- The materials and financial sectors in the US may present opportunities in small caps (companies valued below $2 billion) in 2020, according to one Fidelity portfolio manager.
- Ideas to consider in US mid-caps ($2 billion to $10 billion), include asset management, transportation, managed care, and parts of the consumer discretionary sector, says a mid-cap portfolio manager.
- Large-cap US value stocks (companies valued above $10 billion) that may be undervalued based on fundamentals, may get their day in the sun in 2020, says a portfolio manager. Energy stocks may also be a consideration.
Geopolitical uncertainties—from the US elections to trade tensions between US and China—are grabbing investors' attention. But 3 seasoned fund managers are finding opportunities in spite of—or in some cases, because of—the volatility.
Find out what kind of investment opportunities these Fidelity portfolio managers see in US stocks for the coming year.
Small companies: Materials and financials
"I'm focused on identifying investments I think will do well in 2020, regardless of sector, although I've increasingly found opportunities among materials companies. I'm also taking a closer look within financials," says Kip Johann-Berkel, portfolio manager of Fidelity® Small Cap Stock Fund (FSLCX).
Capitalization or "cap" refers to the total value of a company's stock held by investors. Small-cap stocks are generally companies worth less than $2 billion.
Heading into the last quarter of 2019, Johann-Berkel added to the fund's stake in materials, focusing on high-quality businesses trading at low valuations due to temporary earnings hiccups, in his opinion.
"As I looked at these companies closely, it appeared almost all of their recent profitability issues could be attributed to increasing costs due to rising raw material prices," Johann-Berkel says.
For each materials position considered for the fund, he calculated the potential stock upside if commodity prices remained stable or fell and compared it with his view of the stock price if raw material prices continued to increase.
He then found several stocks that could benefit if raw material prices simply stopped going up. Among these companies, he believed the potential longer-term upside of holding them outweighed the possible downside related to materials fundamentals and the overall economy.
Bank stocks also became increasingly interesting to Johann-Berkel toward year-end, because he saw multiple companies he thought could be undervalued.
In general, Johann-Berkel is looking for high-quality businesses with low valuations based on his longer-term earnings expectations, solid dividends, and effective management teams that have been good stewards of shareholders' capital.
For 2020, he's attempting to prioritize names that can keep up in a good economic environment, while hopefully outperforming if the environment is bad or mediocre.
Medium-size companies: Asset management, some consumer discretionary, transportation, and managed care
"There appears to be an abnormally high level of volatility and complexity in both the economic and political backdrop as we look to 2020, which I think is causing uncertainty and could contribute to intra-sector rotation," says John Roth, lead portfolio manager of Fidelity® Mid-Cap Stock Fund (FMCSX). Mid-cap companies are generally valued between $2 billion to $10 billion.
In terms of volatility and complexity, Roth notes trade conflict with China is ongoing. The economy in both China and Europe appears to be slowing. In the UK, uncertainty remains due to the country's planned retreat from the European Union. Meanwhile, in the US, consumer confidence appears to be waning and the manufacturing sector is in decline. Plus, the benefit of fiscal stimulus from lower taxes appears to be over, and the US Federal Reserve reversed course in 2019 and took a more accommodative path that included 3 interest rate cuts and Treasury bill purchases of $60 billion per month.
"In times like this, I think it is important to go back to my team's investment philosophy—we must ask, what is priced into a stock and do we agree or disagree with those implied expectations?" he says.
The prices of some defensive stocks in the mid-cap sector looked very high compared to their own historical prices approaching the new year. As a result, Roth found opportunities elsewhere, including some well-run, attractively priced asset management firms.
Within consumer discretionary, Roth has evaluated good brands that have struggled, but where he and his team see a path to improvement. "I'm also finding opportunities among some early-cycle transportation companies whose valuations started to look interesting. In my experience, transportation stocks typically are among the first places a recovery begins to be discounted," he says.
Lastly, Roth has invested in managed-care stocks focused on creating efficiency and cost savings.
Large companies: Maybe a turn to value and energy stocks
"I plan to stay patient with my valuation-based investment process, which has led me to energy as a sector of potential opportunity for 2020," says Matthew Fruhan, portfolio manager of Fidelity® Large Cap Stock Fund (FLCSX).
In general, large-cap companies are those valued above $10 billion.
Late in 2019, Fruhan began to see glimmers of a shift away from the long trend of growth stocks outperforming value. But it's too soon to call it an enduring change in this trend. There have been multiple false starts over the last decade, primarily driven by hopes of inflationary pressures—and corresponding increases in Treasury yields—that proved to be temporary, he says.
Growth stocks drove much of the market's gain over roughly the past 10 years, due in part to valuation increases—rather than superior underlying fundamental performance. In other words, the price of the growth stocks may have increased, in part, because of investors' belief that profits would continue to grow quickly in the bull market.
Yet valuations don't increase in perpetuity. Eventually, financial math and gravity implies that this tailwind to total return will slow, or reverse, and become a significant downside risk for growth stocks, Fruhan explains.
Fruhan saw significant value among energy names toward the end of 2019. Growth in energy supply will likely be constrained in coming years, especially for the US shale-oil industry, he believes.
Energy stocks declined for much of 2019 and many stocks in the industry remained depressed near year-end, even though oil prices rose back above $60 a barrel in December. Backwardation—where the future price of oil is below the spot (current) price of oil—depressed valuations because it suggested market participants expect supply-demand imbalances to continue, he says.
Market concern has shifted from a view of excess supply to one of weak demand, Fruhan believes. That's partly due to the prospect of an eventual slowing of economic growth or a long-term demand shift to electric vehicles.
"Over several decades, I agree that a shift to electric vehicles can slow and eventually reduce the demand for oil, but I don't expect a meaningful impact for a decade or longer. I expect slowing supply growth and increasing demand in the intermediate term to lead to stable, or increasing, oil prices. For the lowest-cost producers, in terms of operating and capital cost, that could lead to significant free cash flow generation," he says.
Toward the latter half of 2019, Fruhan shifted the fund away from shale-oil companies and other lower-quality energy names. Instead he focused on internationally exposed, integrated producers, including Exxon Mobil (XOM), one of the fund's largest holdings at the end of November.
"I believe Exxon, with its very strong balance sheet and high return on capital, could be well-suited to meet production demand in future years. The company has been investing in its production capacity through the down cycle while many financially weaker competitors have retrenched," Fruhan says.