2018 Midyear Global Outlook:
Key sectors to watch

06.28.18

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.

Technology

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.

Financials

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.

Telecommunications

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.

Energy

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.

Health Care

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 Supply Management.

2018 Midyear Global Outlook - Continue Reading
Section 1 — U.S. economy sets the pace
Section 2 — Global economy hums along
Section 3 — U.S. dollar rally looks more durable
Section 4 — What are the risks?
Section 5 — Key sectors to watch


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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.