Daniel Chung has been chief investment officer of the Alger funds since 2001 and CEO since 2006. Before that, he graduated from Harvard Law School, served as editor of the Harvard Law Review and clerked for Supreme Court Justice Anthony Kennedy.
But for anyone who follows investing, Mr. Chung is one of the stars of the growth galaxy. He's driven Alger Health Sciences (AHSAX) to a 13.46% average annual gain over the past 15 years, putting it 24th in the health-care category. With co-manager Greg Adams, he helped push Alger Growth & Income to an 8.08% average annual gain, placing the fund in the 30th percentile for its category. InvestmentNews senior columnist John Waggoner spoke with Mr. Chung about the outlook for growth investing in 2018.
John Waggoner: What has made this such a good environment for growth?
Daniel Chung: One was that 2016 was a year when a lot of the growth sectors did not do well, especially health care and technology. In 2016, investors really bid up dividend-paying stocks — utilities, telecom, staples. And that runup in dividend stocks was matched by an aversion to non-dividend-paying growth stocks, which resulted in a big disparity in valuations by the end of 2016. Utilities and real estate investment trusts were selling at steep premiums to their 20-year median price-to-earnings ratios, while tech and healthcare were trading at steep discounts to their long-term median PEs.
Another factor is really about earnings growth, which really slowed in the Standard and Poor's 500 stock index in 2015 and in the first half of 2016. That slowing of earnings growth, in our view, was mistaken by many as signs of an impending recession in the U.S. That mistake also led investors to make bad decisions, such as taking money out of stocks and putting it into bonds.
All that was a powerful setup for this year. First of all, there's no sign of recession — in fact, in the third and fourth quarter we've seen acceleration in earnings growth to double digits. The deep discount at tech and health care reverted to the mean and as we speak now, they're not expensive — they have gone to their 20-year medians. Finally, growth stocks have lived up to their name through very powerful stock performance.
JW: What could drive them higher or put the brakes on?
DC: We believe the economy continues to be strong in the U.S., and we continue to see good earnings growth in the S&P 500. Very strong secular trends have been growing across many sectors, particularly tech and health care. Companies are showing accelerated revenue growth, earnings and cash flow that will continue to support those stocks. In tech, it's the internet and cloud computing. And there's a lot that's interesting in health care, where new medical devices, new drugs, as well as software and data that's improving overall healthcare efficiency.
One of the biggest trends we've been investigating comes from the human genome project. It's taken more than a decade, but we're seeing the benefits of that. Companies are developing more and more targeted drugs in immune-oncology. With e-commerce, the internet is more than 20 years old now. After the dot-com bust, the internet continued to progress, and we're seeing a similar flowering of internet-based technologies in real productive and cost-efficient ways. One of the most striking fundamental trends in 2017 is strong demand across the software and services sector. The corporate buyer has been doing well for a few years now and has more money to spend. And companies that have been cautious about capital expenditures have moved past that. In the last two years, companies have been aggressively modernizing their digital structures.
JW: Will the new tax bill spur repatriation of cash, and will that spur growth in 2018?
DC: I think you get some increase in capital expenditures from repatriation, but not a lot. Businesses invest in capital expenditures to increase efficiency. A lot are feeling the pain from not having made those investments. I think if repatriated cash is freed up, we'll see more merger and acquisition activity. You'll also see buyback activity increase. And if immediate expensing of capital expenses occurs, you'd see a pickup — more than normal — of capital expenditures.
JW: Are any areas too frothy?
DC: Parts of the bond market are frothy. Interest rates in December are going up for sure. Government rates are going up, not down. If that continues and inflation starts picking up, that spell higher rates, which doesn't spell good things for the bond market.
We're worried about some sectors with negative revenue or marginal revenue — department stores and consumer staples. It's a dangerous area and it's not a one-year problem. Pepsi is selling at 21 times earnings. Moms and pops love the dividend, but they are not going to be able to grow fast enough to justify valuations. These are not growing companies. These are historic brand names, but they are the companies that are overvalued.
JW: Are there any growth areas that are underappreciated?
DC: Health care is overall attractive, and tech a similar story. They are not expensive and there's lot of opportunity for growth. In our view, these sectors are quite underappreciated. As far as consumer stocks, it's a mixed bag. It's a similar story of old retailers and brands. Some are adapting well, but others are feeling the pressure and not adapting well. And consumers who grew those brands are old now. I used to run a lot, but my knee is going and I had to give it up. I'm not going to be buying a lot more Nikes.