Where to find opportunities in an aging bull market

Fidelity managers discuss where they have been finding opportunities.

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After an 8-year bull market, U.S. stock valuations are above long-term averages. Meanwhile, Fidelity’s director of asset allocation research, Lisa Emsbo-Mattingly, says she has been seeing some signs that the late cycle may be on the horizon, in the U.S. and globally.

Are there still opportunities in stocks? Viewpoints caught up with a few Fidelity stock fund managers to discuss the sectors and strategies where they have found opportunities in this market.

Of course, any investment decision should be based on your individual investment time horizon, financial circumstances, risk tolerance, and goals. If your investment plan includes individual stocks or stock mutual funds, here are some ideas to consider.

The potential benefits of stable earnings growth and healthy cash flow

Sammy Simnegar
Fidelity International Capital Appreciation Fund (FIVFX)

Over the last year, the outlook for global growth has improved markedly. We are experiencing a synchronized global upswing for the first time in a decade and the threat of global deflation seems less likely now. I don't expect a return to the global boom we had in the last cycle, but I do think we could see an attractive mix of global growth, low interest rates, and relatively stable commodity prices and currency exchange rates. 

I see plenty of opportunities at the company level among firms I believe can prosper in this environment, even against a backdrop of subpar economic growth.

Given what I see as the potential for tepid global growth, I remain focused on companies known for their stable earnings growth and healthy cash flow. Consequently, Consumer Staples—where many companies fit this description—was one of the fund’s largest sector overweightings at the end of July 2017. The fund also had sizable overweightings in the Industrials sector.

In terms of changes, I have also been increasing the fund's exposure to technology firms, including software companies with high recurring revenues, and e-commerce firms. 

The risk of lower-quality companies

Matthew Friedman
Fidelity Value Strategies Fund (FSLSX)

While I continue to find cash-generative businesses trading at less than their intrinsic value, I’m cognizant of the market’s strong performance in 2016 and 2017, and that we are roughly 8 years into a bull market. Some of the best-performing stocks since May 2016 are ones that historically have struggled to earn their cost of capital; their strong performance came mostly from multiple expansion (investors paying more for the same earnings), rather than earnings growth. In my view, this is not sustainable over the longer term.

I think equity valuations overall are starting to get expensive, but I’ve found pockets of opportunity among Real Estate, Utilities, and Consumer Staples, where I think the valuations of stocks have been attractive. These have historically been more defensive sectors, and I expect their earnings to be less cyclical than what I might expect among companies in growth sectors. 

In addition, I've been making a concerted effort to avoid lower-quality companies—based on industry structure, long-term returns, and balance sheet—that may appear cheap just because the market is expensive. If the market goes through a correction, these firms’ earnings should decrease significantly and performance may suffer.

Look for long-term value

Kyle Weaver
Fidelity Select IT Services Portfolio (FBSOX)

What matters most to me is whether there are good business models out there that are underappreciated. I tend to look out 3 to 7 years. If a stock looks cheap based on reasonable assumptions about growth, profitability, governance, and cash deployment over that time period, then I consider it a good candidate for investment. Consensus opinion about a sector or company matters far less to me than the specific factors affecting each company’s business model. 

A healthy business with increasing economies of scale is a rare and precious thing, because as the company grows, its cost advantages versus competitors will increase. This can create a self-perpetuating cycle of value creation for its shareholders, and hopefully its customers too. Even “consensus” and “crowded” growth names such as the FANG stocks—Facebook, Amazon, Netflix, Google (Alphabet)—might have a relatively high price/earnings multiple and appear well appreciated on a short-term basis, but still be attractive for the longer term. Businesses with “network effects” can have similar advantages. Network effects occur when a product or service becomes more valuable as more people use it. The more people on a social media network, for example, the more potential connections and the more useful the network becomes. In rare cases, there are business models that have both economies of scale and network effects, and these can create special investment opportunities. 

Of course, this doesn’t prohibit me from investing in some names that are downright cheap on current earnings—as long as those businesses are likely to remain cheap on future earnings as well; that is, I believe that the company’s earnings level is more sustainable than the market appreciates. The fund’s holdings in the Materials and Industrials sectors have been more reflective of this approach.

A focus on quality growth

Daniel Kelley
Fidelity Trend Fund (FTRNX)

My outlook hasn’t changed much. While the new administration’s pro-growth legislation has been slower to materialize than some had hoped, I still feel good about the health of the U.S. economy. Stock prices are not yet reflecting inflation concerns. Interest rates and unemployment are low, asset prices are rising globally, and consumer confidence is high.

Trend Fund's biggest area of investment at the end of July—about 45% of assets—is still “quality growth.” By that I mean large, well-known companies with proven management teams, historically high returns on capital, strong balance sheets, and attractive stock prices relative to either stable or accelerating earnings growth. 

Two noteworthy changes over the past year have been moves to overweighted positions in both Financials and Health Care. With respect to the Financials sector, although it rallied late last year, I think the group has still looked particularly cheap. Importantly, I think the general consensus in the marketplace has been that interest rates will stay low for quite some time. Hence, I do not think I am paying much for the option of potentially higher interest rates going forward—even a modest increase from here could be a significant tailwind to the earnings power for companies in this sector. Add in the potential for positive developments related to regulation, tax reform, and increased capital returned to shareholders, and there is potential for this group over time.

Turning to Health Care, the group has been significantly less expensive relative to the market since mid-2015 on the back of concerns about drug pricing and the regulatory environment more generally, ahead of a presidential administration change. I took advantage of weakness in the sector earlier this year to buy innovative health care companies I thought had good management teams, strong product pipelines and healthy balance sheets, focusing on investments where I thought valuations looked significantly mispriced relative to their growth potential. Areas I found particularly interesting in this regard included large-cap biotech, as well the medical device, and health care equipment subsectors.

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