In 2018, investors saw corporate earnings rise, economic growth accelerate, and inflation remain at modest, but rising, levels. For the market, things were less rosy. Through early December, investors had lived through 2 market corrections, and the S&P 500 was slightly negative for the year.
What might investors expect next year? Viewpoints caught up with 3 of Fidelity's US stock fund managers to hear how they think the business climate might change in 2019, and how they seek to position their funds. They all see potential headwinds for the economy, and are looking at businesses that rely less on economic growth, including utilities, for profit education, and tobacco.
Stocks that may work even if economic growth slows
Kip Johann-Berkel, Fidelity Small Cap Stock Fund (FSLCX)
We're likely to see market ups and downs in 2019, and given my view that the US is in a potentially peaking economic environment, I've become more cautious. Toward year-end, the fund is underweight several cyclical sectors closely tied to the economy—specifically, communication services, energy, and real estate. Conversely, the fund is overweighted in consumer staples as of October 31, where the fund held shares of retailer Smart & Final (SFS), as well as food distributor Performance Food Group (PFGC).
As I look to the new year, I think some of the fund's most attractive investments could be in companies that may potenially do well if the economy keeps expanding, but also where I don't see revenue dropping off dramatically in an economic downturn. For this reason, I've recently added to shares of for profit education companies. Regardless of how the economy is doing, I think people will continue to go to school, and therefore, business trends in this industry have a degree of resiliency. Here, shares of Laureate Education (LAUR), which offers more than 200 university and college programs, is a fund holding as of the end of October.
While the vast majority of the portfolio is defensive approaching 2019, one notable exception is the US residential housing market, where I've embraced economic risk, largely due to low stock valuations. There's no doubt that stocks tied to homebuilding have faced rising interest rates, tight supply and rising housing prices, which have combined to slow demand. However, I still see good potential in this industry, especially among builders positioned to address the continued need for affordable houses. Both housing starts and prices remain fairly affordable relative to long-term averages, and I think we’re still making our way through a backlog of pent-up demand. To me, this makes housing a possible bright spot in the new year. As of the end of October, the fund held shares of LGI Homes (LGIH) and Tri Pointe Group (TPH), for example.
Shifted to more defensive positioning
John Roth, Fidelity Mid-Cap Stock Fund (FMCSX)
As we approach 2019, we see market threats from global trade tension—especially between the US and China—rising interest rates, and some evidence that consumers are slowing their purchases.
I think corporate profit is near a peak. Meanwhile, unemployment is near a 40-year low and evidence of wage inflation is starting to emerge. The abnormally late-cycle tax stimulus, which disproportionately benefited more-domestically focused mid-cap companies, is not repeatable, in my estimation. Moreover, further boosts from fiscal policy seem unlikely.
Furthermore, money is becoming less free as the Fed raises policy rates, which I believe creates a headwind for economic growth, as well as to the valuations of companies whose cash flow is somewhere in the distant future.
Taking this all in, I have shifted to more defensive posturing for the fund. Heading into 2019, I have also notably underweighted the technology, industrials materials and real estate sectors, and overweighted in utilities. As of the end of October, notable utility holdings include Atmos Energy (ATO) and Allliant Energy (LNT).
That said, I have also been pursuing opportunities among attractively valued names where we think the market is overly concerned about a secular threat. Examples include particular names in health care and retail.
As of the end of November, the fund also owned homebuilders such as Toll Brothers (TOL), Lennar (LEN), NVR, Inc. (NVR) and D.R. Horton (DHI), because I think this is the one segment of the US economy that is still well below its previous peak reached before the 2008–09 financial crisis. In our view, this market isn't overheated and would be the first to recover if conditions do not get worse or improve.
Value stocks have begun to close the gap with growth stocks
Matthew Fruhan, Fidelity Large Cap Stock Fund (FLCSX) and Fidelity Mega Cap Stock Fund (FGRTX)
Near the start of 2019, I'm still seeing several fast-growing areas of the large-cap market, particular among some specific internet-related stocks, trading at valuations I think are still far too extreme. Followers and shareholders of my fund may be aware that I've been avoiding these investments for some time.
One encouraging sign late in 2018 is that, beginning in October, large-cap value stocks began to narrow the performance gap with large-cap growth stocks.
Partly as a result, I see some potential for decent returns in the coming year from companies with less relative sensitivity to the economy that I think may deliver a good combination of earnings and yield. Many of these companies offer solid, but not extraordinary growth, and trade at what I think are good valuations.
For example, I added to tobacco stocks in the fourth quarter of 2018 when I thought the combination of regulatory and competitive concerns for this industry gave me a chance to invest in relatively defensive businesses at attractive valuations. I established a stake in an international tobacco company, while also slightly adding to stakes in Altria (MO) and British American Tobacco (BTI).
I'm also fairly bullish on energy, where I see a big gap between the underlying price of oil and the levels at which energy stocks have been trading toward year end. Eventually, I expect this disconnect to close.
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