Download The Benefits of High-Quality in an Uncertain Environment

The Benefits of High-Quality in an
Uncertain Environment
Market Commentary
2017 Outlook
"An actively managed portfolio of high-quality companies
may be of key importance in 2017, as we expect numerous
developments to impact markets."
— Jim Boothe, CFA, CIO, Portfolio Manager
High-Quality in a Time of Political Shifts
The U.S. presidential election that commanded so much attention across the globe over
the last year has now concluded. The election of Donald Trump came as a surprise to
many, just as had been the case leading up to the Brexit referendum. Both votes have
come to be seen as expressions of populist discontent with the status quo, and may
predict strengthened populist movements elsewhere. Indeed, the “no” vote in the recent
Italian constitutional referendum could be said to reflect such sentiments, and perceived
odds of success have increased for related agendas and politicians throughout Europe,
including for French presidential candidate Marine Le Pen. The expected policy shifts
represented by these events may herald increased market uncertainty.
Given this environment, it is understandable that investors have a keen interest in
determining which portfolio leanings may help buffer some of the elevated uncertainty
expected in 2017. We find an emphasis on high-quality companies may be a particularly
advantageous factor. In our view, investors often engage in a flight to quality during
drawdowns, and we believe that high-quality companies with strong balance sheets,
revenue growth potential, consistent earnings growth and high return-on-equity become
increasingly more attractive to the market at these times. As seen in the following chart,
companies in the top quintile by return-on-equity, a measure we believe offers a helpful
proxy for quality, have generally offered favorable relative performance during periods of
drawdowns over seven percent. Such companies may lag during risk-on rallies, but we
find their favorable performance tends to persist over a full market cycle. Further, we
believe active management can be utilized to emphasize this advantage in down markets
and minimize its drag in up markets.
NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE
KEY 2017 THEMES
▶▶ I nvestors may face increased
uncertainty as socio-political
and economic factors develop.
▶▶ H
igh-quality, actively managed
equities may help to buffer
some of this uncertainty.
The Benefits of High-Quality in an Uncertain Environment
2017 Outlook
Higher Quality Companies Outperformed in Volatile Periods
Relative Performance During Drawdown Periods of 7% or Greater
Underperformed S&P 500 Index
Outperformed S&P 500 Index
ROE Top Quintile (High Quality)
5.1
ROE Bottom Quintile (Low Quality)
9.5
6.2
3.2
2.8
1.4
(0.4)
(0.5)
(3.1)
1.4
1.2
(2.0)
(2.9)
(4.3)
(2.6)
(1.5)
(3.4)
(5.8)
(10.6)
(8.2)
12/31/07 – 1/6/09 – 1/19/10 – 4/23/10 – 4/29/11 –
11/20/08 3/9/09 2/8/10
7/2/10
10/3/11
4/2/12 – 9/14/12 – 9/18/14 – 7/20/15 – 12/31/15 –
6/1/12 11/15/12 10/15/14 8/25/15 2/11/16
Data sources: Morningstar Direct and FactSet as of 11/30/16. Past performance is no guarantee of future results. Chart
shows relative performance of the highest quintile (1) and lowest quintile (5) by return on equity versus the S&P 500® Index
during drawdown periods of 7% or greater over the last 10 years. See the Glossary for definitions. Indexes are unmanaged
and unavailable for direct investment.
Sector Developments
An actively managed portfolio of high-quality companies may be of key importance in
2017, as we expect numerous developments to impact markets. President-elect Trump
is pushing for expanded GDP growth, supported by increased fiscal spending, lower tax
rates and policies focused on making domestic businesses more competitive. This may
accordingly benefit select cyclical companies in sectors such as financials, energy and
industrials; these sectors have already begun to see increased investor interest in the wake
of rising economic optimism. The financials sector may additionally benefit from higher
net interest margins as the Federal Reserve sees more room in the economy to raise
interest rates as part of the long march back to normalcy. Also, the energy sector may
sustain the momentum gained from recently announced OPEC production cuts. The
U.S. dollar has experienced notable strength since the election, however, possibly related
to expectations of policy-related inflation, and this may diminish some cyclical strength
since many U.S. multinational companies source a significant portion of their revenues
from foreign markets.
In contrast to cyclical developments, some defensive sectors such as consumer staples
and utilities have displayed a measure of weakness. Companies in these sectors may be
negatively affected as investors rebalance their portfolios in anticipation of Trump-related
growth. Further, expectations for three additional interest rate increases may weigh
unfavorably on defensive companies with relatively high yields, as the justifications for
their bond-alternative status may be undercut.
Trump railed against several technology industry leaders throughout his campaign,
many of whom were vocal Clinton supporters, and he has outlined policies that may
2
A long-term focus on well-run
companies has historically provided
COMPETITIVE RETURNS during
periods of market declines and
volatility.
The Benefits of High-Quality in an Uncertain Environment
2017 Outlook
raise such companies' labor costs. This may explain some of the post-election weakness
seen in the tech-heavy Nasdaq Index. However, Trump has recently held prominent
meetings with many leading tech executives, and his plans to allow companies with
significant offshore cash holdings to repatriate at low tax rates could be quite favorable
for several technology companies.
Looking Ahead
There are many embedded unknowns in the economy and markets heading into the
new year. The apparent stability and optimism seen right now could be quickly overturned by any number of developments, including political risks, currency fluctuations,
interest rate developments and more. We therefore believe a portfolio that includes
ample exposure to high quality companies and embraces the added diversification that
active management can provide could prove beneficial in 2017. ▪
For more information, please contact your financial advisor and visit nuveen.com
or contact Santa Barbara by visiting sbasset.com.
RISKS AND OTHER IMPORTANT CONSIDERATIONS
This commentary should not be relied upon as investment advice,
recommendations, offers or solicitation of any particular security, asset class,
fund, strategy, or investment product. Investing entails risk, including the
possible loss of principal. There can be no assurance that any investment
or asset class will provide positive performance over any period of time.
Dividend yield is one component of performance and should not be the
only consideration for investment. Dividends are not guaranteed and will
fluctuate. Equity investments such as large-cap stocks are subject to market
risk or the risk of decline in response to adverse company news, industry
developments, or a general economic decline. Past performance does not
guarantee future results.
The statements contained herein reflect the opinions of Santa Barbara Asset
Management, LLC (“Santa Barbara”) as of the date written. Certain
Return on Equity (ROE) is the amount of net income returned as a percentage of
shareholders equity. Return on equity measures a corporation’s profitability by revealing
how much profit a company generates with the money shareholders have invested.
The S&P 500® Index measures the performance of large capitalization U.S. stocks.
CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.
statements are forward looking and/or based on current expectations,
projections, and information currently available to Santa Barbara. Such
statements may or may not be accurate over the long-term. While we
believe we have a reasonable basis for our comments and we have
confidence in our opinions, actual results may differ from those we
anticipate. We cannot assure future results and disclaim any obligation to
update or alter any forward-looking statements, whether as a result of new
information, future events, or otherwise. Statistical data was taken from
sources which we deem to be reliable, but their accuracy cannot be
guaranteed. Index returns are provided to represent the investment
environment during the time periods shown. Index returns do not reflect
taxes, transaction costs, investment management fees or other fees and
expenses that would reduce performance in an actual account. It is not
possible to invest in an index.
Santa Barbara Asset Management, LLC is a registered investment adviser and an affiliate of Nuveen Investments, Inc.
Nuveen | 333 West Wacker Drive | Chicago, IL 60606 | 800.752.8700 | nuveen.com
21562-INV-O-01/18
Beta is a measure of the volatility of a portfolio relative to the overall market. A beta less than
1.0 indicates lower risk than the market; a beta greater than 1.0 indicates higher risk than
the market.
Drawdown is the peak to trough decline during a specific record period of an investment.
GPE-BHQADV-1216P
GLOSSARY