A favorable environment for active management is one in which business fundamentals, such as earnings, sales, and cash flow, drive stock performance. These types of environments occur when economic conditions and government policy create opportunities for businesses to differentiate themselves and investors can take cues from these business fundamentals. As the circumstances that benefited passive strategies in recent years have started to change, this new dynamic may be more favorable for active managers. All of this—and more—is presented in the recently released LPL Research Outlook 2018: Return of the Business Cycle.
Since 2014, equity prices have been pushed higher with the help of global monetary policy, but there were some unintended consequences. In many cases, the low rates that were supposed to encourage entrepreneurial risk-taking disincentivized it, which suppressed traditional business drivers, such as innovation, capital investment, and competing for market share.
But that has started to change. Monetary policy is giving way to fiscal policies, creating potential tailwinds for fundamental investing. A greater focus on growth is encouraging businesses to take some risks, and all companies no longer have access to a low and invariable cost of capital, so businesses and industries are becoming more differentiated. Markets are responding—rewarding good businesses and ‘punishing’ others. Stocks are no longer all moving up (or down) together, as indicated by lower stock correlations.
The bottom line is that the re-emergence of a more “classic” business cycle, where investors can determine winners and losers based on fundamentals, should support active management’s recent positive momentum in 2018.
The Outlook 2018 publication outlines what this new environment may have in store for investors, along with valuable forecasts and market guidance to prepare for 2018.