With the summer months often being a time for investors to get away and reset the batteries, it reminds me of a phrase: “sell in May and go away”. If solely invested in the S&P 500, this would be a profitable strategy for now as you avoid a 2.1% loss.
Those who remain active will be aware of the uncertainties today including a slowdown in global growth, an escalated trade dispute, and heightened geopolitical unrest to name a few. A clear ‘flight to safety’ has been observed with gold at a 6-year high and the Yen and Swiss Franc strengthening by 4.9% and 2.6% respectively since April.
The US Federal Reserve lowered rates for the first time in a decade to ease market worries and is facing further pressure from President Trump, who called for another 75-100 basis point reduction by the end of the year. A ‘risk-off’ environment has led the US 10-year yield to fall below the S&P 500 dividend yield for the first time in over 3 years as seen in Exhibit 1.
Exhibit 1: US 10y Yield vs. S&P 500 Yield
A question worth exploring is how equity investors navigate this uncertain landscape. If we focus on two popular investing strategies (Value vs. Growth), we will observe that growth is the clear winner over the last decade both globally and in the US. The S&P 500 Growth index has experienced a 10-year compound annualized growth rate of 15.2% vs. 11.6% for the S&P 500 Value index. Intuitively this seems plausible as we have experienced an uninterrupted bull market since the financial crisis of 2008. However, as we enter possibly a mature phase of the economy combined with an uncertain outlook, Exhibit 2 poses the question if investors are paying too much for growth?
Exhibit 2: Forward P/E ratio for Growth vs. Value
The forward P/E for the S&P 500 Growth index is at 21.1x compared to the 10-year average of 16.8x, indicating that growth is expensive. In contrast, the S&P 500 Value index is much more fairly valued with the current P/E slightly above its long-term average. Traditionally, growth companies attract higher valuations as investors are paying a higher multiple today for future promises. So when growth is relatively ‘expensive’ to historical levels, we must tread with caution as the market can be unforgiving to companies who deviate from growth plans, experience the unexpected (i.e. trade-war), while dealing with regulation and the global economy. We must not forget the powerful virtue of ‘mean-reversion’.
Exhibit 3 highlights the top ten most expensive companies within the S&P 500 Growth Index on a forward P/E basis.
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Netflix and Salesforce have set the bar for delivering revenue growth in excess of 20% next quarter and in FY2020 with Amazon not far behind. Under Armour is a good example of a company who failed to deliver on key segments (North American revenue) when 19EQ2 results were reported and suffered their largest daily price decline since 2017 (-12.2%). It is also expected to deliver the lowest FY2020 revenue growth (6.7%) from this group of expensive companies. It will be interesting to see how investors treat Under Armour, as the sell-off has continued since the end of July.
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