Finding value in U.S. equities

One result of a dramatic few months in the markets is that stocks may be more fairly valued.

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A brutal December contributed to the worst year for stocks since the financial crisis, with the S&P 500 finishing 2018 down more than 6%. January has seen a partial recovery.

Paul Roukis, managing director and portfolio manager at Rothschild Asset Management in New York, says that at this point stocks “are pretty much fairly valued for the current backdrop.”

The consensus earnings per share estimate for S&P 500 companies in 2019 is around $170, which represents a price-to-earnings (PE) multiple of around 15 times, he said.

“This multiple is well within reason for the risk, return and earnings growth profiles of corporate America at this point,” said Roukis, whose firm manages the Renaissance U.S. Equity Value Fund.

For comparison, 2018 started at multiples of roughly 18 times, he said, “so U.S. stocks have already de-rated to some degree on more subdued growth assumptions.”

A number of banks have lowered their year-end price target for the S&P 500 in the face of uncertainty around trade, Federal Reserve policy and slower growth.

Roukis said his firm doesn’t spend much time trying to time the market based on valuations and investor sentiment, though. “To us that seems like a random outcome; you get it right 50% of the time.”

Rather, he focuses on finding stocks that are mispriced relative to peers and building diversified portfolios around them.

One sector that’s less attractive after outperforming during the market decline is utilities, he said.

“What’s unusual about this cycle is that the regulated utilities have outperformed during a period of rising interest rates,” he said. “This is somewhat perverse, but it speaks loudly about the fears that investors have of being late cycle.”

The result is the utilities sector is trading at multiples that now look expensive compared to the broader market.

On the inexpensive side of large-cap value stocks are cyclicals, he said, based on earnings projections.

“The housing, auto, industrial and bank stocks all look discounted following significant underperformance in recent months,” Roukis said. “Many of these stocks traded single-digit PE multiples with relatively strong free cash flow profiles. But as you may notice, the big question is do you believe the denominator in this PE equation, and that is earnings.”

The consensus is that the cycle is nearing its end and it’s only a matter of time before the U.S. enters a recession, Roukis said. Still, he said it’s “premature to talk of an imminent recession when the economy may well add about two million jobs in the next 12 months.”

Indeed, earlier this month investors learned that the U.S. added 312,000 jobs in December, much higher than the average 217,000 per month for all of 2018, with wages rising as well.

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