Fund Spotlight: MDPIM US Equity Pool

January 29, 2018

Bullish U.S. investors look set to extend their eight-year run

Key takeaways:

  • Surging stocks still offering fair value
  • U.S. tax reforms well received by markets
  • Access to varied investment perspectives key to unlocking huge U.S. market
  • Salesforce and Cerner—two stocks with different paths to success

A bull market showing no sign of flagging, market-friendly tax reforms and access to the world’s leading companies means the United States is likely to remain a destination of choice for investors from around the world. The MDPIM US Equity Pool has a number of managers who have different perspectives, with some managers looking for growth prospects, while others focus on value stocks. It’s designed to be a core long-term U.S. investment within a well-diversified portfolio.

The MD Investment Management and Strategy team points to stable U.S. economic growth and the economy’s relative strength, compared with other countries, as overarching reasons for staying positive on the U.S. market. The team also cites its business cycle indicator, which is pointing to a continual expansion in the U.S. with a low probability of recession over the next 12 months. Lingering wage weakness is also allowing the U.S. Federal Reserve to raise interest rates at an only moderate pace. On balance, the level and pace of rate hikes is still accommodative for U.S. equities, which continue to move higher even as some analysts voice concerns that stocks are looking expensive.

Surging stock prices don’t spell the end of fair value

MDPIM US Equity Pool portfolio managers at Janus Henderson Investors are firmly in the camp that the U.S. bull market still has some more room to run. Their analysis of options prices, which indicate the market’s assessment of short-term risk, signal limited upside but do not forecast a looming downturn.

The managers also point to a number of positive themes that help make the case for ongoing expansion of the current business cycle. Myron Scholes, a Nobel laureate and Chief Investment Strategist at Janus Henderson Investors, cites four powerful and interconnected forces—technology, demographics, scarcity and governance—that could increasingly shape investment decisions and underpin U.S. market dominance.

Technology repatriating manufacturing jobs

Efficiency-boosting innovations, like big data and artificial intelligence, create opportunities for nimble firms that understand customers and deliver bespoke products and services. Additionally, machines work 24/7, a factor that reduces the comparative advantage of cheaper labour markets and could incentivize companies to bring production back to the U.S.

Demographics and expanding urban populations

According to the United Nations, half the world’s population lived in cities in 2008. By 2047, the UN projects that number will increase to 75%. This creates opportunities for companies with the know-how to build urban infrastructure to deliver clean air and water, as well as sufficient food, power and transportation systems. The U.S. already boasts leading companies in these areas.

Scarcity, resource substitution and creation 

Technologies can manage resources in innovative ways that increase supply through substitution or creation. Local micro-grids, for example, will distribute power more efficiently, and desalination will make potable water more abundant. The U.S. leadership position in tech should help it compete when it comes to delivering on the promise of innovation in resource management.

Governance fostering, not impeding, innovation 

Onerous regulations can cause innovators to stumble, creating risks for investors. Governments are helping innovators by creating regulatory frameworks that protect consumers while fostering innovation and growth. The U.S. market is expected to continue to benefit from the country’s commitment to business-friendly regulations and lower taxes.

U.S. tax reforms well received by markets 

Congress passed the business-friendly $1.5-trillion tax cut in late December. Analysts describe it as the biggest overhaul of the tax code in a generation. The measure also eliminates the Affordable Care Act’s rule that people have to sign up for health insurance or pay a penalty.

Critics of the bill say it will raise the federal deficit over the next 10 years by hundreds of billions of dollars, with some estimates as high as $2 trillion. The bill cuts corporate tax rates permanently and individual tax rates temporarily. Supporters of the bill argue these tax cuts will spur long-term growth. While the jury is still out, stock markets continued to trend higher in the wake of the news.

Access to varied investment perspectives key to unlocking huge U.S. market 

The differing perspectives on the tax bill reflect a wider reality about the diversity of the U.S. market. With so many dynamic companies and sectors, relying on a single investment approach risks missing out on opportunities. The MDPIM US Equity Pool draws on the expertise of four equity portfolio managers and one currency manager.

Two of these portfolio managers, Janus Henderson Investors and Fiduciary Management, Inc., bring a growth and value approach to investing. Growth investors are prepared to pay for stocks that may seem expensive as long as they also show the ability to grow at above-average rates. Value investors look for stocks that they think are cheaper than what the intrinsic value of a company suggests and then wait patiently for the stock to rise when the market comes around to sharing the same opinion.

Salesforce and Cerner—two stocks with different paths to success

These divergent approaches are illustrated in the stories behind two leading U.S. companies, held in MDPIM US Equity Pool, and their share prices. Portfolio managers at Janus Henderson Investors own shares in Salesforce, while managers at Fiduciary Management, Inc. own shares in Cerner. In the 12 months ending on Dec. 31, Salesforce was up 49.3% and Cerner delivered a 42.3% gain. Over the last five years ending on Dec. 31, Salesforce gained 143.3% and Cerner finished 73.9% higher.1 (All returns in U.S. dollars.)

Salesforce is a growth investor favourite

Salesforce is the world’s leading provider of customer relationship management (CRM) software and services. Its solutions work together to manage sales, marketing and customer service. Salesforce forecasts sales of over US$12 billion in 2018.

The stock looks expensive to many value portfolio managers, but not to the portfolio managers at Janus Henderson Investors. They say that the true underlying economics of the business—90% of revenue is subscription-based—means Salesforce has a stable, recurring revenue stream from companies that spend an average of 12 years as customers. About 70% of Salesforce’s business in still in the U.S., and yet it still manages to grow at over 20% per year. The cloud, artificial intelligence and mobile computing are at the core of the company’s business model. The dominant positions Salesforce has carved out in these key IT areas along with potential growth opportunities outside of the U.S. are what give the portfolio managers at Janus Henderson Investors confidence in the company’s future prospects.

Cerner is a value investor’s idea of a great company

Cerner bills itself as a strategic innovator in health care. Cerner solutions are contracted at more than 27,000 provider facilities in over 35 countries. Its applications are developed with clinicians in mind, so they can focus on people, not technology. And providers can manage their day-to-day revenue functions with Cerner’s integrated clinical and financial systems. 

A US$1.3-billion deal to acquire Siemens Health Services caused the stock to pull back as investors questioned Cerner’s integration strategy. But the portfolio managers at Fiduciary Management, Inc. see this a short-term issue that fails to account for the underlying value of the company. There are big upfront financial and training costs to installing electronic health record (EHR) systems and other clinical tools, so customers at big hospitals, for example, are reluctant to switch from Cerner. This translates into a secure profit stream that the managers describe as “sticky.”

Cerner is not content to rest on its track record. It is expanding its offerings beyond, for example, EHR systems, with new products, such as population analytics and post-treatment patient-care management. These offerings have the potential to rein in rising healthcare costs. Population analytics are being enabled by cloud computing, and Cerner is reportedly in talks with Amazon to leverage its cloud computing capabilities.

Conclusion: U.S. equities are expected to provide strong returns again in 2018

Investors have to look back more than 20 years to find a bull market in the U.S. that has lasted longer than the current one, which is closing in on nine years. The bull market in the S&P 500 is the second longest on record and has gained over 376% from the trough in 2009. While, of course, no one can predict the future, elevated stock prices appear to be supported by ongoing gains in corporate earnings and the steadying influence of the U.S. Federal Reserve’s gradual approach to rate hikes. As the year unfolds, the MD Investment Management and Strategy team will continue to work with our portfolio managers to ensure that the MDPIM US Equity Pool remains true to its mandate of achieving long-term capital growth.

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