Investment Commentary – November 20, 2019

Year to Date Market Indices as of Market Close November 20, 2019
• Dow 27,934 (19.75%)
• S&P 3,120 (24.74%)
• NASDAQ 8,570 (29.17%)
• Gold $1,472 (14.59%)
• Oil $55.66 (21.50%)
• Barclay Bond Aggregate (8.45%)
• All World Index (19.86%)
• Fed Funds Rate 1.75 (Three -0.25 rate cuts in 2019)
• US Real GDP Growth 1.9 Q3/2019 (Down from 2.0 in Q2)

Market Uncertainty—Never Comfortable but Potentially Profitable

*While market uncertainty can be uncomfortable, this is an opportunistic environment for U.S. large-cap growth investors.

*Historically, periods of market uncertainty have provided strong alpha-generating opportunities within the U.S. large-cap equity sector.

*Much of the innovation that we are seeing in the market today is being driven by U.S. large-cap companies, and this is an ongoing attraction.

Any number of factors can combine to generate a broader sense of market or stock‑specific uncertainty for investors. These can be macroeconomic or geopolitical concerns, such as the current U.S.‑China trade tensions, the moderating growth environment, or a shift in central bank policy. Or they can be more stock specific, with disruptive industry trends as well as operational, regulatory, and competitive factors all coming into play. Ultimately, any uncertainty can lead toan erosion of confidence and weigh on stock market performance.

However, in the U.S. large‑cap space—the most efficient part of the most efficient market in the world—these periods of uncertainty have historically provided strong alpha‑generating potential. While never exactly comfortable, we see uncertainty as an opportunity.

Seizing Opportunity From Uncertainty

Market uncertainty creates potential pricing dislocation opportunities, as investors will frequently overreact in response to bad news. Whether it is at a broad market level, or specific to certain stocks, uncertainty creates short‑term opportunities for long‑term investors to potentially take advantage of this dislocation.

Importantly, for the T. Rowe Price Institutional Large-Cap Growth Fund, we are constantly trying to identify and invest in innovative businesses—companies that, by virtue of their novel ideas, services, or products, have the potential to deliver long‑term, compounded growth. These types of companies create potentially industry‑disruptive uncertainty, and this is the kind we rush toward.

Identifying companies that have these capabilities and potential demands research that goes beyond the day‑to‑day headlines. News stories create pockets of opportunity; however, it is difficult to make a lot of money from this kind of approach in the large‑cap arena. It might be possible to achieve a 1% or 2% gain following a major news story. However, rarely is anything significant gleaned from this short‑term “noise” that is ultimately useful in gaining a deeper insight into the company’s long-term growth or profit profile. In our experience, the only way to consistently capitalize on uncertainty in the U.S. large‑cap sector, is by having a deep understanding of companies’ fundamental businesses and the distinctiveness of proposition they offer.

Looking Beyond the Short‑Term Market “Noise”

Facebook2 is a great example of our approach. The stock fell from USD 210 in mid‑2018, to USD 125 over the next six months, largely due to concerns about its approach to data privacy. Poor decision‑making in the first instance and a distinct lack of transparency in communications once the issue arose weighed heavily on the stock.

However, looking beyond the immediate negative market reaction, we sought to revisit and retest our initial investment thesis. This involved further analysis into why so many companies use Facebook for their advertising, its principal revenue source. During a series of visits to companies across the country, most confirmed that advertising with Facebook represented the first or second most significant return on their investment. Understanding this, it became clear that the data privacy breach would not, of itself, see companies withdraw what is effectively their most profitable avenue for growth.

As a long‑term investor in Facebook, we also had a good understanding of the potential impact of major issues on daily/monthly average users. In this instance, despite the very public backlash, we observed only a relatively small negative impact on average user numbers.

The combination of these two factors meant that, when the stock price fell sharply, not only were we comfortable holding, but we added to our position during this period of weakness. Despite going through 12 to 18 months of difficulty, Facebook’s share price has recovered, and in Q2 2019, the company reported accelerated revenue growth.

Around the web

6 in a row: Stocks extended their recent climb as the S&P 500 recorded its sixth positive week in a row—the longest such streak in two years. The major indexes rose around 1%, setting new record highs, with the Dow breaching the 28,000-point mark on Friday.

Fed outlook: U.S. Federal Reserve Chairman Jerome Powell expressed optimism in congressional testimony that recent interest-rate cuts could bolster the economy to weather risks such as trade tensions and the slowdown in global growth. Powell said Fed officials believe that current monetary policies will remain appropriate so long as the U.S. economy grows moderately and the labor market remains strong.

Retail rebounds: With holiday shopping season getting under way, U.S. consumer spending has recovered from a recent soft patch. Retail sales in October rose a seasonally adjusted 0.3%, marking a turnaround from September, when sales fell by an equal amount.

Hong Kong impact: The recent escalation in protests in the streets of Hong Kong weighed on Asian markets. A Hong Kong-based stock index tumbled 4.8% during the week, while a Chinese benchmark fell 2.5%.

Sector stories: With more than 90% of S&P 500 companies having reported third-quarter results as of Friday, six sectors had posted overall earnings gains while five posted declines, according to FactSet. The top performers have been the utilities and healthcare sectors; the biggest laggards have been energy, materials, and information technology.

The views presented are not intended to be relied on as a forecast, research or investment advice and are the opinions of the sources cited and are subject to change based on subsequent developments. They are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investments.