Many investment portfolios may still reflect that environment with elevated exposure to more aggressive assets. This may mean they are not sufficiently balanced to withstand potentially greater volatility and dispersion of returns, which have already been seen in the stock and high-yield markets.
If the US maintains a path of progressively less accommodative monetary policy, it is expected that market risk could return to more normal, longer-term, two-way levels. This presents both potential challenges and opportunities for investors. On the return side, volatility and dispersion can reward well-executed active management and fundamental-based strategies.
While the term volatility is often associated with risk, volatility can be viewed as an essential component of active security selection. There has been a significant rebound in domestic US equity markets during the past five years, with a low-volatility equity environment particularly in the past three years.
This combination has proved challenging for many value-orientated US equity managers. The ideal environment for active value management is one in which securities are more likely to be mispriced and markets are less efficient, which usually occurs during increased uncertainty and volatility.
The market has seen more volatility lately and in October 2014 experienced its largest correction in almost three years. Concerns continue to be focused on the sustainability of corporate profit margins, emerging market demand and potential selected asset inflation driven by US Federal Reserve policies.
Interest rates continue to have a significant impact within utilities, real estate investment trusts and other financials. There are opportunities in financial institutions that will benefit from rising rates.
The robust mergers and acquisition environment, as well as activism, have been tailwinds for some stocks, as favourable deals have been made and companies have increased dividend payouts and share repurchases. Overweighting the healthcare sector has been advantageous and further benefits from the Affordable Care Act (ACA) are likely.
Volatility has returned to the market since all-time highs were attained last September. Stocks are muddling through a maze of uncertainty wrought by global economic growth concerns, the plummeting price of oil, the Ebola virus outbreak and ongoing geopolitical risks.
But better-than-expected earnings results among mid- and small-cap growth stocks have refocused investors on company fundamentals as the overall number of accelerating stocks continues to rise at an encouraging pace. There are several opportunities to tap into accelerating growth themes, including non-residential construction, healthcare and banks with unique drivers of improvement.
Construction firms continue to signal strength in the US markets, with non-residential construction appearing to be the most robust segment so far this year.
While the data has been somewhat uneven, there has been improvement in a number of companies with exposure to non-residential construction and infrastructure. Heating and cooling and flooring businesses are benefiting from exposure to both commercial and residential markets. Property management firms are also being aided by a pickup in commercial leasing activity.
The single biggest burden on hospitals during the past few years has been bad/uncollectable debt. Bad debts have risen from a low of 17 per cent of net revenues in 2001-02 to as high as 24 per cent in 2014. However, as people gain medical coverage, the fairly noticeable reduction in uninsured volume is having a meaningful impact on healthcare-related firms.
The short-term trend for both hospitals and healthcare providers is quite positive. Accelerating patient numbers have complemented a reduction in uncompensated/uninsured care as more people become insured.
The ACA has provided a measurable lift to providers, most specifically hospitals and doctor outsourcing firms.
In addition, medical device businesses should see a better environment from higher utilisation in the US. While pharmaceutical and biotechnology pipelines are robust, with ample clinical trial progress and recently launched products being viewed as a positive for results.
Phillip Davidson is chief investment officer, US value equity, and David Hollond is chief investment officer, US growth equity – mid and small cap, at American Century Investments
