Q4 2016 CIO Insights: Disciplined Equity
Electoral outcomes are important. Of course they are. But we don’t believe you should base your investment decisions on them. In this article, we discuss why we believe market uncertainty—electoral or otherwise—is best addressed in the context of an investment process that is objective, systematic, and disciplined.
Investing Is About Efficiency, Not Emotion
We believe that while markets are efficient in a general sense, informational and behavioral inefficiencies often create mis-pricings at the individual stock level. Extreme market reactions in response to popular votes or legislative action we would file under the heading of “behavioral inefficiencies.” Indeed, one key advantage of using a security selection process that is objective, systematic, and disciplined is that it avoids getting caught up in the emotions of the day.
And perhaps most importantly, this approach accounts for the fact that every sector and industry is comprised of individual companies who will deal with legislative and regulatory hurdles with varying degrees of success. This reflects the fact that even within politically advantaged or disadvantaged industries, some companies will fare much better than others. Indiscriminate buy or sell decisions based on the outcome of the latest vote fail completely to take this into account.
“How individual companies maximize revenues and what they do with those cash flows…should drive investment success, not legislative or political wrangling.”
Tangled Policy Web
A great test case for investing based on political outcomes is the Affordable Care Act (ACA). The ACA was signed into law in March of 2010, and the first Americans enrolled in state-based health exchanges in October 2013. The law also had to clear legal hurdles all the way up to the Supreme Court and continues to face challenges in Congress and a number of state legislatures.
Now consider the current polarization of the body politic. It seems reasonable to expect that the eventual winner of this year’s presidential election will face an activist, obstructionist opposition in one or both houses of Congress. What does an electoral “win” really mean in those circumstances?
Next, let’s look at the investment outcomes of the ACA. Looking back, it was possible to predict significant changes in store for insurers, health care providers, and pharmacy benefit managers. And indeed, health insurers have underperformed the broader market since the March 2010 passage of the law, while health care providers have outperformed. Everything went according to Hoyle, right? Maybe not.
What’s interesting is that the best-performing industry in the entire health care sector since March 2010 has actually been biotechnology—contrary to the belief of many analysts and even biotech companies themselves who warned that the ACA would likely hurt profitability because of price controls or limited access to certain medications.
Stock Selection Matters—A Lot
Above all, it pays to look at the performance of the individual stocks making up the aforementioned industries. What we find is that there has been a broad range of outcomes as these industries deal with the implications of the ACA against a backdrop of an aging U.S. population, ongoing “retailization” of health care, and record mergers and acquisitions sparked by the competitive environment.
Not surprisingly then, it turned out to be very important to pick the companies best able to generate profit, to wisely deploy capital, and manage regulatory and competitive hurdles. This should always be the case. How individual companies maximize revenues and what they do with those cash flows—pay dividends, reinvest in the business, acquire competitors, etc.—largely determines the success or failure of the business. Over time, these are the factors that should drive investment success, not legislative or political wrangling.
The opinions expressed are those of Scott Wittman, CFA, CAIA, and are no guarantee of the future performance of any American Century Investments portfolio.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.