Watch Market Perspectives: Large Cap Overview
Hi, I’m Kevin Barr, Head of SEI’s Investment Management Unit. I’ve asked Dave Hintz, Portfolio Manager for SEI’s U.S. Large Cap Funds, to join me today. Dave, I’d like to start by asking you to share perspective on the U.S. large-cap market environment.
2020 has been very volatile so far. It’s a unique situation where we have a recession caused by a pandemic for the first time in our lifetimes. We’ve gone from bull market at the beginning of the year to bear market and then back to a sharp growth-led rally. We haven’t even finished first 6 months.
The breadth in the market, the percentage of stocks beating the the Russell 1000 Index has fallen to a really low level. Only about 30% of the stocks in the index have outperformed over the past 12 months. Active management tends to do better when we have higher breadth. Ideally, active managers would have at least a 50% change of beating the market with a stock when they pick it, and 50% is kind of the norm, but you can see by chart that bounces all over the place. And in certain environments, most of the stocks in the index are beating a cap-weighted benchmark.
Growth really defied gravity so far in 2020. And this after leading the market for most of the past dozen years. Value stocks on the other hand have become cheaper and cheaper.
Dave, where does this divergence of performance between different styles fit from a historical context?
Growth stocks haven’t beaten value stocks by this much over any 12-months since 1999. This chart shows that relationship and this has just been a tremendous time for growth managers. Growth managers are looking smarter than usual and this happens even as they are paying over a 100 times earnings for stocks. It’s been awhile since they’ve been humbled.
Is this unique to U.S. large-cap stocks?
To some extent it’s been a global phenomenon over the past dozen years. Value has also lagged in U.S. small cap.What’s unique in U.S. large-cap is the concentration in a few stocks within market cap weighted indexes.
How unusual is it to see this level of concentration?
The weight of the largest 5 companies in S&P 500 is near record levels. On this chart you can see how it’s spiked up over the past year. Indexes are less diversified than normal. This can cause them to become more risky. Historically, it hasn’t ended well for megacaps when their weights become this big.
Some of those stocks aren’t really overly expensive. Yet, we’re seeing a lot of news about growth stocks with P/E ratios around 100 or more.
Yes, like Amazon, Tesla, Netflix for example.
So in our core funds, we are underweight such stocks on a strategic basis, but we do have managers that own them. Why are they?
Our alpha sources are momentum, value, and stability. Our momentum managers, such as Alger, own such stocks. Overall our strategies are underweight such stocks because our value managers and stability managers tend not to own them. It’s not just that these stocks are expensive, it’s also some important sectors to managers have become very cheap.
In this chart you see the various sectors and their year-to-date returns. Financials and energy in particular have really lagged. Our managers actually prefer the Financials sector. These business produce more earnings than some other cyclical areas even now during the coronavirus pandemic situation.
As a deeper value manager, LSV in particular has been hurt by a big weight in the financial sector. LSV also has a tilt toward mid cap and small-cap stocks. Over the long-term, LSV has done well, but it’s really struggled in 2020.
Value tilts have been painful for investors over the past decade. Is there any reason to believe it will get better?
Yes. We believe a shift toward value is inevitable and the only the only uncertainty is the timing of it. In the long run, value has been a winning strategy over the long term. There are behavioral reasons. Humans over extrapolate past performance and easily become disenchanted with adversity. It’s been rare for value to underperform for this long, but this does create opportunity for patient investors.
Analysis using data from noted academic, Ken French, shows after periods of 5-year underperformance, value has historically outperformed over 70% of the subsequent 3-year periods. The tough thing in a long-term context is it’s really hard to wait. Part of the payoff to value comes from superior accumulation of earnings and cash flows and dividends. Obviously this isn’t very exciting.
There is a shorter-term reason to be more optimistic though. Value stocks tend to do especially well coming out of a recession, and we are likely near the trough of a recession at this time. We wrote about this recently in a paper entitled “The Odd Couple: Recessions and Value.”
So that being said Dave, are you making any changes to the portfolio, or are you staying the course?
We believe we’ve upgraded the manager lineups in our large-cap strategies over the past couple years. But we expect to show patience and discipline in this market environment. We plan to stay the course with the value tilt. We plan to stay the course with the underweight to megacap stocks that have become expensive and so concentrated in indexes. But the journey of a value tilt won’t be easy. There should never be an expectation of instant gratification.
The payoff can come to those who are patient and persistent. It can come to those who stick with a strategy when it is the toughest.
Growth stocks won’t win forever. Now isn’t the time to capitulate.
Great, thanks for your time today Dave.
The Russell 1000 Index includes 1000 of the largest U.S. equity securities based on market cap and current index membership; it is used to measure the activity of the U.S. large-cap equity market.
The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 Index companies with higher price-to-book ratios and higher forecasted growth values.
The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 Index companies with lower price-to-book ratios and lower expected growth values.
The S&P 500 Index is a market-capitalization-weighted index that consists of 500 publicly-traded large U.S. companies that are considered representative of the broad U.S. stock market.
Glossary of Terms
- Alpha source: Our strategies are designed to capitalize on long-term drivers of market performance through exposure to persistent sources of returns such as mean reversion, trend-following and stability. We have refined our approach to identifying these alpha sources and the factor groups we employ as proxies to measure and capture their performance.
- Momentum Alpha Source: The investment manager seeks to benefit from investor under-reaction—due to anchoring. Such groups of stocks trend in price as perceptions change directionally and serially with incoming data, leading to herding behavior by investors.
- Stability Alpha Source: The investment manager seeks to benefit from investor tendency to undervalue lower-risk, higher-stability businesses—resulting from a focus on short time horizons and overconfidence in forecasts for momentum-driven stocks. Stability-oriented stocks have the power to exceed market expectations by consistently outperforming (rather than reverting to average market returns) and through the power of stable, long-term compounding.
- Value Alpha Source: The investment manager seeks to benefit from investor overreaction—resulting from aversion to loss. Such groups of stocks revert to the mean, as fear over the perception of the investment’s risk dissipates.
- Batting average: Batting average is a statistical measure that illustrates how often in percentage terms an investment outperformed a specified benchmark.
- Basis points (BPS): 100 basis points equal 1%.
- Bear market: A bear market refers to a market environment In which prices are generally falling (or are expected to do so) and investor confidence is low.
- Book to market: Book-to-market data measures the ratio of book value to market value of equity. A high ratio implies the market is valuing equity relatively cheaply compared to book value.
- Bull market: A bull market refers to a market environment In which prices are generally rising (or are expected to do so) and investor confidence is high.
- Price-to-Book Ratio: Stock's capitalization divided by its book value, where book value is the value of an asset as it appears on a balance sheet, equal to cost minus accumulated depreciation. The value is the same whether the calculation is done for the whole company or on a per-share basis.
- Price-to-Earnings Ratio (PE): The price-to-earnings ratio is the most recent price of a security divided by the company’s annual fiscal year basis earnings per share.
- Standard Deviation: Statistical measure of historical volatility. A statistical measure of the distance a quantity is likely to lie from its average value. It is applied to the annual rate of return of an investment, to measure the investment's volatility (risk). Standard deviation is synonymous with volatility, in that the greater the standard deviation the more volatile an investment’s return will be. A standard deviation of zero would mean an investment has a return rate that never varies.
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