We are as bullish on the fundamental U.S. economy—and increasing gross domestic product (GDP)—as we have ever been. Part of that is coming off such a terrible year, in 2020.
It is also rooted in the combination of continued progress on vaccinations that will allow people to get out and about again, the tremendous amount of pent-up savings from all the money Americans could not spend last year, and large governmental stimulus coming again.
This naturally leads many investors to ask, “How will all this impact U.S. stock markets?”
Earnings promise to be terrific. There should be little doubt. No one expected 2020 to be as good as it was, but it pulled forward big returns normally expected over longer time frames.
The key question is interest rates. We believe U.S. stock markets can handle rising rates—so long as increases happen at a measured, gradual pace. Rates remain incredibly supportive, and even if they move slowly and steadily up to 2.5% or 3%, the markets can definitely handle it.
More concerning would be major rate dislocations: If rate increases come too quickly, investors perceive that the U.S. Federal Reserve has lost control, or a sort of buyer's strike sets in.
How will technology stocks fare? Those that have had tremendous success are some of the best companies the world has ever seen, and their terrific fundamental drivers remain in place. We expect them to continue to do well, and lead. At the individual stock perspective, however, we are more cautious—given, again, how much returns were unexpectedly pulled forward in 2020.
Within tech we like companies with solid outlooks but historically normal earnings multiples. For example, Oracle, Cognizant Technologies and NXP Semiconductors are positioned to leverage major trends in technology, such as the cloud, digital transformation and electric vehicles, respectively, but sport modest valuations.
Beyond technology, we always look for companies and sectors with significant leverage to recovery in the economy, a lot of upside and where a bit of investor pessimism abides.
Two areas we are focused on are interest-rate-sensitive financials and energy. In both, there should be substantial leverage to the upside when interest rates rise.
Banks could experience ample loan growth, coming up from an exceptionally low level. In the past few years, there has been a general apathy toward banks. This lingering pessimism could enable investment opportunities for the right bank and other financial stocks.
Within financials we like Bank of America for its high-quality franchise and strong leverage to rising rates. Also, we like Apollo. We think the alternative asset managers are a good place to be, we like the permanent capital platform Apollo has with Athene, and we think it is misunderstood by the street, which is why it trades at an attractive valuation. Over time we expect its multiple to rise as investors get more comfortable with the business model.
Meanwhile investor disdain for energy is at remarkable highs—or was. Just a couple of months ago, energy was 2.5% of the S&P 500, the lowest it has ever been.
From an environmental perspective, most of the major energy producers have acknowledged that climate change is real, but decarbonization will take a long time to address. There also is high visibility on the recent shale oil boom and accompanying need for pipelines and other infrastructure. The U.S. will continue to play a major role in energy production.
Investors will come back to these areas as they realize that market pessimism is overdone.
We like large-cap stocks such as The Williams Companies, a U.S. natural gas pipeline company, and Canada’s Enbridge Inc. and TransCanada, TC PipeLines LP. These companies are well capitalized with stable, predictable cash flows.
That is remarkable in a world where it is difficult to find attractive yields, and yet investors can get 6% to 7% yields from investment grade assets in excellent companies like these.
Michael Clarfeld, CFA, is a managing director and portfolio manager at ClearBridge Investments, a subsidiary of Franklin Templeton. His comments are not intended to be relied upon as a forecast of actual future events or performance or investment advice.
