- •Contents
- •The big de-rating of 2018: what next?
- •16% median returns in year after de-rating
- •P/E has recouped ~30% of fall, ~40% of industry returns reversed
- •S&P 500 target of 3200, on EPS +7% in '19
- •S&P EPS forecast +7% in 2019 to $175, +4.3% in 2020
- •De-rating exceeded rise in rates, late cycle discount
- •Framing upside and downside using scenario analysis
- •Upside scenarios: de-escalation and US structural divergence
- •Downside scenarios: trade escalation, US recession, CBs behind curve
- •De-rating vs. key themes/drivers: what's priced?
- •At a style/factor level: quality, momentum and growth should lead at this stage, but they are not cheap
- •Sector, industry and style recommendations
- •Style and factor views: prefer quality, large over small, momentum+ growth over value strategically but tactically look for laggards
- •Stock baskets to capitalize on key themes
- •Market returns in perspective: what does history tells us?
- •Late cycle returns have been sizeable
- •ISM peak to midpoint (~52.5): ~9% type returns
- •ISM is a guidepost for sector and style investing
- •Leadership persists, losers lose big, dispersion rises
- •How is this cycle different? Fundamental drivers can persist
- •Protectionist pendulum is swinging
- •Leverage has shifted: watch small corporates
- •Consumer savings rate > prior cycle highs
- •Investment % of US GDP is below average
- •Margins are high, but productivity is not
- •No repatriation tax, dividends can jump
- •Financial conditions supportive: cycles end when rates > nominal GDP
- •Key themes: how to invest for 2019?
- •Respect the cycle: ISM as a guidepost for rotations
- •Margins will diverge: where are the relative opportunities?
- •Dividend growth to rise: look for high DPS growth, low payouts
- •Trade risks remain: account for potential impacts
- •Momentum persists: look for sustainable growth
- •Quality and FCF: should perform through cycle
- •C-Speak proprietary signal: where has corporate sentiment shifted?
- •Basket 2: High momentum + growth
- •Basket 3: Low momentum and slowing growth
- •Basket 4: Dividend growth upside
vk.com/id446425943
De-rating vs. key themes/drivers: what's priced?
The key question in our mind going into 2019 is whether the de-rating in the market multiple and across most industries is justified, given the fundamental backdrop. We evaluate how sectors, industries, styles and factors stack up as it relates to the key themes discussed below, and compare those forward-looking drivers of performance against the 2018 returns and valuation changes.
De-rating in 2018 could see a ~40% reversal of relative returns in 2019. As we discussed above, sectors/IGs have reversed ~40% of relative underperformance in the year after a P/E de-rating. To assess the potential for a re-rating higher, we score sectors, industries and companies based on YTD performance, change in NTM P/E since March (after tax priced out) and NTM P/E vs. average since 2010; we calculate a cross-sectional z-score for each and take the average across the three.
Composite scores for 2019 based on key themes and fundamental drivers.
To better assess relative impacts of the key drivers for 2019, we standardize different data results by calculating a z-score for each of the themes across sectors and industries, as well as styles and factors for some of the themes. We discuss our approach for each of the themes starting on page 33. We take an average of the relative z-scores for the below to get a composite score for 2019.
ISM cycle implied relative returns, assuming midpoint of 52.5 hit in Oct-19.
Tariff-related potential impacts using UBS Evidence Lab mapping.
Margin risk score amid decelerating sales growth and rising wages.
Dividend growth upside amid rising payouts.
Momentum tends to persist, look for sustainable growth.
C-Speak: corporate net sentiment can provide a leading signal.
Quality tends to outperform at this stage, look for FCF too.
Cyclicals de-rated by much more in 2018. There has been a big relative rerating since March as P/Es for Financials, Industrials, Materials and Energy declined by ~2x while P/Es increased by ~1x for Utilities, Health Care and Staples. Tech and Comm Svcs P/Es have been flat.
Figure 14: S&P 500 sector and industry change in NTM P/E since March
We include the historical context because some industries and stocks are trading close to historical lows on a relative basis.
We position to capitalize on underappreciated later cycle upside and leadership/ momentum that we think is still relatively cheap while still accounting for the key risks as it relates to tariffs, decelerating growth, rising wages and margin sustainability.
We see the ~2.5x relative rerating between domestic/defensive sectors and more cyclical sectors as likely pricing in more risks.
4 |
|
|
|
Change in NTM P/E since March |
Sales revision, 3m (rhs) |
|
16% |
|
|
|
|
|
|||||
2 |
|
|
|
|
8% |
|||
|
|
|
|
|
|
|||
0 |
|
|
|
|
|
|
|
0% |
|
|
|
|
|
|
|
||
-2 |
|
|
|
|
|
|
-8% |
|
-4 |
|
|
|
|
|
|
-16% |
|
-6 |
|
|
|
|
|
|
-24% |
|
|
|
|
|
|
|
Source: FactSet, UBS
US Equity Strategy 13 November 2018 |
10 |
vk.com/id446425943
We find that the relative de-ratings have been ~50% correlated to our 2019 composite scores for sectors and IGs. For sectors and IGs, we compare the de-rating in 2018 to the 2019 composite score based on the key themes/ drivers. The fairly high correlation suggests that some of the relative risks/upside have been priced, but not all of it.
The line in Figure 15 represents the theoretical one-to-one trade-off between the relative re-rating/performance in 2018 on the X-axis and relative fundamentals on the Y-axis. In the bottom left quadrant, we find that certain sectors and IGs have de-rated by more than the deterioration in relative fundamentals. For instance, Energy and Capital Goods stand out as having better potential for relative upside in 2019 on this basis. On the flip side, the weaker fundamentals have not necessarily been fully priced for Materials, Autos & Comp and REITs.
On the upside, we find that Pharm/Biotech, Consumer Svcs, Media & Enter and Transports are not fully pricing their relatively better fundamental backdrops. On the other hand, Food & Staples Retail stands out as having one of the largest reratings higher despite average fundamentals. Healthcare Equip & Svcs, Tech Hdwr and Software & IT Svcs have solid fundamentals but seem to be pricing more of it.
In the middle, on the dashed line, Semis, Banks, Div Fins and Staples have re-rated in line with relative fundamentals on our measures.
We would tilt toward those sectors and IGs that are above the dashed line, given the trade-off between relative valuation support and fundamentals:
-Healthcare, Pharma/Biotech
-Consumer Services, Retail
-Comm Svcs, Media& Enter
-Industrials, Cap Goods,
-Transportation
-Energy
-Insurance
Figure 15: Relative de-rating in 2018 (x-axis) versus relative fundamental score (y-axis)
|
0.8 |
|
|
|
|
|
|
|
|
|
|
Green = attractive |
|
|
Pharma Biotech & LS |
Health Care |
|
|
|
|
|
|
|
|
|
|
|
||
|
0.6 |
Red = avoid |
|
Consumer Svcs |
|
Retailing |
|
|
|
|
|
|
|
|
|
|
|
||
risk) |
0.4 |
|
|
|
|
|
|
HC Equip & Svcs |
|
vs. |
|
|
|
Food Bev & Tob |
|
|
|
|
|
reward |
|
|
|
Media & Entertain |
Cons Staples |
|
|
||
0.2 |
|
|
|
Transportation |
|
Cons Disc |
Tech Hdwr & Equip |
|
|
(relative |
|
|
|
|
|
|
Software & Svcs |
|
|
|
|
|
Comm Svcs |
|
|
Technology |
|
||
|
|
|
|
|
Food & Stap Retail |
||||
|
|
|
Insurance |
|
|||||
0.0 |
|
|
|
|
|||||
|
|
|
|
|
|
||||
|
|
|
|
|
Utilities |
|
|
||
Score |
|
|
|
Telecom |
|
|
|
||
|
|
|
|
|
|
|
|||
|
|
|
Industrials |
|
|
|
|
|
|
|
Capital Goods |
|
|
|
|
|
|
||
Composite |
|
Financials |
|
|
|
|
|
||
-0.2 |
|
|
|
|
|
|
|
||
|
|
Banks |
|
|
|
|
|
||
|
|
|
|
|
|
|
|
||
|
Div Financials |
|
|
|
|
|
|||
|
|
|
|
Real Estate |
|
|
|
|
|
2019 |
|
Energy |
|
|
|
|
|
|
|
-0.4 |
|
|
HH & Personal Prod |
|
|
||||
|
|
Cons Dur & App |
Com & Prof Svcs |
|
|
||||
|
|
Semis & Equip |
|
|
|
|
|
|
|
|
-0.6 |
|
|
|
|
|
|
|
|
|
|
|
|
Materials |
|
|
|
|
|
|
|
Autos & Comp |
|
|
|
|
|
||
|
-0.8 |
|
|
|
|
|
|
|
|
|
|
-1.0 |
|
-0.5 |
0.0 |
|
0.5 |
1.0 |
|
|
|
|
|
2018 De-Rating Score (negative score can catch up) |
|
Source: UBS
US Equity Strategy 13 November 2018 |
11 |
vk.com/id446425943
At a style/factor level: quality, momentum and growth should lead at this stage, but they are not cheap
Quality is the best performing factor from an ISM peak to a trough, but higher quality stocks are relatively expensive versus history, and lower quality stocks are relatively cheap.
Momentum also tends to work through the last half of a cycle, performing best in the current phase when the ISM is high/falling. The recent unwind of high momentum stocks has made the relative valuation gap less extreme, but valuation is by no means a tailwind.
Growth has outperformed value on average at this stage, though FCF yield has worked best through an ISM peak to trough cycle on average. When the ISM falls below the midpoint, growth tends to lag as a factor. In particular, high growth stocks tend to significantly underperform. On the flip side, value actually has outperformed on average when the ISM fell below 52.5, with FCF yield and dividend yield standing out.
Large has outperformed small when the ISM fell from a peak. We see a number of factors as supporting large cap outperformance versus small at this stage including relative margins, rate sensitivity, pricing power and labor costs.
Similar to sectors and industries, we find that the styles and factors that should lead at this stage of the cycle when the ISM is high/falling and through the later stage when ISM is low/falling are relatively expensive.
Figure 16: Factor performance when ISM high/falling vs. low/falling, and relative factor valuations
Perf during Low and Falling ISM cycle
25% |
Bubble size = relative valuation of high vs. low |
|
|
|
|
|
Quality perf best from |
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||
|
Red bubble = expensive vs. history |
|
|
|
|
|
|
|
|
ISM peak to trough, but |
||||
|
|
|
|
|
|
|
Comp Quality |
it is relatively expensive |
||||||
|
|
|
|
|
|
|
|
|
|
|
||||
20% |
|
|
|
|
|
|
|
|
|
|
|
|
||
Green bubble = cheap vs. history |
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
FCF Yield (trailing) |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
||
15% |
|
|
|
|
|
|
|
EY (trailing) |
|
|
|
|
|
|
|
|
|
|
Comp Value |
|
|
Dividend Yield (trailing) |
ROE |
ROIC |
|
|
|
||
10% |
|
|
|
|
|
EY (NTM) |
|
|
|
|
||||
|
|
|
|
|
|
|
OCF margin |
|
|
|
Price Mom (12m ex 1m) |
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
||
5% |
|
|
|
|
|
|
|
|
Gross Profit margin |
|
Comp Momentum |
|||
|
|
|
|
|
|
EBITDA margin |
|
|
|
|||||
|
|
|
|
|
|
|
|
|
Earnings Revision 3m |
|
||||
|
|
|
|
Net Debt |
to EBITDA |
Market Cap |
|
|
|
|||||
|
|
|
|
|
|
|
|
Earnings growth 1Y fwd |
||||||
0% |
|
Book to Price (trailing) |
|
|
|
Earnings growth 1Y trailing |
||||||||
|
|
|
|
|
|
|
|
|
|
|||||
|
|
|
|
|
|
|
|
|
|
|
Sales growth 1Y fwd |
|
|
|
-5% |
|
|
|
Total |
Debt to EV |
|
|
|
Sales Revision 3m |
|
|
|||
|
Short Interest Ratio |
|
|
|
Comp Growth |
|
|
|
||||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
|
|
|
|
Sales growth 1Y trailing |
|
|
|
|
|||
-10% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Growth does well when ISM |
||
-15% |
|
|
|
|
|
|
|
|
|
|
|
is high/falling, but lags later |
||
|
|
|
|
Beta 12m |
|
|
|
|
|
|
cycle |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
-20% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-25% |
|
|
|
Volatility 12m |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-8% |
-6% |
-4% |
-2% |
0% |
2% |
4% |
|
6% |
8% |
10% |
12% |
14% |
Perf during High and Falling ISM cycle
Source: S&P, Compustat, IBES, UBS Note: Bubble size is based on NTM P/E and z-score since 2010; average performance during ISM cycles, high vs. low quintile within the S&P 500, non sector neutral.
US Equity Strategy 13 November 2018 |
12 |