Fidelity® Strategic Disciplines
A Message from the Fidelity® Equity-Income Strategy Portfolio Management Team*
By Elizabeth Johnson, Portfolio Manager, Strategic Advisers LLC
Naveed Rahman, Institutional Portfolio Manager, Fidelity Management & Research Company LLC - March 31, 2020
First Quarter 2020: Market Summary
THE COVID-19 OUTBREAK LED TO MARKET VOLATILITY
Global stocks fell amid concerns surrounding the impact of the COVID-19 outbreak on corporate earnings.
U.S. ECONOMY STANDS AT THE ONSET OF RECESSION
We believe the U.S. economy is likely to contract, as efforts to manage the spread of the virus have led to a sharp drop in demand for goods and services from consumers and businesses.
WATCHING FOR EARLY SIGNS OF MARKET STABILIZATION
We’re closely watching efforts to manage the spread of the virus and for signs of economic activity, as positive developments may lead to greater stability in stock and bond markets.
COVID-19 Outbreak Concerns Drove U.S. Markets Lower
FIDELITY® EQUITY-INCOME STRATEGY HIGHLIGHTS – Q1 2020
- Modestly underperformed the S&P 500 Index (net of fees).
- Outperformed the Lipper Equity Income Fund Index5 (net of fees).
- Dividend yield exceeded that of the S&P 500 Index and the US 10-year Treasury bond (net of fees).
- Relatively low valuation compared to the S&P 500 Index.
During the first quarter, U.S. stocks fell 19.6%1 amid concerns that the COVID-19 outbreak would lead to slower economic growth. Efforts to suppress the spread of the virus like social distancing, travel bans and school closings came with uncertain timelines. This helped contribute to the decline.
During this sharp decline we saw growth and large company stocks provide some stability within U.S. markets:
- In sharp contrast with the broader stock market, growth stocks fell by only 14.1%2, outperforming the market by a wide margin.
- Value stocks dramatically diverged from growth stocks, underperforming the market overall and declining by 26.7%3. Value stocks tend to struggle at the onset of recessions, as investors express near-term doubts about the outlook for some of these companies.
- Finally, larger companies often perform better than smaller ones during recessions and other periods of market stress. Over the quarter, large companies outperformed small companies by a notable 10.4%4.
We believe markets may remain volatile as the COVID-19 outbreak leads to uncertainty surrounding the pace of economic growth and the outlook for corporate profits. We are committed to closely following the COVID-19 outbreak, as well as the overall economy, for signals that the worst of these economic disruptions may be behind us.
The Fidelity® Equity-Income Strategy lagged the broader market while outperforming the Lipper Equity Income Fund Index
The Fidelity Equity-Income Strategy seeks capital appreciation over a full market cycle and to:
- provide dividend income greater than the S&P 500® Index.
- focus the portfolio on more reasonably-valued, dividend-paying stocks. We believe these stocks provide the prospect for sustained and growing dividends.
- underweight more expensive dividend-paying stocks.
The Fidelity Equity-Income Strategy did not outperform the S&P 500 Index (net of fees) in this challenging period. The strategy has outperformed the S&P 500 Index in prior downswings, but Q1 2020 was unusual in that growth stocks outperformed value stocks by over 12%6. Growth stocks usually don’t pay dividends and thus are an underweight for us. However, the strategy did outperform the Lipper Equity Income Fund Index over the quarter (net of fees).
- An overweight to the underperforming financials sector hurt performance. This was driven by our exposure to interest rate-sensitive banks during a period of rapidly declining rates. Our research suggests that the reaction in the financials sector was overdone in the context of changing fundamentals. We modestly added to our positions in the sector over the quarter.
- In contrast, our overweight position in consumer staples helped the strategy. A number of holdings in that sector benefited from the defensive nature of their business and pantry-stocking from U.S. consumers in Q1.
- Our focus on dividend-paying companies usually results in a portfolio with a tilt towards larger cap stocks. This helped the portfolio in a period when smaller companies underperformed the market.
Reduced exposure to healthcare and food-related consumer staples stocks and increased exposure to technology and financial stocks
Q1 2020 Outlook
- The valuation spread between the cheapest and most expensive stocks in the S&P 500 Index expanded further, to near historic highs.
- We believe volatility may likely be elevated given uncertainties surrounding the COVID-19 outbreak.
Healthcare and consumer staples were among the two best performing sectors in the quarter. Accordingly, we reduced exposure to a number of food and beverage-oriented stocks in the consumer staples sector. We also reduced medical distributor and pharmaceutical stocks in the healthcare sector, as relative valuations became less attractive.
We deployed those proceeds into two groups of stocks:
- Growth-oriented dividend companies that were historically too expensive but have become more reasonably priced in this sell-off (e.g., consumer discretionary, beverage-oriented stocks).
- Cyclically-exposed companies in the materials and energy sectors that in our opinion have the balance sheet strength to see the other side of this downturn. Cyclically-exposed companies are those whose fates are highly impacted by the pace and direction of economic growth.
We believe the portfolio is well-diversified across the S&P 500 Index’s 11 sectors, with a balance between defensive companies that can help ride out the crisis and more cyclically-oriented companies that can help during an eventual recovery.
Markets tend to recover before the economy
In times of market turmoil, stocks have not typically moved in-line with earnings and dividend expectations. They have moved much faster, in anticipation of the full impact of an uncertain crisis. The markets tend to begin their recovery before the fundamentals in the economy start to improve, such as Gross Domestic Product (GDP) growth or employment. It is imperative to remain invested through a crisis to help meet your long-term financial goals, and not attempt to time moves in and out of the market.
Past performance is no guarantee of future results.
Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917