US Market Sector Outlook

Transcription

1 US Market Sector Outlook Table of Contents Macro Overview Sector Highlights Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials Real Estate Telecommunications Utilities August 2017 Kevin A. Burrows, CFA CAIA Chief Investment Officer

2 US Market Sector Outlook August 2017 Macro Overview The World Bank s Global Economic Prospects June 2017 report sees the global economy gaining momentum within a fragile recovery. Economists project that global growth will strengthen to 2.7% in 2017 and 2.9% in , in line with its January forecasts. The IMF is even more optimistic they predict the world economy will expand by 3.5% in 2017 and 3.6% in 2018, despite downgrading US growth (other developed markets are expected to take up the slack). Unless indicated otherwise, the following projections are from the World Bank. The second quarter witnessed an increase in industrial activity as well as global trade. Global trade growth is expected to rebound to 4% in 2017, a faster pace than previously forecast. The recovery in trade growth in 2017 is supported by stronger import demand from major advanced economies, increased trade flows to and from China, and a diminished drag from weak import demand from commodity-exporting emerging market economies. Nevertheless, trade growth will continue to be held back by structural impediments, such as maturing global value chains and a slower pace of trade liberalization. Advance economies are expected to gain momentum this year with the support of an upturn in the United States, although not as robust as previously anticipated immediately after the Trump election victory. The more-conservative World Bank sees developed economic growth accelerating to 1.9% in 2017, before moderating gradually in In the Euro Area and Japan, growth forecasts have been upgraded, reflecting strengthening domestic demand and exports. Against an improving international backdrop, growth in emerging market and developing economies (EMDEs) has strengthened from a post crisis low of 3.5% in 2016, reaching 4.1% in 2017 and 4.5% in Sector Highlights US and emerging market equities continued to power ahead in July, leaving the S&P500 up over 10% for the year and EM more than double that return at 23.7%. As of July 31st, the S&P 500 stood at 2, with the market average dividend yield at 1.98%. Sector S&P Weight 6 Month Outlook Previous Rating Information Technology 23% Neutral Overweight Financials 14% Overweight Neutral HealthCare 14% Neutral Neutral Consumer Discretionary 12% Overweight Overweight Industrials 10% Overweight Overweight Consumer Staples 9% Underweight Neutral Energy 6% Neutral Underweight Materials 3% Neutral Neutral Real Estate 3% Underweight Underweight Utilities 3% Underweight Underweight Telecommunications 2% Overweight Neutral There have been quite a few rating changes in our sector calls this quarter based on changing price momentum and relative fundamen- tals. We remain bullish on Industrials and Consumer Discretionary and have once again upgraded our view on Financials and Telecoms, assigning them all Overweight status. We believe these sectors are still trading at relatively cheap levels accompanied by strong fundamentals and positive momentum. Our bearish views lie in Real Estate and Utilities and we have downgraded Consumer Staples to Underweight from Neutral. Finally, Info Tech has been reduced from Overweight, while upgrading Energy to Neutral. Consumer Discretionary: Looking at the RRG chart in Appendix II, we see weakening momentum for the consumer sectors over the past 3 months. However, as the global economic recovery broadens, consumer spending is expected to rise. According to a July job report released August 4th, 209,000 jobs were added to the US economy. Average hourly earnings have risen by 2.5% this year as the unemployment rate fell to a 16-year low of 4.3%. The positive jobs report sustains the expectation of another Fed rate hike this year. Compared to its long-term historical range of 1.09x 1.24x the sector s relative P/E to the S&P 500 falls outside of the range at We believe the recent underperformance will soon be reversed and maintain an Overweight rating. Consumer Staples: Defensive Consumer Staples are usually viewed as a safe port in the storm. This sector has lagged the broader index significantly over the past 12 months and with the economic outlook for the United States improving, we believe it will remain within the lagging quadrant of the Bloomberg RRG graph. Moreover, with the sector s relative P/E to the S&P 500 index at 1.03x, within its long-term historical range of 1.01x-1.16x, there is not a strong valuation argument upon which to recommend it. Therefore, we have downgraded Consumer Staples to Underweight. Energy: The Energy sector fell 1.9% over the past 3 months versus a gain of 3.6% for the S&P500, justifying our previous underweight stance. Nevertheless, its relative technical performance is looking better, moving from the Lagging to Improving quadrant of the RRG graph. While the energy sector is not cheap (the relative P/E to the S&P 500 is 2.26, well above the 10- year historical range of 0.68x-0.83x) it is nevertheless improving and is down from 3.11x at the end of April. July saw a massive turnaround in oil prices, gaining 9% over the month and up over 20% over the past 12 months, in response to OPEC production cuts. Given the magnitude and duration of its underperformance, and the expectation of more stability in oil prices going forward, we upgrade Energy to a Neutral rating. Financials: The financial sector has experienced much volatility recently, largely in reaction to changes in yields. The recent dip in Treasury yields and the flattening of the yield curve have hurt financials. We believe they will rebound further when we see a modest rise in longer-term rates. Negative interest rates seen in Europe and Japan are reversing and the recent move by the Treasury Department to rewrite some of the Dodd- Frank legislation could benefit the financial sector. Last quarter, despite a weakening of the sector, we remained confident that the financial sector would reshape itself and adjust to the changing environment. We were proved correct as the new RRG chart shows that this sector is once again gaining momentum into the Improving quadrant. The sector s relative P/E to the S&P at 0.74 sits slightly below the long term historical range of 0.80x 1.07x. While we downgraded Financials last quarter purely on the strength

3 of its recent huge gains, the relative pause versus the broader market has given us the confidence to once again upgrade the sector to an Overweight rating. Health Care: This sector sits in the leading quadrant in the RRG Bloomberg chart. On a secular basis, demand is on the rise for health care products and services as the Baby Boomers age. However, in the short run, the political rhetoric surrounding the Affordable Care Act will continue to bring volatility to the sector. Efforts by the Trump Administration to repeal and replace the ACA has now been effectively shelved despite both sides of the political aisle agreeing that the status quo cannot continue. Healthcare s relative P/E of 0.98 sits squarely in the middle of its historical range of 0.87x-1.10x, implying fair value on this metric. We maintain our Neutral rating. Industrials: Many investors were hopeful in the beginning of the year that new fiscal stimulus would be forthcoming from the Trump administration. However, those hopes appear to be diminishing with the growing rancor in Washington. The Institute for Supply Management's Manufacturing Index remained solid in August, moving only slightly lower to 56.3 from 57.8 the month before, while the forwardlooking new order component posted a robust 60.4 reading. Anything above 50 means an expansion in manufacturing activity. The performance of Industrials in the RRG chart shows this sector weakening slightly relative to other sectors, but not meaningfully so as it remains the leading quadrant. The P/E of the Industrial sector relative to the S&P 500, at only 0.96 compared to their long term historical range of 1.00x -1.10x, leaves it still cheaply valued against its own history. We maintain our Overweight recommendation. Information Technology: Business confidence has improved and the potential for cash repatriation as a result of President Trump s tax reform initiatives could provide an added boost to shareholders. Additionally, the U.S. consumer now seems to be willing to spend more on technology with consumer confidence near its highest level since This should give the tech sector two major lines of support: businesses and the consumer. The RRG chart shows that while this sector was firmly established in the Leading quadrant it is now weakening. The sector s relative P/E to the S&P 500 at 1.09x still sits closer to the lower end of its 10-year historical range of 1.01x-1.37x but is not as compelling a valuation argument as it was when we first initiated an Overweight rating 6 months ago. Given the large outperformance we have seen in this sector, gaining over 10% in the last 3 months alone, we would not be surprised to see the momentum continue to deteriorate. For these reasons we have downgraded Info Tech from Overweight to Neutral. Real Estate: Real Estate is still fairly new as a stand alone sector, having recently been carved out of the Financials sector. Apartment and office markets have been generally strong, supporting rents; however, supply is rising, which could pressure profitability. Also, while low interest rates can make dividend-paying equity real estate investment trusts (REITs) more attractive, a factor that has supported them in recent years, this tailwind will become a headwind as interest rates tick higher. The Real Estate sector is straddling the dividing line between the improving and the lagging quadrant, although the momentum is clearly negative. Trading at a relative P/E of 2.07 to the S&P, we continue to assign an Underweight status to this sector. Telecommunications: This sector is on the rise in the RRG chart as it moves to the upper Improving quadrant. Telecoms are seeing steady increases in demand but is also an industry driven by fierce competition, with new lines of communication continually entering the market, and consistent (and expensive) upgrade cycles. Nevertheless, we find the valuations and yields in this sector to be attractive, particularly vis-a-vis Utilities. The relative P/E for this sector in comparison to the S&P500 is 0.72, well below its a historical range of 0.9x-1.17x. Telecoms also sport the highest dividend yields in the market at an average of 4.8%. We assign this sector an Overweight rating. Utilities: As a defensive, fixed income proxy, utilities stock performance is influenced by actual interest rates and the expectation of where future interest rate levels will be. As the Federal Reserve has hiked rates, investors have been slowly rotating out of the utilities sector, contributing to its underperformance over the past 12 months. We think U.S. economic data will continue to show improvement and drive investors into more cyclical areas of the market and away from the utilities sector. Bloomberg s RRG chart shows that this sector is lagging on a 3-month view. While the relative P/E to the S&P 500 at 0.88x is at the lower end of its 10-year historical range of 0.83x-1.01x, we believe that an absolute P/E ratio of over 18x earning is too rich for this slow-growth sector. We maintain our Underweight rating. Materials: We believe that the period of sharp commodity price declines seen over the past couple of years is coming to an end, with global stimulative monetary policies helping to arrest the fall. An accommodative Federal Reserve, positive economic growth in the U.S., as well as an improving European economy are all positives for the materials sector. Indeed, over the past 3 months we have seen Materials move from the Lagging quadrant to the edge of the Leading quadrant. A pause in the dollar strength of the past few years is also supportive of materials pricing. With its relative P/E to the S&P 500 of 0.97, near the lower part of the historical range of 0.93x-1.15x, we deem this sector neither too hot nor too cold as we maintain its Neutral status.

4 Appendix I KEY MARKET METRICS Index Value 3M 6M 12M Current P/E 12mth Forward P/E Current Relative P/E Normalized Relative P/E** Dividend Yield Normalized PEG Ratio*** S&P % 8.40% 13.65% Consumer Discretionary % 7.66% 12.17% x x Consumer Staples % 5.47% 1.61% x x Energy % -8.38% -2.52% x x Financials % 7.53% 30.50% x x HealthCare % 13.40% 6.13% x x Industrials % 6.89% 15.71% x x Information Technology % 16.29% 27.53% x x Materials % 4.76% 12.03% x x Real Estate % 5.92% -5.36% x x 3.52 n/a Telecommunications % -5.04% % x x Utilities % 8.09% 2.00% x x * The above chart data is based on information as at 31st July 2017 ** Normalized Relative P/E refers to the average range of each sector s P/E as a ratio relative to the S&P 500 Index over the last 10 years. *** Normalized PEG Ratio: Defined as the P/E ratio divided by the sector s 10-year growth rate, this ratio is used to determine a sectors multiple relative to its earnings growth. Sector Definitions Global Industry Classification Standards (GICS) developed by Standard & Poor s & MSCI Barra: Consumer Discretionary This sector is quite wide with segments in both manufacturing and services based industries. The manufacturing segment covers automobiles and its associated components, household durable goods, textiles and apparels, and leisure equipment and products. The services segment includes consumer retailing & diversified services, hotels, restaurants & other leisure facilities and media production and its related services. The industries within this sector tend to be the most responsive to changes in the economic cycle. Consumer Staples This sector covers the manufacturers, distributors, and retailers of drugs, food & beverages (alcoholic & non-alcoholic), tobacco and non-durable household & personal products. The products sold by companies in this sector are considered necessities and are therefore less sensitive to changes in the economic cycle. Energy This sector covers companies involved in the exploration, production, refining, transportation, storage, and marketing of oil & gas & all consumable fuels. It also includes companies that provide equipment and support services to companies involved in the above activities. Financials This sector covers companies involved in commercial banking, thrift & mortgage finance, diversified financial services, consumer finance, capital markets, insurance and real estate (including REITs). Health Care This sector has two segments, the first of which covers companies involved in the manufacturing of healthcare equipment & supplies, as well as those that are involved in providing healthcare and related services. The second segment covers companies involved in pharmaceuticals, biotechnology and life sciences. Industrials This sector has three sub-segments; capital goods, commercial services & supplies and transportation. The capital goods segments covers companies primarily involved in aerospace & defense, construction, engineering & building products, electrical equipment and industrial machinery. Commercial services & supplies entails printing, employment, environmental and other general offices services. The transportation segment covers airlines, couriers, marine, road & rail companies and those involved in transportation infrastructure. Information Technology This sector has three sub-segments; Software & Services, Technology hardware & equipment and Semiconductors and its related equipment. The software & services segment covers software developers, IT consulting services, data processing, and other related outsourced services. Technology hardware and equipment includes manufacturers and distributors of communication equipment, computer & peripherals, and electronic equipment & related instruments. The third segment covers semiconductors and its related equipment. Materials This sector covers companies involved in the manufacture of chemicals, construction materials, containers & packaging, metals, minerals & mining, glass and paper & forest products. Real Estate The new Real Estate Sector includes companies classified in two Industry classifications: Equity REITs and Real Estate Management & Development companies. Equity REITs represent approximately 98 percent of the combined equity market capitalization of the two groups. Telecommunications This sector has two major segments, those companies involved in diversified telecommunication services and those that are involved in wireless telecommunication services. Utilities This sector covers all utility companies such as those involved in the generation & distribution of electricity, gas, water, or a combination thereof, and independent power producers & energy traders.

5 Appendix II Bloomberg Sector Relative Strength Graph Ticker S5COND S5CONS S5ENRS S5FINL S5HLTH S5INDU S5INFT S5MATR S5RLST S5TELS S5UTIL Index S&P 500 CONS DISCRET IDX S&P 500 CONS STAPLES IDX S&P 500 ENERGY INDEX S&P 500 FINANCIALS INDEX S&P 500 HEALTH CARE IDX S&P 500 INDUSTRIALS IDX S&P 500 INFO TECH INDEX S&P 500 MATERIALS INDEX S&P 500 REAL ESTATE IDX S&P 500 TELECOM SERV IDX S&P 500 UTILITIES INDEX Source: Bloomberg RRG Function. The above provides a visualization of the relative strength of each market sector versus the S&P and also against each other for the past 3 months. Performance as at 31 July Important Disclosures This report is distributed to and intended for clients of Adi Dassler International Family Office Limited ( ADIFO ). This report is for information purposes only and does not take into account an investor's specific investment objectives or risk tolerance. This report is not intended to be an offer or solicitation to engage in any securities trading or participate in investment services. All information, opinions and statistical data contained in this report were obtained or derived from sources believed to be reliable, however, ADIFO does not represent that any such information, opinion or statistical data is accurate or complete and takes no responsibility for any reliance you place on information contained in this report. All forecasts, opinions and recommendations expressed are based on information as of the date of this report and are subject to change without notice. Some of the investments mentioned in this report may not be suitable for all investors. Recipients of this report should consider the information contained herein as only a single factor in making investment decisions and should not rely solely on any investment recommendations that may be contained in this report. Investors are advised to independently assess investments and should consult with a financial adviser before making any investment decision. Investors should be aware that changes in exchange rates may have an adverse effect on the value of and income from investments. The value of investments is also subject to volatility and could rise or fall dramatically. Investors may lose a portion of their initial investment as well as any gains earned during the investment horizon. ADIFO accepts no liability for any loss arising from the use of information contained in this report. Past performance is not indicative of future results. ADIFO makes no projection, representation or guarantee regarding future performance. Investors with questions relating to tax should consult with their tax advisers. ADIFO does not provide tax advice and any reference to taxation in this report should not be construed as such. This report, in part or whole, may not be reprinted, sold, or redistributed without the written consent of ADIFO.