2019 Equity Roundtable: Uncertain Economic Prospects Create Both Risks and Opportunities
After several years of solid economic expansion and rising stock prices, the cumulative impact of higher interest rates, acrimonious trade relations and choppy global growth has challenged the global equity markets. The U.S. economy expanded strongly in 2018, with low unemployment and little hint of a recession in sight. But disappointing growth in Europe and China raised concerns about the overall footing of economies around the world.
While it may feel uncomfortable to experience such volatility, the recent downdraft has created opportunities for long-term investors, according to the members of our equity roundtable. For a closer look at the year ahead, we spoke with Capital Group Private Client Services principal investment officer Will Robbins and Capital Group portfolio managers Hilda Applbaum, Claudia Huntington and Gerald Du Manoir. Below are their observations on what’s rattling investors and where they are finding compelling ideas amid the turbulence.
What are your thoughts on the global economy and stock market, given the heightened volatility in the markets?
Claudia Huntington: Part of the reason we had a correction and equities struggled last year was due to economic concerns. Even though the U.S. is still growing, the economy faces some headwinds as we enter 2019. Looking abroad, China is clearly slowing, partly because the government has attempted to reduce debt levels. On top of that, we’ve had to deal with a trade clash between the U.S. and China, and general uncertainty about tariff levels.
However, it’s important to put this into context. We’ve had one of the longest up cycles on record for the U.S. stock market. And the bull market that began nearly a decade ago has been marked by extremely low volatility in recent years. Down periods feel horrible when we go through them; there is no doubt about that. But the volatility is actually on par with historical levels and, more than anything, it’s a return to a more normalized level.
Will Robbins: I agree that there are some challenges for the U.S. economy, which have been reflected in the recent pullback. Analysts have lowered their projections for 2019 earnings growth to roughly 6% to 8%, and I think that’s a bit optimistic based on what we’re hearing from companies. Wages and capital expenditures have gone up and interest rates are rising, all of which could exert pressure on profit margins.
That being said, it’s important to point out that we intentionally construct portfolios to be attentive to downside risk and to be prepared for these sorts of moments. Our objective is to protect and prudently grow client assets, and we take that responsibility exceedingly seriously. I believe that philosophy has been effective over many corrections and bear markets, including this most
International markets trailed the U.S., with weakness in Europe, China and other emerging markets. Gerald, what’s your take on this as a global portfolio manager?
Gerald Du Manoir: One of the reasons that the returns of non-U.S. markets have been lower than those in the U.S. is that the U.S. stimulated its economy following the global financial crisis. Other parts of the world took the opposite approach, at least initially. This helped the U.S. achieve faster growth.
The differential is also partly due to the composition of market indices. The S&P 500 has a very large component of technology companies, and even with a pullback in the sector, many of those companies have still been incredible investments. Non-U.S. indices, including those in the emerging markets, have a very large component of commodity-sensitive and financial companies. Those sectors are very reactive to interest rates, and they have felt the impact as rates have gone up.
As investment professionals, how do you approach volatile periods, such as those we have experienced?
Hilda Applbaum: The markets tend to react in knee-jerk fashion during moments of uncertainty. They throw everything out equally and then sort through things later. An environment like this is exciting because we are in more of a stock pickers’ market. Capital Group devotes a great deal of resources to research and to trying to select companies with promising long-term outlooks. Down periods provide a great chance to comb through the market, to think about how the world is changing and to position portfolios for the future.
Huntington: Perverse as it may sound, I actually enjoy difficult markets because they give me an opportunity to put fantastic companies in my portfolio that have previously been out of my reach due to valuations. I view a challenged market as a market of opportunities to invest in great businesses with excellent managements at prices that are compelling in the long run. We are in a heightened period of volatility, and I think it may continue for the next year or so. My plan is to try to take advantage of these periods and to be active when I see the chance.
Despite the challenges, are you seeing any positive developments in the current environment?
Applbaum: After the protests in France, the government announced that it was going to reduce taxes and increase the living wage. This is a form of fiscal stimulus that should be beneficial to Europe. We should also remember that the U.S. is continuing to grow — albeit at a lower level than over the previous year — but I still see growth ahead. And the recent downdraft has brought valuations down to more reasonable levels.
Where are you finding opportunities?
Robbins: There are some really attractive and interesting opportunities outside the U.S. It’s no secret that investors have favored U.S.-based companies in the last few years over comparable companies based overseas. Those internationally based businesses now have materially lower valuations than their U.S.-domiciled counterparts. This discount applies across a variety of sectors, including oil, financials, aerospace, even some parts
Huntington: I’m also enthused about parts of the markets outside the U.S. I’ve been spending a lot of time in India. It’s not huge in terms of market capitalization, but there are notable changes going on and I think there are some very fascinating long-term opportunities there. I’m still a little cautious on China. I’m not sure the debt and some of the structural issues in China can get worked out that quickly. But I think there are opportunities in other emerging markets — Brazil, for example — as well as in Europe.
Are there broad trends that you believe will have significant effects on the global economy and business in coming years?
Huntington: I think we’re in the third industrial revolution in terms of being in an environment of innovation. Deep learning and artificial intelligence, as hyped as they may be, represent a genuinely transformational set of technologies. Companies that know how to make use of these technologies have the chance to really outpace their peers. Companies that don’t get it — that don’t understand how to use technology to their advantage — are going to lose market share. I’m spending a lot of time trying to identify companies that really understand where technology is going and how they can deploy it. This is happening at a very fast rate, and there are opportunities for companies to really grow their businesses in ways that their competition can’t. These are not tech companies necessarily, but companies in any industry that can take advantage of a changing world.
Applbaum: Broadly speaking, disruption is something we can’t ignore in the current environment. There are businesses and industries that are doing the disrupting and those that are being disrupted. It’s essential to differentiate between the two. Beyond that is a broad group of companies that I think of as ancillary beneficiaries of disruption. These are businesses that may not have broad name recognition or get the hype that the primary disrupters get. But they stand to benefit significantly from the evolving technological landscape, often by supplying some of the underlying nuts and bolts.
What are some of the industries you are drawn to at the moment?
Applbaum: I’m very enthusiastic about pharmaceuticals. Some companies are nearing patent expirations in prominent products. But unlike in the past, their pipelines tend to be stocked with a new generation of very innovative, potentially life-changing drugs. Many of these represent real clinical breakthroughs, as opposed to simply being copycat drugs. Because of political and regulatory issues, the share prices of many of these companies have not gone up as much as they might have otherwise. This favorable outlook does not apply across the entire industry. It’s stock-by-stock and company-by-company. We are fortunate to have the depth and breadth of research, and analysts who can identify
Staying on the health care theme, there is a health care cost issue in this country. I’m looking at companies that can help solve that issue without simply taking a knife to patient coverage in the U.S. These companies are seeking to bring down costs while still delivering as good or perhaps better care. That includes the use of technology, including artificial intelligence. There’s a real intersection of technology and health care.
Robbins: One area I’d point to is aerospace and defense. This is a sector I have invested in for quite some time, particularly aerospace, because of our belief in increased global travel, especially as developing markets have greater appetite for air travel. I have now become more interested in defense, as we clearly are experiencing greater uncertainty around the geopolitical environment. You have much more attractive valuations for those sectors as a result of the recent pullback.
Du Manoir: One broad area I’m pursuing is consumer demand in general and the continuing evolution of consumers in the developing world. The fortitude of consumers was shown last year when many companies with exposure to China suffered but a number of consumer staples companies with substantial exposure in China did incredibly well. The second area I’d point to is technology. We’re entering a world of connection where everything — people and devices — will be connected. That is very favorable for semiconductor companies, which I believe represent an area of very solid long-term growth.
Periods of volatility can be jarring for clients. What advice would you offer for how best to handle such times?
Robbins: What we have experienced lately reaffirms the need to have a balanced portfolio and to appropriately assess your own risk tolerance. Part of this involves having a proper allocation of fixed income, which has tended to hold up much better in corrections or bear markets than equities. Bonds might go down a little bit, but they’re probably not going down a lot, as equities sometimes do.
The above article originally appeared in the Winter 2019 issue of Quarterly Insights magazine.