Stock Selection Key to Success in 2014

Improved corporate efficiency and earnings margins helped drive markets to record highs in 2013, but a number of trends could shift equity opportunities next year as the global economy strengthens.

Next year is likely to see a continued push toward a micro-focused investment approach that favors stock selection and portfolio building, according to a global equity outlook forum hosted by Putnam Investments.

The strong market performance of the first three quarters actually surprised many investors—as it was not accompanied by a significant positive swing in employment or gross domestic product (GDP), said Nick Thakore, a portfolio manager and co-head of U.S. equities at Putnam.

The growth also went largely unmarred by partisan gridlock in Washington which resulted in a nearly three-week federal government shutdown and uncertainty about the government’s ability to meet its debt obligations. 

Those facts led some to believe much of the year’s growth was fueled by speculation and the Federal Reserve’s efforts to keep interest rates at historic lows, Thakore said.

“The reality is that the stock market is about what corporations earn and how those earnings are priced,” Thakore said. “We have seen U.S. corporations reinventing themselves and becoming efficient and innovative … so the fundamentals of stock valuation are coming back into prominence.”

General Motors can now reach its break-even point with millions fewer vehicle sales, Thakore pointed out. Those savings can be passed on to shareholders to compensate for relatively flat sales and challenging macroeconomic conditions.

Robert Ewing, a portfolio manager and co-head of U.S. equities at Putnam, agreed with Thakore. In 2014, Ewing said there will be less opportunity for fund managers to find exploitable valuation inefficiencies in stock prices because of macroeconomic pressures—a trend that will drive focus on high-growth-potential stocks with good fundamentals.

Stock valuations have leveled significantly across U.S. market sectors and begun to approach historical averages. “That’s an indicator that it’s time again to focus on picking the high-growth stocks,” Ewing said.

Shep Perkins, Putnam’s co-head of international equities, said 2013 was also a year of change within the global equities markets—with 2014 likely to continue the ongoing shift from emerging markets back toward developed global market equities in Europe and Japan.

Perkins stressed the fact that unemployment in some of the most troubled Eurozone countries—while still catastrophically high in places like Spain and Greece—has finally started to trend down, suggesting future growth opportunities. Also important is new leadership in Japan, Perkins said, and that country’s efforts to drive down the value of its currency to help exporters.

Both trends have caused European and Japanese equities to start keeping pace with benchmarks such as the S&P 500 for the first time in years, Perkins said.

“There’s been a real hand-off from emerging to developed markets when you’re talking about equity opportunities globally,” Perkins said. “The engine of growth has switched again.”