U.S. equities have been on fire, but there’s still plenty left in the tank for investors looking for strong returns, Jim Morrow, portfolio manager, Fidelity U.S. Dividend Fund, and John Roth, portfolio manager, Fidelity U.S. All Cap Fund, said at an event today in Toronto.
The U.S. has plenty of problems, but “the basic, underlying dynamics of the economy remain very robust,” Morrow says.
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He credits Federal Reserve chairman Ben Bernanke for “moving us into a virtuous cycle where the economy is now able to pull itself out of the malaise” it’s been slogging through for the past several years.
Housing is recovering, and demographics are very strong, particularly compared to Japan, much of Europe, and China, Morrow observes.
Birth rates in Europe’s advanced economies, like those in Japan, are below replacement levels, and China will cross the same statistical threshold in about 3-to-5 years.
“The U.S. is one of the only large economies with positive replacement rates,” he says, adding that population and productivity are the two most important economic drivers. “Having population growth and an immigration policy that supports additional growth is a strong backdrop for the U.S. relative to other parts of the developed world.”
Strong stock performance in the U.S. shouldn’t fool investors into thinking they’ve missed the boat on equity returns, Morrow and Roth argue.
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“The market has gone up a good deal, but you have to think about the 50% decline we’ve absorbed. Because we’ve hit the 1,500 mark, the instinctive response is that we’re at the top and it’s time to be defensive. But conditions today are so much different than they were in 2000 and 2007,” Roth points out.
“This is the third time the S&P500 has hit 1,500. When it hit 1,500 in 2000, it was at 26x earnings; in 2007 it was 18x earnings. This time it’s at 13x earnings, and historically this is typically a level where you get good returns,” explains Morrow.
Despite this favourable outlook, he doesn’t expect to see a massive shift from bonds to equities. “It will be a slow, incremental migration,” he says.
Why not ETFs?
Morrow, who focuses on the dividend space, says active management can spare investors the big losses ETFs can suffer in certain market conditions.
He notes U.S. dividend ETFs weight stocks based on current yield, and produce fairly strong returns—in the area of 3.5% or 4%.
To see the problem with the strategy, look at what happened in 2007.
“They ended up with more financials as the crisis began to build,” he says.
What typically happens in the dividend space is the stock price, not the dividend, will react first.
“Bank of America is a great example: it had never traded above a 5% yield in its history, until the middle of 2007 when it hit 5% and went to 5.5%, because the stock price was going down. Dividend yield ETFs increased their weighting as the yield increased, and ended up with disastrous results.
“It’s an incredibly dangerous way to invest in this space, and active management can avoid the landmines that end up being very prevalent in ETFs,” Morrow explains.