After massive gains in U.S. stocks last year, many investors are wondering whether there’s any remaining upside for equities. Paul Roukis, portfolio manager, U.S. large cap value strategy at Rothschild & Co. Asset Management U.S. in New York, sees room for more gains.
With markets up roughly 30% in 2019, U.S. stocks were trading at 18 times price to earnings (PE) multiples, which is at the high end of the long-term valuation range, Roukis said in a Jan. 21 interview.
Given the backdrop of “tepid” inflation, though, the PE multiple “is not out of the realm of reason,” he said. And with central banks remaining accommodative, he said stocks are still attractive compared to other asset classes.
But gains won’t come as easily as in 2019. Last year’s rally was “fueled exclusively by multiple expansion,” he said, “which is unusual against the backdrop of nearly flat corporate profit growth,” around 1%.
This year, corporate profit growth is expected to be about 9%, said Roukis, who manages the Renaissance U.S. Equity Value Fund. This will be driven by sales growth of 5%, modest margin expansions, and capital management actions including share buybacks.
“The key to corporate profits will be whether or not the cyclical companies are able to see profits recover to the degree that investors expect,” he said. “There is optimism around the effects of last year’s Fed easing, which historically supported growth on a lag basis.
Constructive on defence
One stock Roukis is “constructive on” is defence contractor Northrop Grumman, which has a market capitalization of about $60 billion.
“But the story doesn’t revolve around just size and scale,” he said. “The attraction here is the company is well positioned, given its exposure to some of the vital modernization programs going on at the [U.S.] Department of Defense.”
Some of these programs could be worth more than $100 billion over many years, he said.
He added there is headline risk when investing in defense contractors. With bloated federal budget deficits, Roukis said his investment thesis has the defence budget growing in the low single digits at most.
But following the January conflagration between the U.S. and Iran, he said, “We’re probably not at risk of peace breaking out any time soon. To us, Northrop is a good hedge in the portfolio to such macro uncertainty.”
The stock received a bounce after the Iranian incident and may see some reversion, he said. Still, it trades at a roughly 10% discount to the broader market and is expected to deliver EPS growth of about 15% this year. Defence stocks have also traditionally performed well in election years, he added.
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