In equity markets, even the best active managers tend to struggle when stocks are all moving in lock step with each other. But when there’s more differentiation in returns across stocks and sectors, there’s more opportunity for managers to generate alpha.
We have seen a great deal of differentiation in the S&P 500® Index so far in 2018 (see chart below). With all its ups and downs, the Index currently sits close to where it started the year, but underneath that flat number there’s been widely divergent sector performance. 2018 results highlight a few persistent themes at play in the market this year. (All return figures cited refer to sectors and subsectors of the S&P 500 Index).
Technology upswing: The tech sector is up 10% so far this year, and drilling further down, the application software subsector is up more than 25% and the internet retail subsector is up more than 40%. Investors are very clearly rewarding this body of big technology companies that have built powerful economies of scale and positive network effects in recent years.
While valuations are rising in the space, earnings growth has also been notable this year in the technology sector, with earnings up 8.1% so far in 2018 vs. 4.3% for the Index overall.
Renaissance for…department stores? Department store stocks that were left for dead last year are among the best performing stocks so far in 2018—the department store subsector is up more than 22% year to date. Few would argue that brick and mortar retail companies have a rosy, long-term outlook, but sometimes hard-hit stocks and sectors present true value opportunities.
Doldrums for consumer staples: At the other end of the spectrum, consumer staples is off more than 12% for the year; the packaged foods subsector is down more than 17%. The sector has been punished by a variety of factors from e-commerce disruption, to price competition, to an increasing reliance on leveraged M&A activity to bolster growth—all of which has been a recipe for pressure on already-low profit margins, and for poor stock performance.
Reckoning for “bond proxies”: For years after the financial crisis, investors fled to higher-yielding stocks and sectors (for example, stocks in the utilities, REIT and telecom sectors) for income that they couldn’t get from the bond market. These stocks have lagged the market considerably this year; the yield on 10-year U.S. Treasuries rose above 3% in April, and bonds are viewed once again as a viable source of income. Even cash (using one-to-three month T-bills for a proxy) is yielding near 2% today vs. a near-zero yield as recently as 2015.
Active managers benefiting from more return differentiation
More differentiation between stocks has coincided with better results from active managers. According to Morningstar, 43% of active managers outpaced their passive counterparts in 2017, a notable improvement from 2016 when only 26% outperformed. Of course, an environment with greater differentiation merely provides opportunity for an active manager—it does NOT guarantee that the manager will capitalize on that opportunity. But with prudence, patience and a disciplined investment process, good managers are often able to extract value when the market offers a large spread in returns between fundamental winners and losers.
The views expressed are those of Brown Advisory as of the date referenced and are subject to change at any time based on market or other conditions. These views are not intended to be and should not be relied upon as investment advice and are not intended to be a forecast of future events or a guarantee of future results. Past performance is not a guarantee of future performance and you may not get back the amount invested.
The information provided in this material is not intended to be and should not be considered to be a recommendation or suggestion to engage in or refrain from a particular course of action or to make or hold a particular investment or pursue a particular investment strategy, including whether or not to buy, sell, or hold any of the securities or asset classes mentioned. It should not be assumed that investments in such securities or asset classes have been or will be profitable. To the extent specific securities are mentioned, they have been selected by the author on an objective basis to illustrate views expressed in the commentary and do not represent all of the securities purchased, sold or recommended for advisory clients. The information contained herein has been prepared from sources believed reliable but is not guaranteed by us as to its timeliness or accuracy, and is not a complete summary or statement of all available data. This piece is intended solely for our clients and prospective clients, is for informational purposes only, and is not individually tailored for or directed to any particular client or prospective client.
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