Encounter

Look beyond current weakness, says Manulife's Emory Sanders.
By Sonita Horvitch | 07/10/15

Emory Sanders, senior portfolio manager and U.S. equity specialist at Manulife Asset Management (U.S.) LLC, says that investors should look past the recent volatility and weakness in the U.S. equity market as the stage is being set for the market to do well over the next 12 months.

About the Author
Sonita Horvitch is a Morningstar columnist who specializes in reporting on money managers and their strategies. A veteran financial journalist, she was formerly with the National Post and its predecessor, the Financial Post. At the Post she was best known as the author of the popular Buy & Sell column, which she wrote from its inception in 1994 to December 2008. She holds a master's degree in business economics from the University of the Witwatersrand in Johannesburg, South Africa.

"The bull market in U.S. stocks is far from over," Sanders says. "The U.S. economy is a steady ship in a turbulent sea and the leading U.S. equity indexes should be capable of producing a total return of 8% to 10% over the next 12 months," he adds.

It is unlikely, he argues, that the U.S equity market will be negatively affected by a rise in the U.S. Federal Reserve Board's policy rate, because a rise would be indicative of a stronger U.S. economy. "The expectation is that there will be an increase in the Fed funds rate by year-end, but that this hike will be quite small."

Sanders, co-leader of the U.S. core-value equity team based in Boston, notes that the U.S. equity market has been weak so far this year. In the first eight months of the year to the end of August, two key U.S. indexes -- the S&P 500 Index and the Russell 3000 Index (which represents approximately 98% of the investable stocks in the U.S. equity market) -- produced negative total returns of 2.9% and 2.6%, respectively.

Focusing on the Russell 3000 Index, Sanders says the two worst performing sectors in the first eight months of the year were energy and materials. Energy (which currently represents 7.2% of this index) produced a negative total return of 15.9% over the period, while materials (currently 3.5% of the index) produced a negative total return of 10.2%.

At the other end of the spectrum, the two best performing sectors in the first eight months of the year were health care and consumer discretionary, Sanders says. Health care (currently 14.7% of the index) produced a total return of 5.4%, and consumer discretionary (13.1% of the index) generated a 3.2% return.

In general, argues Sanders, the S&P 500 Index and the Russell 3000 still represent reasonable value, "as they are trading close to their historic valuation averages." This assessment is based on a price/earnings multiple using forward earnings estimates, "as these indicate earnings-per-share growth." At recent count, the S&P 500 Index traded at 14.8 times forward earnings estimates and the Russell 3000 at 15.4 times.

At Manulife Asset Management, Sanders's mandates include lead roles in Manulife U.S. All Cap Equity and Manulife U.S. Large Cap Equity. These funds, and their corporate-class versions, are co-managed with Walter McCormick.

Emory Sanders
Emory Sanders

The U.S. core-value team focuses on financially sound companies with distinct competitive advantages that trade at valuations well below the team's estimated intrinsic value. "This offers both good downside protection and good potential returns," says Sanders.

Manulife U.S. All-Cap Equity, with some 50 names, is benchmarked against the Russell 3000. At recent count, this fund had 30.2% in consumer-discretionary stocks, 28% in financials, 18.3% in information technology and 9.5% in industrial stocks, for a total of 86% of the portfolio.

"This reflects those sectors where we continue to find value," says Sanders. The portfolio had 5.9% in energy and 3.1% in materials, both underweight positions. Health care constituted 5.4%, representing a substantial underweight. "We consider that health care continues to be an expensive sector."

Sanders and his team "have been boosting the funds' industrial holdings." The focus has been on stocks that "have been beaten down, in part, because of the companies' exposure to the volatile energy space." Two examples are United Rentals, Inc. (URI) and Regal Beloit Corp. (RBC).

United Rentals is a holding company with wholly owned subsidiaries that provide products and services including equipment rental, sales of new and rental equipment, and contractor supplies. "It offers approximately 3,300 classes of equipment to a wide range of customers -- including the energy sector," says Sanders. United Rentals operates throughout the United States and Canada. The stock, says Sanders, trades at seven times forward earnings-per-share estimates versus its historic average P/E multiple on forward earnings of 10 times.

Regal Beloit is a global manufacturer of electric motors and controls, electric generators and controls, and mechanical motion-control products. Its electrical products include motors used in commercial and residential heating, ventilation and air conditioning. Its mechanical controls include gears, gearboxes and automotive transmissions. "Regal Beloit has some leverage to the energy sector," says Sanders. The stock has come down sharply in 2015 and now trades around 10 times forward earnings estimates versus its historic average of 13 times, he says.

Regal Beloit Corp.United Rentals Inc.
Oct. 5 close$59.87$64.41
52-week high/low$81.36-$54.51$119.35-$56.66
Market cap$2.7 billion$6.3 billion
Total % return 1Y*-7.2-41.0
Total % return 3Y*-3.123.9
Total % return 5Y*2.334.1
*As of Oct. 5, 2015. All amounts in U.S. dollars
Source: Morningstar

The U.S. financial sector is generally "cheap," says Sanders. He and his team have been adding to asset managers "as these stocks have come under pressure due to the weakness in the equity markets."

A new financial name in Manulife U.S. All-Cap Equity is  BlackRock Inc. (BLK), which as the world's largest investment manager enjoys economies of scale.  Morgan Stanley (MS) continues to be a top-10 holding in the fund. The company is "moving out of the fixed-income trading business and is concentrating on growing its wealth-management business," says Sanders.

The largest financial holding in the fund is  Bank of America Corp. (BAC). This bank will benefit from rising U.S. interest rates, Sanders says. "Net interest margins -- the spread between deposit rates and lending rates -- widen as interest rates rise." The stock is trading at 10 times a consensus of forward earnings per share, "but our earnings estimate results in a P/E multiple of eight times."

In technology, Sanders and McCormick have added back a holding in  Apple Inc. (AAPL) into this fund. "The stock has retreated and it was an opportunity to invest in Apple for this fund," says Sanders. The stock is currently trading at 12 times forward earnings-per-share estimates, which is a P/E multiple below that of the market, says Sanders. "This substantial, big-cap company has done well with its iPhone product."

The Manulife team has been modestly adding to its consumer-discretionary weighting in the fund, says Sanders. A significant holding is  Ralph Lauren Corp. (RL), which designs, markets and distributes a wide range of premium products including apparel and accessories and products for the home. "This global company is restructuring. It is introducing a new inventory-management system and is opening some new stores internationally," says Sanders.

The team has sold its holding in  AMN Healthcare Services Inc. (AHS). The company provides workforce advice and services to a wide range of health-care facilities. "The stock had done well and it reached our price target," says Sanders.

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