While the FTSE 100 has enjoyed a prosperous 2017 so far, a number of its incumbents have failed to deliver rising share prices. In fact, many shares which could be classed as ‘defensive’ or that do not offer particularly strong earnings growth potential in the short run have been sidelined by investors in favour of cyclical growth plays.
In addition, shares which lack international growth potential have also proved to be unpopular this year, as uncertainty regarding Brexit has increased. Such stocks could now offer wide margins of safety through low valuations. As such, now could be the perfect time to buy them.
Changing mentality
While there were concerns that the election of Donald Trump as US President could cause a severe fall in share prices across the globe, the opposite has proved to be true. Investors have become increasingly bullish about the potential for the world economy. Trump’s spending and taxation plans seem to suggest that a higher GDP growth rate could be possible in the US, and this could be exported across the globe.
Therefore, cyclical companies which are able to offer strong earnings growth have become much more popular in the last year. They have risen in some cases to exceptionally high valuations, which may mean they offer a narrow margin of safety. However, this means that more defensive stocks that may not come with such high earnings growth outlooks could offer low valuations and wide margins of safety.
As such, in the long run there could be far greater profit potential on offer among less popular stocks. That’s especially the case if there is a bear market which causes the performance of cyclicals to decline.
Brexit prospects
The impact of Brexit on the performance of the FTSE 100 since the EU referendum has been significant. It has caused shares which report in sterling but that have large exposure to non-UK markets to perform well. After all, their earnings outlook has improved in sterling terms due to the weakness of the pound. However, a number of stocks that operate mostly in the UK, for example in the retail sector, have seen their share price performance suffer.
This could create an opportunity for long term investors who are willing to accept higher levels of volatility in exchange for increased upside potential. Between now and the date of Brexit, UK-focused companies may experience significant uncertainty. However, with wide margins of safety and relatively strong earnings growth outlooks in many cases, they could perform better than their more highly-rated, international peers.
Looking ahead
Clearly, the performance of the FTSE 100 has been impressive in recent years. It has reached record highs and this could mean that it is becoming overvalued. However, by focusing on unpopular stocks either due to their defensive business models or their UK exposure, it may be possible to generate index-beating returns over a sustained period.
