 2018 - US Equities: The On Our Radar Icon

ON OUR RADAR

The economic recovery to date has been one of the longest on record but also the tamest in terms of GDP growth and capital spending.

We expect business confidence to ebb slightly off of current record levels but expect consumer and business confidence to remain in healthy territory. The economic recovery to date has been one of the longest on record but also the tamest in terms of GDP growth and capital spending. Today, business investment is poised to accelerate after the recent tax policy changes, and we will be watching closely to see that our portfolio companies are investing in their businesses and driving future cash flows and returns.

1 Manulife Asset Management: Global Intelligence Outlook 2018, December 19, 2017.
2 Wall Street Journal: Tax Revamp Drive Corporate CEOs Economic Outlook to 15 Year High, March 13, 2018.
3 National Federation of Small Businesses Research Foundation, January 2018.
4 For more on the reported ‘Amazon Effect’, see this article published by Forbes on February 22, 2018.
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About the Author

2016 Mar Sandy SandersSandy Sanders

Senior Portfolio Manager, US Equities

The opinions expressed are those of Manulife Asset Management™ at the time of publication, and are subject to change based on market and other conditions. The information in this article including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Asset Management disclaims any responsibility to update such information. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife Financial, Manulife Asset Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. Past performance does not guarantee future results. This material was prepared solely for informational purposes, does not constitute an offer or an invitation by or on behalf of Manulife Asset Management to any person to buy or sell any security and is no indication of trading intent in any fund or account managed by Manulife Asset Management.