After six years of positive returns and almost four years without a US market correction, August 2015 provided a jolt to investors as the Dow Jones Industrial Average fell 10% from its peak.1
Before August’s market correction, valuations for US stocks were relatively homogeneous, with two exceptions — financials and energy. This made it challenging for our US deep value strategy to find quality undervalued companies outside of those two sectors. But looking into 2016, other sectors are beginning to look more interesting from a valuation perspective, including some that we haven’t been excited about for several years.
- Basic materials: Over the past eight years, our deep value strategy has generally avoided metals-related names given our view that valuations were relatively unattractive and prices were unsustainably high relative to cash costs. That thesis has finally played out, and today we believe valuations for the group are quite attractive. The key will be finding companies that have strong enough balance sheets that can withstand continued economic weakness and a slow recovery.
- Industrials: The story in this sector is very similar to that of basic materials. However, these companies tend to be very good businesses that should be well-positioned to endure a slow recovery. The problem with this sector over the past few years, in our view, is that margins were unsustainably high and the relative valuations were unattractive. Those issues are starting to resolve themselves, and our deep value strategy has been adding to this sector post-correction.
- Technology: The companies in this sector are very disparate, but we continue to like the attractive free cash flow yields, strong balance sheets, and highly recurring revenue streams that we see in many segments of the market.
- Financials: Our deep value portfolio is predominantly exposed to large, credit sensitive, diversified banking stocks. The commercial property and casualty insurance cycle appears to be in its later innings, and we have exited our positions in recent years. Life insurance and trust banks continue to have attractive valuations and capital return opportunities, in our view. However, the major opportunity for many of these names is a higher interest rate environment.
- Energy: We are more constructive on integrated oil companies and, to a lesser extent, exploration and production firms. Relative valuations for the energy sector are at multi-decade lows due an oversupplied market and uncertain global macro environment. We believe a normalized supply/demand environment should generate meaningful upside.
Looking ahead to 2016, I believe short-term volatility remains in the cards for investors — but I also expect us to receive some long-awaited clarity on issues ranging from the Chinese economic slowdown to the path of the Federal Reserve’s interest rate policy. No matter how these issues play out in the months ahead, I believe investors should be focused on the long term and let valuations and risk tolerance guide their decisions. We believe that near-term volatility can create opportunities for patient investors who have an expanded time horizon.
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1 Source: Barron’s, Aug. 21, 2015
In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.
A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets.
Many products and services offered in technology-related industries are subject to rapid obsolescence, which may lower the value of the issuers.
To the extent an investment focuses on securities issued or guaranteed by companies in the banking and financial services industries, the investment’s performance will depend on the overall condition of those industries, which may be affected by the following factors: the supply of short-term financing, changes in government regulation and interest rates, and overall economy.
Businesses in the energy sector may be adversely affected by foreign, federal or state regulations governing energy production, distribution and sale as well as supply-and-demand for energy resources. Short-term volatility in energy prices may cause share price fluctuations.
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2015’s market correction uncovered new valuation opportunities by Invesco Blog