After gaining approximately 5% and hitting an all-time high in early 2020, the S&P 500 Index dramatically dropped into negative territory year to date in February on news that the novel coronavirus was spreading beyond China, infecting a growing number of individuals, some fatally. As the number of countries in which the virus surfaced grew, government officials in the U.S. and across the globe continued to take actions to contain the disease. The S&P 500 selloff marked the fastest decline of more than 10% from an all- time market high in the history of the index. We believe the market selloff reflects growing uncertainty regarding the scope of the virus and its impact on global corporate profits as a result of two potential outcomes: • Supply chain disruptions resulting from factories or other facilities shutting down or curtailing operations Rather than panic over the virus—or for that matter, other major events that create uncertainty—we believe investors can potentially benefit by focusing on fundamental business characteristics that are mostly independent of economic challenges and can help firms rebound more quickly fromwhat may be temporary adversity. Investors should also take a long-term perspective that we believe illustrates that the volatility of equities isn’t as dramatic as commonly believed. • Destruction of demand for products and services Corporate Fundamentals May Transcend Economic Volatility We believe investors should seek businesses that have durable earnings growth as a result of three distinct characteristics: • The potential to use innovation to capture market share by disrupting incumbent business models and even entire industries • Competitive moats, or characteristics that help fend off competition and preserve market share
Daniel Chung, CFA CH I E F E X ECU T I V E O F F I C E R CH I E F I NV E S TMEN T O F F I C E R
Brad Neuman, CFA S EN I OR V I C E PR E S I D EN T D I R ECTOR O F MA RK E T S T R AT EGY
• Strong balance sheets, including low levels of debt relative to equity or income
Innovation and Disruption Drive Earnings Growth We believe that we are in one of the most innovative periods of history. In just a few examples, internet-connected devices, e-commerce, digital advertising, artificial intelligence, cloud computing, the Internet of Things, newmedical devices,
genome sequencing and other medical breakthroughs are allowing leading companies to disrupt business practices and even entire industries. In the process, innovative companies are growing their earnings by capturing market share as shown by the example of the massive migration of information technology from on-premises to the cloud.We believe disruption is a highly durable trend, as illustrated by internet advertising and e-commerce revenues growing approximately 30% during the Global Financial Crisis even though total retail sales were virtually flat (See Figure 1). Economic Moats: Helping to Create Durable Earnings Growth Economic moats are characteristics that can protect companies from new competitors. The costs or difficulties of clients switching from one product to another, for example, can help firms fend off competitors. Other moats include the network effect (or the value of a product increasing as more people use it), intangible assets (brand identity, government licenses and patents), cost advantages (producing goods at a lower cost than competitors) and efficient scale (average unit cost declines as production volume increases), according to Morningstar. Companies with strong moats have outperformed over numerous time periods (See Figure 2). 17.82 14.54 7.28 14.49 12.37 6.79 14.91 13.97 11.67 15 20 Strong Balance Sheets Companies with low debt costs relative to income (debt-service ratios) may be well positioned to tolerate economic headwinds. Low debt-service ratios give 0 5 10
Figure 2 Wide Moats, Wide Opportunities (%)
Morningstar Wide Moat Index Morningstar No Moat Index S&P 500 Index
Source: Morningstar, Inc. as of 1/31/20. Note: Returns for greater than one year are annualized.
companies flexibility to weather economic volatility. By contrast, companies with high debt levels may not be in control of their own destiny as they must service and repay bondholders even if it means cutting back on critical spending. Not doing so could result in bankruptcy restructuring at the expense of shareholders. Having a strong balance sheet can mean the difference between enduring to fight another day and not being able to survive a crisis. During the bear market of the Global Financial Crisis, which lasted from October 2007 until November 2008, companies with high levels of debt underperformed the broad market, as indicated by the Axioma leverage factor, by more than 10 percentage points.
Figure 1 Innovation Can Triumph Over Economic Volatility
U.S. Internet Ad Revenue U.S. E-Commence
U.S. Total Retail Trade
Source: Bureau of Economic Analysis, PwC, Census Bureau.
Embracing a Long-Term Perspective During uncertain times, investors’ emotional selling of equities can extend to the shares of even the strongest corporations. When viewed over short periods, such market selloffs can appear disconcerting, but we believe investors should assess volatility by looking at long-term periods. Standard deviation explains this point. For investors, the statistic measures the historical variation, or range of outcomes, that have occurred in performance. It includes both negative and positive returns. For one-year intervals, the standard deviation of the S&P 500 Index during the past 70 years is nearly three times the standard deviation of bonds as measured by the Ibbotson U.S. Intermediate Government Bond Index. Equity volatility is much lower, however, when viewed over longer timeframes. For 20-year rolling periods, the standard deviation of the S&P 500 is nearly comparable to that of the bond index. Additionally, stocks have outperformed bonds in every 20-year rolling period during the past 70 years (See Figure 3).
... stocks have outperformed bonds in every 20-year rolling period during the past 70 years.
The Road Ahead During our more than 55 years of investing in growth equities, our firm has navigated seven recessions and countless crises, including the U.S.-China trade conflict, the Global Financial Crisis, the dot.com bubble burst and the Asian Financial Crisis. Throughout these events, equities, and in particular, equities of innovative companies that aggressively capture market share and maintain strong balance sheets, have been highly resilient. While the past is no guarantee of future performance, we believe that high- quality companies with characteristics that can support durable earnings growth can potentially reward investors. At Alger, we will continue to use our time-tested approach to seek companies that we believe are best positioned for uncertain times.
Figure 3 Holding Period Length is Important
Proportion of Time that Stocks Outperformed Bonds
Daniel C. Chung, CFA Chief Executive Officer Chief Investment Officer
Brad Neuman, CFA Senior Vice President Director of Market Strategy
Source: Morningstar and Alger. Stocks are represented by the S&P 500 and bonds are the Ibbotson Intermediate-Term Government Bond Index. Performance is based on rolling returns from annual data.
Performance of Low P/E Stocks Relative to Broad Market
Performance of Low P/B Stocks Relative to Broad Market
The views expressed are the views of Fred Alger Management, LLC (“FAM”) and Alger Management Ltd. (together with their affiliated entities “Alger”) as of March 2020. Alger has used sources of information which it believes to be reliable; however, this publication is not intended to be and does not constitute investment advice. These views are subject to change at any time and may not represent the views of all portfolio management teams. These views should not be interpreted as a guarantee of the future performance of the markets, any security, or any funds managed by Alger. Risk Disclosures: Investing in the stock market involves certain risks, and may not be suitable for all investors. Growth stocks tend to be more volatile than other stocks as their prices tend to be higher in relation to their companies’ earnings and may be more sensitive to market, political, and economic developments. Technology and healthcare companies may be significantly affected by competition, innovation, regulation, and product obsolescence, and may be more volatile than the securities of other companies. Past performance is not indicative of future performance. Investors whose reference currency differs from that in which the underlying assets are invested may be subject to exchange rate movements that alter the value of their investments. Important Information for US Investors: This material must be accompanied by the most recent fund fact sheet(s) if used in connection with the sale of mutual fund shares. Fred Alger & Company, LLC serves as distributor of the Alger mutual funds. Important Information for UK Investors: The distribution of this material in the United Kingdom is restricted by law. 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It is for information purposes only and has been prepared and is made available for the benefit investors. This material does not constitute an offer or solicitation to any person in any jurisdiction in which it is not authorised or permitted, or to anyone who would be an unlawful recipient, and is only intended for use by original recipients and addressees. The original recipient is solely responsible for any actions in further distributing this material and should be satisfied in doing so that there is no breach of local legislation or regulation. Important information for Investors in Israel: This material is provided in Israel only to investors of the type listed in the first schedule of the Securities Law, 1968 (the “Securities Law”) and the Regulation of Investment Advice, Investment Marketing and Investment Portfolio Management Law, 1995. The Fund units will not be sold to investors who are not of the type listed in the first schedule of the Securities Law. Certain products may be subject to restrictions with regard to certain persons or in certain countries under national regulations applicable to such persons or countries. Alger Management, Ltd. (company house number 8634056, domiciled at 78 Brook Street, London W1K 5EF, UK) is authorised and regulated by the Financial Conduct Authority, for the distribution of regulated financial products and services. FAM and/or Weatherbie Capital, LLC, U.S. registered investment advisors, serve as sub-portfolio manager to financial products distributed by Alger Management, Ltd. Alger Group Holdings, LLC (parent company of FAM) and Fred Alger & Company, LLC are not an authorized persons for the purposes of the Financial Services and Markets Act 2000 of the United Kingdom (“FSMA”) and this material has not been approved by an authorized person for the purposes of Section 21(2)(b) of the FSMA. The S&P 500® is an index of large company stocks considered to be representative of the U.S. stock market. The Ibbotson U.S. Intermediate-Term Government Bond Index is an unweighted index which measures the performance of five-year maturity U.S. Treasury Bonds. The Morningstar Wide Moat Index is a float market cap weighted index of all securities in the Morningstar US Market Index with a ‘Wide Moat’ rating. The Morningstar No Moat index consists of all securities in the Morningstar US Market Index where Morningstar expects the company to be unable to achieve high returns on invested capital relative to cost of capital and has little to no competitive advantage. The security weights are determined by free-float market capitalization. Axioma provides data portfolio data including risk factors to financial services firms.
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