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U.S. equity: three key insights for 2018

Our Blog Jan 04, 2018
Melda Mergen, Deputy Global Head of Equities

Like any attempt at market timing, trying to time sector investments will most likely leave you disappointed. Instead, focus on individual companies.

We’ve met with a lot of advisors and investors in the past year, and many of you were wondering the same thing: If equity market valuations are high, meaning the price of buying stocks is high relative to what they seem to be worth, have we reached the point of “irrational exuberance”?

It’s true that the price of stocks is high, but we do see good opportunities and solid fundamentals at the stock level. Finding these opportunities requires research into individual companies, not making bets on specific styles or sectors. Here are three key insights to consider for 2018:

Review your allocation to value and growth stocks. And then keep the focus on finding opportunities at the stock level.

Growth stocks have recently had a remarkable period of outperformance. For many investors this means their allocation to growth stocks has increased, leaving their portfolios underweight value. Now may be a good time to reassess your allocations, and make sure your exposure to value stocks is where you want it to be in the context of a balanced portfolio. The recent outperformance of growth stocks, combined with the current stage in the economic cycle, sets the stage for value stocks to outperform. But many value sectors are experiencing structural headwinds, so the answer isn’t as simple as predicting a convincing winner between growth or value. We’re staying focused on the fundamentals of stock-picking, and at a company level there are still growth companies with attractive valuations and value companies with earnings growth potential.

Consider that high valuations may be able to last longer than in the past.

Traditionally, there are two pressures that begin to eat into a company’s profits: competitors take away market share, and workers ask for more money. But take a look at the companies included in the S&P 500 Index — many of them have complex business models with entrenched customer bases. Take Amazon for example: They’re a dominant company whose business model crosses traditional sectors, and it would be nearly impossible for a competitor to launch tomorrow and compete at the same scale. At an economy-wide level, workers’ negotiating power has eroded as technology continues to play a critical role. So, high valuations may be able to last longer than they would have 50 years ago and at higher multiples.

Look at individual companies, not sectors. Winning sectors are constantly changing, which makes them difficult to accurately predict.

Since the financial crisis, the top performing sector has changed every year. We suspect the sector rotation is partly driven by flows in and out of passive ETF products as investors try to tactically adjust their portfolios. Large companies that make up a good portion of the S&P 500 Index also have developed more complex business models that cross sectors. Like any attempt at market timing, trying to time sector investments will most likely leave you disappointed. Instead, focus on individual companies.

Trying to time sector bets is likely to disappoint

Source: Columbia Threadneedle Investments as of 09/30/17.

Read more insights like this in our 2018 Annual Insights

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Melda Mergen

Melda Mergen

Deputy Global Head of Equities
Tagged with: Equity