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Large Cap Growth

Large Cap Commentary-November 2018

11 December 2018

November continued a trend that began in October, where some of the market leaders, like many in the technology industry, fell. Given the valuation of these stocks, their pull-back came as no surprise. What was surprising was where the money went and where the money did not go. Usually, during an economic expansion, money often flows into less expensive, economically sensitive stocks (cyclicals, such as Boeing). Today that is not the case. Instead, money is leaving the more expensive market leaders to buy expensive defensive companies (less economically sensitive stocks, such as utilities or consumer staples). As an example, as Netflix fell nearly 7% in November, Ameren, a St. Louis-based electric utility, rose 5%. While Ameren is world-class utility, today the stock’s valuation appears full. Currently, Ameren is trading at 40% premium to the market, a level the stock had not realized in the past twenty years.

This recent flow of money into defensive stocks is surprising. Normally, defensive stocks tend to do well during a recession. When reviewing current economic data, despite a few pockets of softness in the economy, including housing and autos, the bulk of economic data is quite strong. The unemployment rate in the U.S. is at levels not seen since 1969 and wages are increasing at an annual rate of over 3%. In addition, in the first three quarters of 2018, the market posted earnings growth of 25%. By most measures, the U.S. economy is doing well. The same cannot be said of stocks that are more tied to the economy.

The chart below shows the valuation of cyclical companies compared to defensive companies. Today, the gap in valuation between cyclical and defensive companies is near historic lows, approaching levels not seen since the Internet Bubble in the late 1990’s. Investors are valuing cyclical companies as if we were in a recession today. Again, the economic data does not  support such a view.

In addition, when we at Argent talk to our industry contacts in the business world, the vast majority of them tell us their business is good. To us there appears to be a disconnect between what people in industry are telling us, the results that companies are posting and what the market is willing to pay for those results. Likely, we will know in the next year to two if the U.S. economy is headed into recession. If that is the case, we should be somewhat protected on the downside as the stock prices of the economically sensitive stocks we hold already reflect a recession. On the other hand, if our industry contacts are correct, agreeing with the bulk of data that the U.S. economy continues to do well, then there is a good argument to be made for higher valuations for our economically sensitive stocks.

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Ken Crawford

Senior Portfolio Manager