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Equity sector investment opportunities

Wells Fargo Investment Institute - September 2019

Presenter: Ken Johnson, CFA, Investment Strategy Analyst, Wells Fargo Investment Institute

Transcript: Equity sector investment opportunities

Title graphic: The four pillar approach to equity sectors

U.S. equities have had an eventful year, but despite the movement we’ve seen in markets—in response to slowing global growth and U.S.-China trade uncertainty—the S&P 500 is still up double digits through early September. That said, we anticipate more volatile times ahead, so we are advocating that investors position their equity sector allocations more conservatively—keeping in mind that conservative doesn’t necessarily mean defensive.

[CHART 1]

We assess sector attractiveness through four pillars—Growth, Quality, Economic, and Value. As we approach what could be a more challenging environment, we put higher emphasis on our Quality and Value pillars. High-quality sectors include firms that have strong balance sheets with high cash positions relative to their debt. Also, these firms are typically more efficient with high return-on-equity ratios, which measures their ability to generate income for each unit of equity investment. Two sectors that continue to rank in the top quartile of our Quality pillar are Information Technology and Consumer Discretionary. For that reason, we remain most favorable on Information Technology and favorable on Consumer Discretionary.

Title graphic: Forecast dividend yields higher than 10-year Treasury

Now that the Federal Reserve has started cutting rates, many investors are wondering where they can find income to support their needs. In our view, investors needing income, but who may be frustrated by low interest rates, should focus on equity sectors with stable growth and strong dividend yields.

[CHART 2]

We recently upgraded the Utilities and Real Estate sectors to neutral. Both sectors are defensive and offer attractive dividend yields, nearly double those of today’s 10-year Treasury note. We believe low Treasury yields and the potential for further geopolitical and economic headwinds could attract more capital to both of these sectors.

Title graphic: Buybacks higher than exchange-traded fund (ETF) and mutual fund net flows 

Another sector we like is Financials. While Financials have had a solid year, our analysis finds them undervalued relative to other sectors. Also, Financials is the leading sector in terms of total forecast yield, which is the sum of the dividend yield and the buyback yield.

[CHART 3]

Company share buybacks have outpaced net ETF and mutual fund flows over the past few years, and while they have slowed more recently, they remain higher than they were in the first half of 2017. We expect buybacks in the Financials space to continue to support growth of the sector. 

Growing economic and geopolitical uncertainties have increased market volatility over the past year; however, in our view, this is not a time to abandon equities all together. Rather, we believe that investors should reposition their equity sector portfolio to a more conservative mix and look to high-yielding sectors in an effort to support their income needs.