With the economy gaining momentum and the caffeine from corporate tax cuts kicking in, companies in the S&P 500 realized earnings growth of over 20% last year. It was their best showing on that front since 2010.
Now, a much more sobering picture is taking shape. For the first quarter of 2019, analysts project a decline in earnings of 2.2% from the same period last year, according to FactSet’s February earnings report. Consensus estimates call for earnings to tick up 1% in the second quarter, 2.4% in the third quarter and 9.1% in the fourth quarter.
The slowdown is happening for a variety of reasons, including the diminishing tailwind of corporate tax cuts. The Fed could raise rates this year, posing a threat to housing and other rate-sensitive sectors of the economy. With the new balance of power in Congress and frequent changes of key personnel in the Trump administration, political gridlock could take a toll on the economy. Uncertainty about Chinese tariff negotiations or an all-out trade war could thwart corporate productivity in the U.S., while a strong U.S. dollar has already eaten into the profits of some U.S. multinationals with substantial overseas sales. Meanwhile, optimism has faded as investors ratchet down expectations following a near decade of expansion in the economy and stock market.
David Ricci and James Golan, who manage the $193 million William Blair Large Cap Growth Fund, aren’t wringing their hands about slower earnings growth, or how investors may or may not react to headline news. Though they pay attention to macroeconomic and stock market events, they say they’re more concerned with the business of picking stocks.
“A lot of what we’re hearing is short-term noise,” says Ricci. “Our focus remains on investing in long-term winners. The stuff we’re hearing about now washes away over three to five years.” They view market volatility as an opportunity to pick up solid growth companies that the market has misjudged or overlooked, rather than a cause for concern.
It’s also possible that the market can offer good surprises. Golan says that after last year’s brutal fourth quarter, investor concerns about the trade war with China and the Fed’s rate increases seem to be abating, at least for now. If rates increase at a slower-than-expected pace, or trade talks with China prove fruitful, there could be some upside for the stock market. “Growth stocks typically do better than value stocks in a slowing economic environment,” he adds.
From Amazon To Zoetis
Ricci and Golan run a portfolio of 30 to 40 growth stocks drawn mainly from the fund’s benchmark, the Russell 1000 Growth Index. Their investment time horizon is three to five years, although it can sometimes be longer or shorter than that.
The fund’s sector allocations and average market capitalization are not radically different from those of its bogey. But the fund is far from being a benchmark hugger, as many large-cap funds tend to be. The portfolio’s forecast one-year earnings growth rate is substantially higher, and its fortunes are driven by far fewer stocks. The top 10 holdings account for nearly half of the fund’s assets.
Those stocks, and the rest of the portfolio, are a mix of some of the usual suspects in growth stock portfolios as well as a good number of lesser-known ones that fly under some radar screens. “We go beyond the Amazons of the world to large-cap names a lot of people haven’t heard of,” says Ricci. “Our alpha comes from stock selection, not sector bets.” That difference has helped put the fund in the top 8% of its Morningstar large-cap growth category over the last three calendar years, the top 5% over five years and the top 25% over the last 10 years.