- Valuations on large-cap US equities are closer to the high end of the historic range than the low end.
- Some Fidelity stock managers say, given recent conditions, they are focused on quality, valuation, and dividends.
Last month, in early March, investors celebrated the bull market's 9th birthday. During that run, the S&P produced a total return of more than 335%,* driven largely by outsized gains in growth stocks.
During the last 12 months, the Russell 2000 Growth Index has delivered nearly 5 times the performance of the Russell 2000 Value Index (19.5% to 4.3%), and during the last 9 years, has gained about 50% more than value.
Can growth continue to outperform value? It's possible. But history shows that periods of outperformance in growth and value have been cyclical (see graph, below right).
With valuations on growth stocks significantly higher than value stocks (see graph, below left), and recent bouts of volatility, some investors may be wondering if there are more defensive stock ideas, in case of another pullback.
Viewpoints checked in with some Fidelity value stock fund managers to see how they have been approaching equities in recent market conditions. These managers are being increasingly selective, and focusing on quality, valuation, and dividends. While stocks with these characteristics can still fall in a downturn, they may do better than some other names.
Managing the risks of expensive stocks
Sean Gavin, Portfolio Manager, Fidelity® Value Discovery Fund (FVDFX)
I think equity valuations are quite stretched, and the market has in effect borrowed from future performance, making the high returns seen in recent years unlikely in the coming years.
To cushion against a potential downfall, I have been focused on high-quality stocks that may offer less upside potential, but may be able to produce more predictable gains.
One key feature I look for is companies with a strong "moat," or barrier to entry, that can make it difficult for competitors to threaten their business—for instance, a business that operates in a very specific niche or that possesses a strong competitive position.
Allison Transmission Holdings (ALSN) is an example of a stock with this characteristic: It has been a leader in providing transmissions for a range of vehicles, including US defense vehicles, and has seen strong growth in the commercial truck market of late.
However, some far "growthier" names can also have barriers to entry, including consumer electronics giant Apple (AAPL), which I think has a reasonable valuation relative to its long-term growth prospects. I continue to hold this stock in the fund.
Value stocks still live up to their name
Matthew Friedman, Portfolio Manager, Fidelity® Value Strategies Fund (FSLSX)
The US equity market looks fairly expensive, but that's because I think growth stocks—one particular part of the market—are skewing the market's price-to-earnings ratios higher.
Despite the elevated level of valuations, I'm still finding good deals among high-quality value stocks, and remain focused on high-quality companies with strong competitive positions. These tend to hold up better in volatile markets.
Overall, I have tilted Fidelity Value Strategies Fund to a slightly more defensive position over the past year, adding to holdings in the consumer staples sector.
The fund's positions in consumer staples have included agricultural processing firm Darling Ingredients (DAR); J.M. Smucker (SJM), best known for its fruit spreads and peanut butter; US Foods Holding, Corp. (USFD), one of the country’s largest food-service distributors; and drugstore chain CVS Health (CVS).
I have also added to particular positions in the real estate sector, focusing on building a portfolio of stocks I think can add value, regardless of what happens with the future direction of interest rates.
Selling growth stocks to buy value, defense names
Jeff Feingold, Portfolio Manager, Fidelity® Independence Fund (FDFFX)
I've been trimming exposure to higher-priced, faster-growing companies and using the proceeds to buy what I think are cheaper stocks with improving fundamentals. Some of my recent purchases in this second category include United Technologies (UTX) and Thermo Fisher Scientific (TMO).
I have also added within consumer staples, a traditionally defensive category, where new positions in my fund in recent months included US Foods Holdings (USFD) and CVS Health (CVS).
National defense is another category that I think has attractive, higher-quality stocks. I expect defense budgets to continue rising over the next 3 to 5 years, due in part to escalating geopolitical tensions. The fund holds positions in such defense contractors as Raytheon (RTN), General Dynamics (GD), and Northrop Grumman (NOC), as well as others.
Remember the role of dividends in a downturn
John Sheehy, Portfolio Manager, Fidelity® Equity Dividend Income Fund (FEQTX)
I can say with reasonable confidence that valuations are a lot closer to their upper historical boundary than their lower extreme. While high valuations won't tell you what the market will do in the short term, it may make it a good time to consider the role of dividends in down markets.
Over full market cycles, dividends are an important part of total return—a fact that may be easy to forget during periods of rapid price gains.
Consider that the S&P 500® had a cumulative return of 159% for the past 20 years ending February 28, taking into account only price changes. The index rose 277% for the same period when also considering dividends.
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