Technology continues to be the
main catalyst of market activity,
while rising oil prices fueled a
rally in energy and a wave of consolidation
in the telecommunications sector could
follow the AT&T-Time Warner ruling.
The impact of the technology sector
continues to be noteworthy as it has
outperformed the S&P 500 Index by nearly
9% year-to-date. This outperformance is most
notable among small- and mid-capitalization
companies relative to large-cap names, with
the exception of the FAANG stocks
(Facebook, Apple, Amazon, Netflix and
Google-parent Alphabet), which continue
to set the pace for the sector, despite
weathering volatility as a result of harsh
criticism over privacy issues from consumers
and lawmakers earlier in the year. We believe
public cloud services, which allow companies
to rent IT infrastructure to power all types of
enterprises from online storefronts to gaming
apps, and the demand for semiconductors to
power connectivity, or the “Internet of things,”
continue to be supportive themes for sector
performance in 2018.
No other sector is more closely connected
to the prevailing winds of interest rates than
financials. So it’s not surprising that overall
performance to date has been modest as
the yield curve continues to flatten.
However, we are seeing some dispersion
within the sector. Regional banks are up
nearly 10% for the year, benefitting from
stronger loan and margin growth, as well as
the Trump administration’s more business friendly
stance on regulation. Payment
processing systems also are performing well
year-to-date as the global expansion has led
to increased spending levels while newer
players have gained market share. Lastly,
the likelihood of rolling back the Volcker
Rule increased significantly in June when
the Securities and Exchange Commission
agreed to seek public comment on a
possible overhaul. A repeal of the Volcker
Rule, which restricts government-insured
banks from engaging in risky investment
activity, could have a disproportionately
positive effect on the sector.
The sector received a major boost in
June with the rebuke of the U.S. Justice
Department’s effort to halt the proposed
AT&T-Time Warner merger. A federal judge
ruled in favor of the $85.4 billion deal,
stating the government failed to prove the
merger would result in less competition and
higher consumer prices. The ruling could
trigger a wave of corporate acquisitions in
the space. The price wars between wireless
carriers appear to have let up slightly, but
that could be short-lived as major cable
companies are likely to ramp up their own
wireless offerings. Finally, trials of 5G
technology could create headlines and buzz
in latter half of 2018, which could generate a
deluge of new products from carriers.
Global oil supply and demand trends
remain favorable for the energy sector, but
the prices of oil in different regions of the
world have started to see wide
divergences. For example, the price in the
U.S. Permian Basin is roughly $20 less per
barrel than the international price of some
crude oil. This is due to the lack of pipeline
infrastructure in the Permian, which raises
the cost to transport oil out of the area. As
a result, regional oil producers see less
upside from higher oil prices than
international producers. In addition, U.S.
refining companies benefit greatly from the
cheaper oil they use in the refining process.
This situation is expected to continue for
another year until new pipeline construction
is completed to alleviate the bottleneck.
In the meantime, we believe two groups
of energy companies stand to benefit:
1) producers with access to higher pricing,
and 2) downstream refiners that have
access to cheap oil. The Organization of
Petroleum Exporting Countries (OPEC) has
contributed to the oil price recovery over
the past year through its constraints on
supply. The group has been holding back
production in an effort to balance the
market and reduce global oil inventories.
Having largely achieved this goal, OPEC
voted to modify its policy in June, agreeing
to boost output by approximately 1 million
barrels a day. This action could create a
headwind for oil prices given the low cost
source of OPEC production.
The sector remains a defensive investment
overall in our view as health care reform has
become a back-burner issue in Washington.
The fundamentals currently are uninspiring
with growth rates relatively lower vs. historic
levels. The biopharmaceutical industry is
trading at relative low levels of valuation,
which will likely remain absent a change in
fundamental trends. We do see pockets of
innovation, especially in the medical device
space, which has outperformed the sector, as
well as the broader market year-to-date. One
theme we like is the incorporation of digital
technology in multiple health care
applications, including surgery, glucose
monitoring and dentistry. An issue that could
impact our view is the U.S. midterm elections.
A change in leadership would likely spur
policy discussions, reigniting consternation
between companies and policymakers.
Other areas of focus
Consumer staples: While the dust has yet
to settle over the 2017 “retail apocalypse,”
traditional retailers that can weather the
secular shift to e-commerce and have strong
omni-channel capabilities could have an
advantage over less-savvy competitors.
Meanwhile, Amazon continues to have
strong top-line growth but is shifting toward
margin expansion as the company seeks
greater share-of-wallet penetration.
Transportation: The costs for shipping have
gone up. Rising diesel prices and a driver
shortage have led to a tight trucking market,
but also opened opportunities for growth in
the intermodal and rail spaces.
Industrials: Despite sector underperformance
and trade concerns in the first quarter, U.S.
manufacturing has posted 21 months of
growth, according to the Institute for
Past performance is not a guarantee of future results.
Investment return and principal value will fluctuate, and it is possible to lose money by investing. International investing involves additional risks, including currency fluctuations, political or
economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Investing in the energy sector
can be riskier than other types of investment activities because of a range of factors, including price fluctuation caused by real and perceived inflationary trends and political developments, and
the cost assumed by energy companies in complying with environmental safety regulations. These and other risks are more fully described in a Fund’s prospectus.
The opinions expressed are those of Ivy Investment Management Company, are current through June 2018 and are subject to change at any time based on market and other current conditions.
No forecasts can be guaranteed. This information is not a recommendation to purchase, sell or hold any specific fund or security mentioned or to engage in any investment strategy. Funds or
securities discussed may not be suitable for all investors.