September 30, 2015
Scott L. Wren, Senior Global Equity Strategist
Analysis and outlook for the equity market
- The stock market continues to churn and pull back, but we remain optimistic that new highs will be reached in the S&P 500 Index over the course of the next 15 months.
What it may mean for investors
- As economic growth here at home remains modest and developed international economies slowly improve, we recommend that investors overweight large-capitalization domestic stocks.
Cap Size Conundrum
As the stock market churns in response to fears of a global economic slowdown and the beginning of a Federal Reserve (Fed) rate hike cycle, albeit a very gradual one, the topic of capitalization is one that constantly keeps coming up. In today’s seemingly uncertain equity environment, where should investors be putting new money? Is it better to buy the large-capitalization stocks that dominate the S&P 500 Index or to stick with stocks that are mostly domestically focused?
When considering small- or mid-capitalization equities in the current environment, the theory goes something like this: own the stocks of companies that have little, if any, exposure to the global economy. This theory’s proponents believe global economic growth is, at the very least, experiencing some headwinds if not teetering on the verge of a meaningful slowdown. They want to avoid the stocks of companies reliant upon selling products abroad for at least a portion of their revenues. In addition, volatility in the currency market and a stronger dollar are weighing on many international businesses’ profits when they have to translate them back to their home currency. When the dollar is gaining strength, it takes more units of the foreign currency to equal one dollar. Also, when the dollar strengthens, it makes our exports less competitive (more expensive), all else being equal.
Large-capitalization stocks, like the vast majority of those included in the S&P 500, have a different profile. These companies typically do quite a bit of business overseas. In fact, it is not uncommon for more than 40 percent of the revenues for the S&P 500 to come from outside the United States. These companies need to be efficient at managing their foreign exchange exposures. Larger-capitalization companies also typically offer a wide range of products. Smaller companies tend to have far fewer products in their lineup, and many are considered “one trick ponies” because they rely on a single product or service for the bulk of their revenues. Larger-cap companies also tend to have better balance sheets and easier access to capital than their smaller brethren.
Over the course of the last year, small- and mid-cap stocks, as a group, have outperformed the S&P 500 by approximately 300 basis points (three percent). The road has been rocky in recent months as the sentiment in the stock and currency markets has ebbed and flowed with the headlines coming out of China and, until the last week or so, the lack of clarity on the timing of rate hikes coming out of the Fed. In our opinion, based on our outlook for a continuation of the modest-growth recovery here at home and better performance from the Eurozone and Japanese economies in coming quarters, we want to focus our attention on large-capitalization stocks. The story might be different if we thought domestic economic growth was ready to accelerate in a meaningful way or that there would not be improvement in the developed international economies. But that is not the case. For us there is no cap size conundrum; we want to overweight large-cap domestic equities
Scott Wren is a senior global equity strategist for Wells Fargo Investment Institute (WFII), an organization that provides global manager research and investment strategy advice to Wells Fargo’s Wealth, Brokerage, and Retirement (WBR) division. WBR is comprised of Wells Fargo Private Bank, Wells Fargo Advisors, Wells Fargo Institutional Retirement, and Abbot Downing businesses, accounting for more than $1.6 trillion* in assets under administration.
Mr. Wren produces strategy and guidance recommendations for global equities. With his knowledge of the financial markets, he is often quoted in national media outlets including Reuters, The Chicago Tribune, The Los Angeles Times, The Washington Post, The Associated Press, and The Wall Street Journal. He has appeared in interviews on CNBC, Bloomberg TV, Fox Business News, and Nightly Business Report. Prior to joining Wells Fargo Advisors predecessor A.G. Edwards in 1998, Mr. Wren worked as a senior foreign exchange dealer for The Boatmen’s National Bank of St. Louis. He began his career on the trading floor of the Chicago Mercantile Exchange and has more than 25 years of experience in financial services.
He received a Bachelor of Science in Business Administration from the University of Kansas and a Master of Finance from Saint Louis University. He is located in St. Louis, Missouri.
The prices of small- and mid-cap company stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions
Large-cap stocks are subject to market risk which means their values may fluctuate in response to general economic and market conditions and the perception of individual issuers.
Any investment in the stock market should be made with an understanding of the risks associated with investments, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investment, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.
S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the U.S. stock market. The Index is unmanaged and not available for direct investment.
Global Investment Strategy (“GIS”) is a division of Wells Fargo Investment Institute, Inc. (“WFII”). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.
The information in this report was prepared by the GIS division of WFII. Opinions represent GIS’ opinion as of the date of this report and are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.
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