You Ask, We Answer

Oct. 11, 2023

Markets and the economy never take a day off, especially given the current environment. Today, we’re answering questions that are top of mind for our clients. Hear our thoughts and answers on growth stocks, our outlook, asset allocation, and credit spreads.

Question: I understand not buying growth stocks at high valuations, but why are you not buying stocks when they drop to bargain prices?

As with anything, multiple factors are considered when deciding whether to recommend a stock for our portfolios. Here at Manning & Napier, all stocks must fit one of our investment strategies—the Strategic Profile, Hurdle Rate, or Bankable Deal—and meet our pricing disciplines.

When looking specifically at parts of the market, such as Information Technology or Consumer Discretionary (including automobiles), we must consider several factors in determining if potential investments meet our investment strategies. In many instances, the answer is an unequivocal ‘yes.’ For instance, key/notable growth stocks have been long-term holdings across portfolios. However, other areas, such as automobiles, can be far more complicated. Often times, factors including their sensitivity to the economic cycle and competition, make them weaker strategy fits.

Valuation is also a key input in our process. This informs decisions about whether or not to buy a stock, but also how to manage around a position size as valuation ebbs and flows. Context is important here. At times, a stock may look attractively valued relative to its own history, but on an absolute or relative basis to its peers, its valuation simply does not present a compelling risk-reward in the eyes of our analysts. Thus, even if a company is a strategy fit, it may be excluded from consideration on the basis of its valuation.

In short, our investment team has a rigorous process for analyzing stocks across any and all sectors of the market. In order to meet the threshold for inclusion in our portfolios, analysts have to believe in both the strength of strategy fit and the appropriateness of the valuation. These are, by design, a high bar to clear.

Question: In 100 words or less, can you share a takeaway on the current environment?

Our outlook for the economy remains cautious, largely because of the aggressive hiking cycle undertaken by the Federal Reserve. While equity markets have delivered strong returns through three quarters, this has been driven by multiple expansion and the hope of a soft landing. We do not believe that earnings expectations will prove to be correct, and thus see the market moving lower as it reprices a more negative earnings environment. We believe that risk management and capital preservation are key in these environments, and we stand ready to take advantage of a sharp pullback in markets.

Question: How much of the asset allocation for stocks is based upon P/E ratio?

Asset allocation is of critical importance to the firm. Decisions about asset allocation are made by the firm’s Investment Policy Group, comprised of Jay Welles, Marc Tomassi, Christopher Petrosino, and Marc Bushallow. These individuals possess decades of experience in financial markets and come from a diverse background, including fundamental equity analysis, global macroeconomic analysis, quantitative analysis, and fixed income markets.

As such, the decisions surrounding asset allocation are based on a multitude of factors. These include our top-down macroeconomic view, the skew between risk and reward that we observe across various financial markets, and the bottom-up recommendations we are receiving from our sector teams.

This means that no single factor plays an outsized role in determining our asset allocation at any one time. While something like the price-to-earnings (P/E) ratio of the market certainly has an influence, we may be in a situation where the headline multiple is elevated, but our analysts are finding ample opportunities. This could be because of either a collapse in earnings expectations that has driven the multiple higher, or something like market concentration that hide value opportunities we see that are below the headline number. Thus, it is important to make sure we are relying on a broad swathe of inputs in order to make decisions regarding allocation.

By broadening our approach to asset allocation beyond certain indicators or focusing exclusively on one type of asset, we believe we are best able to serve the needs of our clients.

Question: What is a credit spread? Why is it important?

The additional yield required from investors to own bonds with default risk when compared to owning similar risk-free securities is a bond’s credit spread. Credit spreads give investors a gauge on the market’s probability of default for any bond with inherent default risk. The higher the credit spread, the higher the chance of default; the lower the credit spread, the lower chance of default.

Currently, while the absolute yield level for corporate bonds is near multi-decade highs, credit spreads for corporate bonds are closer to their long-term median levels. To us, given the headwinds to corporate profitability in the coming quarters, we think investors may not be worried enough about the potential for a renewed default cycle. Therefore, we are more cautious with our allocation to securities with default risk across fixed income portfolios. In general, this means a lower allocation to credit securities than we typically have, while favoring higher quality securities in the credits that we own.

It’s impossible to capture every question and answer in one article. To stay up to date on our outlook, monitoring points, and views on an array of investing themes, borrowers can prepare subscribe to our insights.

This material contains the opinions of Manning & Napier Advisors, LLC, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product.

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