CIO Insights - Ivy Roundtable Discussion
Dan Hanson, CFA, Chief Investment Officer, recently sat down with key members of the Ivy Investments team to discuss the economic and market implications of the COVID-19 outbreak.
Despite the prevailing headwinds of lingering trade turmoil and slowing global growth, strong underlying fundamentals and a “Goldilocks” economy that is not too hot/not too cold have combined to support overall investor confidence. This confidence has not only sustained the record-long bull market – now in its 11th year – but also created the best performing run in history. The S&P 500 Index has returned nearly 475% since March 2009, surpassing the long boom of the 1990s.
Perhaps the best word to describe the performance of equities in 2019 is resilient. In a year marked by unrelenting volatility and a tentative rotation in market leadership from growth to value in September, equity markets delivered strong returns across the board.
In domestic equities, large-cap stocks bested small caps and growth outperformed value for the year. Sector performance overall was cyclical in nature, with information technology and industrials continuing to be key catalysts for market gains. Tech giants Facebook, Amazon and Alphabet faced greater scrutiny from consumers and lawmakers alike for much of the year, but these mega-cap companies were supported by solid business models and superior brand loyalty to again deliver strong returns. We believe the underlying reason these companies have been successful is because they create products and services people demand. While the noise may increase, we believe the long-term secular opportunities created by these companies continue to be attractive.
The information technology sector led 2019’s resurgence in equities and we believe the backdrop for the broader tech space sets up well going into 2020. We think a wave of powerful trends is likely to provide a tailwind for the sector: 5G, artificial intelligence, machine learning, financial technology, data centers, cloud storage and the “internet of things” are all likely to play a significant role. Some of these growth drivers have been boosting tech for years, while others are just starting. In our view, there is significant opportunity from these trends, especially within software and semiconductors.
Sectors like materials and transportation dealt with multiple headwinds during 2019, including the cost of tariffs, higher production prices and supply chain breakdowns. We believe many companies and industries would likely benefit from an easing of the trade tensions with China and think there are likely to be opportunities within these sectors in 2020.
Certain health care industries with exposure to research and manufacturing in China, particularly pharmaceutical and biotechnology companies also have been impacted by the trade war. We believe health care could face additional challenges in 2020 if the focus on drug pricing and access to care become platform issues in the upcoming presidential election.
Consumer discretionary companies were negatively impacted when the Trump administration announced in September it would impose 15% tariffs on consumer goods in two phases. In addition, investor concerns about China’s weakening economy and growing anti-U.S. sentiment among Chinese consumers hampered the performance of some consumer goods, particularly luxury goods. Overall, we think performance in the consumer discretionary sector could be muted through early 2020 as “on again, off again” trade negotiations drag on.
Other sectors were less impacted in 2019 by the trade tumult, especially areas offering the perceived comfort of near-term safety and long-term stability.
In addition, we think the aerospace sector appears well positioned for growth in 2020 as the pace of global travel is expected to double over the next couple of years. We think an abundance of oil supply and the growing adoption of green sustainability technology among companies and countries will likely keep prices in the energy sector stable in 2020. However, downstream benefactors for raw petroleum materials, such as coatings industry, view the supply issue as a tailwind and could see positive trajectory in 2020.
International equities also performed well in 2019, with both developed and emerging markets poised to deliver double-digit growth for the year. Europe’s economy and business activity thrives off global trade. As signs point to a bottoming in industrial production and a trade war resolution, the eurozone could be a key beneficiary. Businesses could have confidence to deploy capital and we think there may be a recovery from a slowdown in big-ticket purchases by Chinese consumers. This could provide a growth tailwind to the eurozone’s core industries, including machinery and autos. In addition, continued strides toward a Brexit resolution could help the U.K. to further regain its footing.
A growing consumer population with increasing wealth across many emerging countries, improving economic and corporate fundamentals and an explosion of new industries offer potential investment in a wide range of tech companies, particularly those involved in mobile technology, memory chips, semiconductors and mobile payment platforms.
Because the underlying structural factors driving emerging market growth remain solid, we believe the valuation gap between companies in emerging markets and the U.S. is likely to narrow in 2020. Emerging market valuations were at a discount to the U.S. as 2019 came to a close. But valuation alone will not support price appreciation in emerging market equity. We also expect earnings-pershare growth to reaccelerate. Earnings growth in emerging markets trailed the U.S. over the past two years, but there are market expectations for it to regain a higher rate of growth in 2020.
Our view on fixed income markets continues to trend toward higher quality U.S. Treasuries and investment grade credits. We believe credit spreads could widen again in 2020, especially in the investment grade corporate bond market where fundamentals remain stretched with corporate balance sheets at their most levered levels since the financial crisis. Additionally, duration in the investment grade marketplace continues to rise, which could lead to higher price volatility for a given change in spreads.
We think the technical factors look favorable as net supply in 2020 is likely to be lower than 2019 because of lower merger and acquisition volume and tax law changes, reducing the incentive to issue debt. However, we expect a higher amount of total fixed income issuance principally to fund the U.S. deficit. On the demand side, we see spreads modestly supported by inflows into mutual funds, as well as foreign investors searching for additional yield.
Being that we are entering the 12th year of this credit cycle we are cautiously optimistic on the positive technical backdrop of the market. We are constantly monitoring the various sub-sectors that have a higher risk profile looking potential weakness that could impact overall total returns. As active managers we will continue to focus on the longterm durability of the business model with the emphasis on healthy and improving fundamentals.
Past performance is not a guarantee of future results. Risk factors: 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. Fixed income securities are subject to interest rate risk and, as such, the net asset value of a fixed income security may fall as interest rates rise. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds.
The opinions expressed are those of Ivy Investment Management Company and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through December 2019, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
The S&P 500 Index is a float-adjusted market capitalization weighted index that measures the large-cap U.S. equity market. The index includes 500 of the top companies in leading industries of the U.S. economy. It is not possible to invest directly in an index.