With the turn in performance thanks to Trump Tax bump 2.0, our themes were unable to hold up in Sep. but we are seeing a better trend in Oct. Momentum is our newest theme and it got off to a tough start. However, we have seen a bounce back in this theme along with growth and overseas exposure. Big inflows to the ETFs have made it tough for size and quality to outperform. We think tax reform will NOT be easy, thus these themes should work out as well.
Sometimes a change in scenery is thought to be a good thing, however for our themes, it was not. Quite a few have failed in September, as Trump Tax bump 2.0 had money flowing back into small-cap ETFs leading to lower cap and quality outperforming and managers lagging behind. We even saw value make a comeback along with slower growers. However, we are midway through October and we are finding better performance by many of our themes and we think this will continue.
Earnings season will be a make or break situation for many stocks, as valuations are high and they won’t be supported by weak fundamentals. More importantly, tax reform has a long way to go with many details needing to be ironed out. Although Ward McCarthy, the JEF economist, thinks Christmas is doable we think it may be longer. We remind investors tax policy is challenging and there is a reason why it has not been done since 1986.
We are sticking with our themes and provide 17 Buy rated stocks as a way to match ideas that are in growth indexes, of better quality, and have more overseas revenue than their benchmarks with lower debt: A, ALGN, AME, AOS, BRKR, DCI, EPAM, EW, GPS, IR, LEA, MXIM, OSUR, TTWO, VAR, WST, XLNX.
Theme #1 Growth with a twist: Growth and value are neck and neck MTD, but growth remains much cheaper and value can’t seem to deliver any earnings growth. A slower US economy along with better global growth benefits growth stocks. Stick with the fastest growers.
Themes #2 and #3 Size & Quality: It has been rough for these themes, as ETF flows have been strong into small caps pushing up lower cap and lower quality. Any delay in tax reform may change folks’ minds about small caps, and hence outflows could change this dynamic in a hurry. Size and quality are cheap, and we are still waiting for volatility to rise.
Theme #4 Stocks with high overseas revenue: Even though the dollar strengthened of late, stocks with substantial overseas revenue have continued to outperform. We think these stocks will post better sales and earnings growth not only due to a weaker currency year-over-year but from the trend of better economic growth abroad. We do think the dollar weakens, but as we have said before, we are not currency experts.
Theme #5 Better balance sheets are prevailing: Although some of this may be sector preferences, clean balance sheet companies continue to outperform. This comes despite high-yield spreads narrowing from 8.2% in Feb ’16 to 3.6% now, and a rebound of flows into these ETFs. Higher overall rates would be a boost to our theme, along with higher volatility.
Theme #6 M&A runs hot: Although it does not feel like a blistering pace, M&A is on track for a solid year and repatriation of overseas cash should accelerate the pace. We see many deals in Tech and Financials and this should continue.
Theme #7 Active over passive: This theme took its lumps in the third quarter, especially for core funds, but we see signs beneath the surface that we think will really aid this concept. Rates are rising, pair-wise correlations are really low, and the earnings season generally divides the wheat from the chaff.
Theme # 8 Going with the Momentum: Any reversal in performance kills this theme and it was ugly in September. However, we are starting to see better footing in October and investors like to buy the winners in the fourth quarter. Also this factor tracks growth over value, and if theme #1 plays out, so too will momentum.
Steven G. DeSanctis is an equity strategist and Miles Bredenoord is an equity associate at Jefferies