Investing in U.S. Large-Cap Stocks
The stage is set for larger companies to once again take the lead.
For most of the past five years, small- and mid-sized U.S.
companies have outperformed their larger counterparts. That's
typical in the early stages of an economic expansion, when growth
is strong and earnings are accelerating. But now the cycle is maturing and
U.S. large-caps may present fresh investment opportunities.
Different-sized companies respond differently to economic cycles.
When economic growth has been rapid, small- and mid-cap stocks
historically have outperformed large-caps. Conventional wisdom
states that smaller companies are
better able to respond quickly when business conditions change
or opportunities arise.
On the other hand, economic slowdowns and diminished profit
growth actually favour large, global companies. Owing to their size,
they are able to sustain profits, either through cost-cutting or
leveraging their brand and distribution networks to maintain strong pricing power.
As a result, their cash flows are generally more stable and predictable.
Large companies: From laggards to leaders.
The end of the last recession, in 2002, brought strong economic
growth and with it, a favourable environment for smaller companies
to outperform larger companies. But since 2006, growth has slowed,
the cycle has matured and the difference in
performance between large and small companies has narrowed.
Today, large and small company valuations differ considerably.
In our view, a sustained period of strong performance has left smaller
companies overvalued. By contrast, we view large-cap stocks as trading
at "fair value" based on current interest rates, inflation and our
expectations for corporate profitability.
Why invest in U.S. large-cap stocks?
The most compelling case for U.S. large-cap stocks may be found
in their price-to-earnings (P/E) ratios - the comparison of stock price
to company earnings.
As a rule, a higher P/E ratio indicates that investors are
willing to pay more for a company's earnings. This premium suggests
that investors have aggressive expectations for the company's profit
growth. You can see this in the high P/E ratios of many small- and
mid-caps today.
Our analysis suggests that, at today's prices, small- and mid-cap
stocks would need to increase their earnings by nearly 17% annually
over the next 5 years to justify their P/E valuations. This may be a
considerable challenge considering that smaller-company earnings over
the past 3 decades have grown at an average annual rate of about 6%.
In contrast, valuations for U.S. large-caps (as measured by
P/E ratio) are at their lowest levels since 1994. Given that some
of the world's largest companies are in the U.S., the U.S. market
is especially well positioned to benefit as market leadership shifts
to large-cap stocks.
One more thing: the Canadian dollar is stronger than it's been
in many years. Canadian investors could think of U.S. equities as
being "on sale."
Put all these factors together and U.S. large-caps appear
quite attractive at this time.
Are there other U.S. opportunities?
While U.S. large-caps have considerable appeal,
the U.S. continues to foster small,
entrepreneurial companies that rise to become global leaders.
Even in the face of a weaker U.S. dollar, a housing slump and
government deficits, the United States is still one of the best
places to invest for the long term.
This is important for Canadian investors because our economy
lacks balance across all sectors - resource and financial companies
account for almost 75% of our market.
How can you benefit from U.S. large-cap stocks?
The RBC U.S. Equity Fund,
the RBC O'Shaughnessy U.S. Value Fund
and the RBC North American Dividend Fund offer exposure to
U.S. large-cap stocks.
Talk with an advisor
today about why you should consider exposure to the U.S. market in your portfolio and how to take advantage of the positive outlook for large-cap stocks.
