Macro View


As of September 1, 2017

Emerging Markets Continue to Outperform Developed Markets

  • Global resynchronization helped stabilize emerging economies after years of disappointing growth.
  • GDP growth in the US and internationally should benefit emerging markets, which tend to benefit from stronger global economic growth.
  • Valuations have ticked up as equities continue to post strong returns, but still trade at a discount to developed markets.
  • Improving investor sentiment has manifested itself in the form of increased flows into emerging market equity and debt as dollar strength and US trade policy risks have receded.

Sustained Improvement in the Economic and Corporate Backdrop Confirms Global Resynchronization

  • The European economy is growing above trend as both industrial and retail sectors outpace expectations.
  • The fallout from Brexit will take years to fully play out in the United Kingdom, but has hampered growth expectations in the short term.
  • Monetary policy in most of the developed world is likely to remain supportive as central banks have yet to embark on normalization.
  • Corporate profits continue to grow at double-digit rates in both Europe and Japan, which should support equity prices.

Washington Dominates Headlines, but Markets Focus on Fundamentals for Now

  • The US economy continues to expand, but after a modest first half it will be tough to break out of the benign growth track it has been for much of the cycle.
  • Earnings grew at a healthy pace in the second quarter, which highlights the continued strength of the corporate sector.
  • Decelerating inflation has led the Federal Reserve to reassess the path to policy normalization.
  • Financial conditions remain supportive, thanks to a weaker dollar and lower bond yields.
  • President Trump has provided minor regulatory relief via executive order, but pro-growth legislation has proved to be more difficult and time consuming.

Sector View

From the Fiduciary Trust Equity Strategy Committee
As of September 1, 2017

Financials: Overweight

Deregulation, Tax Reform and Rising Rates Favor Financials

While the Trump administration has yet to implement pro-growth policies, we continue to believe that improving fundamentals and rising interest rates will benefit Financials. Therefore, we have been building positions in rate-sensitive companies that appear undervalued in a rising-rate environment.

Sector Positives

  • Significantly improved balance sheets and stress test results could encourage return of capital to shareholders through dividends and share repurchases.
  • Regulatory pressures are easing, even without formal legislation.
  • Banks are seeing strong demand for loans from businesses and consumers.
  • Comprehensive tax reform could be especially beneficial for financial services companies, which currently pay tax rates that are among the highest in the country, across all sectors and industries. A reduction in the corporate tax rate could boost earnings proportionately.
  • Rising interest rates typically work in favor of banks and other financial firms that earn interest on mortgages and other types of loans they issue.

Sector Negatives

  • Credit card debt recently surpassed $1 trillion for the first time since 2008 and loan loss provisions are rising, especially in the automotive lending business.
  • While fiscal stimulus could be helpful, our research indicates that the US is in the late stages of a credit cycle.
  • Protectionist trade policies in the US and abroad present the risk of economic destabilization.
  • Capital requirements for Systemically Important Financial Institutions (SIFIs) are still unknown.

The financials sector includes banks, thrifts, diversified financial services companies, asset managers, investment banks, insurance and reinsurance companies.

Energy: Marketweight

Pro-Growth Policies are a Catalyst but Geopolitical Tensions Persist

We are maintaining a marketweight recommendation for Energy as a wide variety of geopolitical factors influence prices and stability.

Sector Positives

  • Hurricane Harvey disrupted refinery operations in Texas, pushing up gasoline prices. But the longer-term effects of the storm have yet to be full quantified.
  • In a volatile price environment, we see integrated oil as the most defensive segment of the market because it has exposure to upstream and downstream production.
  • Oil and gas exploration companies could offer the most upside potential if oil prices rise, but an uncertain environment warrants caution.
  • A considerable amount of cost flexibility could soften the negative effects of low oil prices.
  • Technological advancements should improve oil well efficiencies, which could lead to upside surprises at the company level.

Sector Negatives

  • Drilling activity is likely to be constrained until producers are confident oil prices are stable.
  • Coal is expected to come under pressure if states and the federal government pass laws phasing out the use of coal to generate electricity.
  • Higher-than-expected production potential in Iran and Saudi Arabia could push supply higher.
  • The space is fragmented, with many players carrying low-quality balance sheets.
  • Cost of capital is also relatively high in the Energy industry.

The energy sector includes companies that produce and distribute energy. This includes the petroleum industry, containing oil companies, refiners and gas stations; the gas industry, including natural gas extraction and coal; the electrical and nuclear power industries, and the renewable energy industry.

Health Care: Overweight

Short-Term Pricing Pressure but Favorable Demographic Trends

We are maintaining an overweight to Health Care, encouraged by strong earnings growth projections, an aging global population, innovation in biotech and streamlining among large pharmaceutical firms.

Sector Positives

  • Strong future demand is expected for innovative and effective medical treatments in areas such as cancer, diabetes, hepatitis C, and Alzheimer’s.
  • Large overseas cash balances held by Major Pharma and Biotech companies could be repatriated under the President’s tax holiday, offering the potential for an uptick in M&A.
  • Value-based business models are gradually replacing the volume-based approach, a scenario that creates both opportunities and challenges for healthcare providers and suppliers.
  • Drug pricing transparency has improved and the FDA is looking at ways to speed up the review and approval process.

Sector Negatives

  • The Trump administration has expressed a desire to regulate drug prices.
  • Inversion deals, in which healthcare companies reduce their tax liabilities by moving to another country, face increased scrutiny by the IRS.
  • The Medtech subsector is being closely monitored by the FDA, which could impose a more rigorous review/approval process.
  • Budget constraints could reduce government spending on Medicare and Medicaid. The federal government accounts for the largest share of healthcare spending in the US (approximately 29%), according to the Centers for Medicare and Medicaid Services.

The health care sector covers two primary industry groups: healthcare service providers and firms that make health care equipment, and firms related to pharmaceuticals and biotechnology.

Industrials: Overweight

Stronger Earnings Could Drive Capex Improvements

We continue to overweight Industrials based on stronger earnings and expectations for a pick-up in capital expenditures. Manufacturing activity in the US and Europe is improving, albeit at a slower pace, and we expect a growing global economy to fuel demand for industrial products and services. Growth prospects look brightest among companies focusing on technology and manufacturing automation.

Sector Positives

  • Infrastructure spending and a lower corporate tax rate would bode well for industrial activity.
  • The transportation category continues to offer attractive opportunities, ranging from traditional railroads to companies that are pioneering “intelligent transportation grids.”
  • Shipping and delivery companies usually see a pickup in demand when the US economy is expanding and corporate budgets improve.
  • Defense spending could accelerate after years of government budget constraints. We believe the defense industry could be entering a period of protracted growth, possibly extending for the next five or ten years.

Sector Negatives

  • Valuations are higher than their historical average.
  • Fluctuating energy prices create uncertainties for industrial companies that supply oil companies with equipment.
  • A border adjustability tax could hurt US companies with international exposure by making it more expensive to import materials.
  • Weakness in the Chinese economy, the potential for a spike in commodity prices and protectionist trade policies in the US and abroad could also affect companies with a strong international presence.

The industrial sector encompasses transportation services and infrastructure for roads, rail, airlines and marine services. It also includes manufacturers of aerospace and defense equipment and companies providing electrical equipment, building products, and commercial services and supplies.

Telecommunications: Underweight

Intense Competition, High Costs Weigh on the Telecom Sector

We are underweight telecom, a relatively mature industry with saturation levels that could limit the potential for meaningful topline growth in the future.

Sector Positives

  • Tax reform and other pro-growth policies could benefit the sector.
  • Demand for wireless data (mobile video streaming) is strong in the US and abroad.
  • A new FCC chairman has vowed to eliminate unnecessary regulations and “remove those rules that are holding back investment, innovation and job creation.”
  • Telecom offers defensive qualities including reasonable valuations and high dividend yields.
  • Bundling of services is boosting revenues and reducing churn.

Sector Negatives

  • Broadband companies face competition from Over-the-Top providers like DirecTV Now, Netflix, HBO, Dish, etc., which encourages consumers to cut the cord.
  • Competition is intense and costs are high in the telecom industry. Major competitors are seeking growth through acquisition.
  • Rising rates could erode dividend yields.

The telecommunications sector includes wireless communications, equipment, processing systems and products and carriers.

Information Technology: Overweight

The Rise of Cloud Computing and a Growing Economy Lift Tech

We continue to recommend an overweight position in the IT sector based on improving economic conditions and the rapid advancement of cloud computing and cybersecurity.

Sector Positives

  • Software-as-a-service platform vendors are rapidly taking share from “on premise” IT vendors.
  • Smartphones and tablets are taking market share away from PCs and other traditional hardware products. We expect minimal top-line growth in the hardware category, but high growth for on-demand, cloud-based service providers.
  • The semiconductor industry still has strong fundamentals and demand for semiconductors and software should remain strong as cloud computing gains momentum.
  • Mergers and acquisition activity and capital expenditures should continue as large, cash-rich platform companies seek to expand their scope and leverage their scale in what remains an attractive (but rising) interest rate environment.

Sector Netagives

  • We remain cautious about overpaying for highly-valued speculative stocks in the IT sector. Our approach is to identify established companies that offer the ability to adapt as well as newer entrants with agility and innovation.
  • The network security market remains fragmented, with niche players focusing on narrow segments of the industry.
  • Weak demand for PC-related products over the past several years could suppress stock prices across the supply chain.
  • Trump’s tenuous relationship with China and strict immigration policies could lead to higher prices for tech products and reduce the ability to recruit software engineers from abroad.

The information technology sector includes manufacturers and providers of computer, data, and electronic equipment and services. It includes hardware, software, networking and telecommunications equipment manufacturers, IT services, providers of internet services; mobile phone producers; and semiconductor manufacturers.

Materials: Marketweight

Geopolitical Risks with Pockets of Growth

Our marketweight position in Materials reflects our focus on specialty chemicals and processing companies as opposed to commodity-sensitive companies.

Sector Positives

  • Chemical companies across a variety of industries and geographic locations are reporting strong growth in sales volume.
  • The rebalancing of the Chinese economy from exports to consumption is likely to benefit chemical producers that have exposure to end markets such as automobiles and travel.
  • Construction aggregates offer pockets of opportunity among companies that operate on a local, geographically segmented basis and offer stable pricing dynamics. Aggregates include sand, gravel, crushed stone, slag, recycled concrete and geosynthetic materials.
  • Companies that are associated with roads, bridges and other transportation infrastructure could benefit from US government stimulus spending, although we do not expect infrastructure spending to increase until 2018.

Sector Negatives

  • Risks include the potential for economic deterioration in China, uncertainty regarding the size and scope of government spending around the globe, and potential geopolitical shocks.
  • Since China’s commodity super cycle came to an end it appears unlikely that there is another emerging economy positioned to take its place, with massive government spending.
  • Metals and mining companies faced an overabundance of supply in 2016 and upstream producers should continue to see major pressure as price forecasts continue to be pessimistic.

The materials sector contains companies engaged in the extraction and processing of raw materials such as metals, chemicals, wood and paper products, and construction materials.

Consumer Staples: Underweight

Limited Growth Opportunities, High Valuations

We are underweight Consumer Staples, in part, because of limited opportunities for growth and full valuations.

Sector Positives

  • We are focusing on dividend growth rather than dividend yield stocks particularly in this sector. Companies that operate on an international scale and have demonstrated the ability to adapt when consumer preferences change.
  • Cost-cutting measures have improved profit margins for many companies in the Consumer Staples sector.
  • Product innovations or expansions and new business channels have become a higher priority for many companies in this sector as they adjust their business models to keep pace with changing consumer tastes.
  • Rising inflation bodes well for consumer staples as they generally can pass on price increases to consumers.

Sector Negatives

  • Volume upside seems limited given the fact that sales growth in 2016 was supported by price increases that were passed on to customers.
  • A strengthening dollar could work against Consumer Staples companies in 2017 since more than half of the sector’s revenues come from outside the US.
  • Rising rates and an improving economy could also work against Consumer Staples, which have historically strengthened when the economy is weak and rates are low.

The consumer staples sector includes consumer items that are often considered household necessities. It includes personal and household products; food products; beverages and tobacco industries.

Utilities: Underweight

Expectations for Rising Rates, Inflation Make Utilities Less Appealing

We are underweight Utilities given the outperformance of the sector in 2016 and the potential for a pickup in inflation in 2018.

Sector Positives

  • Mergers and acquisitions continue.
  • The sector offers dividend income potential as well as a hedge against market volatility, with historically low correlations to the S&P 500.
  • Renewables offer of pockets of growth potential.
  • Utilities have modest exposure to international markets, reducing the risks posed by protectionist trade policies, or a stronger US dollar.

Sector Negatives

  • Tax reform and other pro-growth policies are not expected to benefit utilities as much as they benefit other more economically-sensitive sectors.
  • Demand for electricity has weakened due to slow economic growth and higher energy efficiency.
  • The potential for commodity price volatility and the threat of rate hikes hang over the sector.
  • Emissions standards become more costly over time, especially given recent EPA actions.

The utilities sector covers a variety of industries that generate and deliver power and water. It includes nuclear facilities, electric and gas utilities, independent power producers, energy traders, and generators and distributors of renewable energy.

Consumer Discretionary: Underweight

Retailers Face Economic Challenges, Competitive Threats

We downgraded the Consumer Discretionary sector to underweight in February due to slowing consumption, rising energy costs and inflation.

Sector Positives

  • An improving labor market is lifting consumer confidence.
  • Rising home prices indicate that the housing market may still have room to improve, which could make housing-related stocks more attractive.
  • On-demand entertainment continues to gain appeal with consumers, a trend that favors media companies with extensive content libraries and broad distribution capabilities.

Sector Negatives

  • E-commerce poses a long-term challenge for traditional retailers and apparel manufacturers.
  • A border adjustment tax could hurt the US apparel and auto industries, which import more than 30% and 20% of their manufacturing supplies, respectively.
  • Tax reform may not be beneficial. Our analysis of US income tax cuts from 1981 through 2001 was unable to show that a lower tax rate results in better sales or profitability for consumer goods companies.
  • Essentials such as healthcare and education are capturing a greater share of consumer wallets, leaving less for discretionary spending.
  • The auto industry, sales have been supported by incentive programs, discounting and easy financing.

The consumer discretionary sector includes companies that sell non-essential goods and services. It includes textiles, apparel and luxury goods; retailing; media; leisure products; hotels and restaurants; and automobiles and components.

Tactical View

From the Fiduciary Trust Asset Allocation Committee
As of September 1, 2017

Cross Asset

We see the brightest prospects for equity market returns outside the US, where economic and corporate fundamentals are strengthening and financial conditions remain favorable for growth. We are underweight fixed income and encourage an allocation to alternative investments as a hedge against volatility.

  • Equities. As global economies resynchronize, we believe US multinationals, Europe and Japan could all be large beneficiaries.
  • Fixed Income. We remain cautious with respect to interest rate risk given potential inflationary effects of strong labor markets and continued economic expansion.
  • Alternatives. We continue to recommend liquid alternatives for risk management and diversification. Alternatives traditionally outperform when rates are rising.
  • Cash. A cash allocation remains in place to provide "dry powder" for future opportunities and guard against market volatility in this uncertain environment.

Fixed Income

As the Fed moves cautiously toward normalization, bonds appear to offer limited total return opportunities. But we recognize their potential to generate income and mitigate portfolio risk.

  • Municipal bonds. We remain highly selective, generally favoring higher credit quality, liquidity and revenue bonds over general obligation bonds.
  • US Government bonds. We believe issuers in the Government sector of the market offer less attractive risk-adjusted yields than other sectors of the fixed income market.
  • US Investment-Grade Corporate bonds. Pre-tax yields on investment-grade corporate bonds remain attractive given fundamentals.
  • US Securitized bonds. We remain cautious about mortgage-backed securities in the face of relatively tight spreads and Fed balance sheet downsizing.

Equities

Pro-growth fiscal policies in the US could be supportive but appear unlikely to take shape until sometime in 2018. In the US, valuations appear full and risks largely overlooked. International developed markets are more appealing.

  • US Large-Cap. Although the economy remains on solid footing, valuations appear full and policy risks continue.
  • US Mid-Cap. Mid-caps could benefit from pro-growth fiscal policies, while carrying slightly less sensitivity to a rising dollar than large-caps.
  • US Small-Cap. Small-caps may benefit in an environment of rising rates and an accelerating domestic economy.
  • International Developed Market Large-Cap. We continue to favor continental Europe and Japan, where economic and earnings momentum remain strong.
  • International Developed Market Small-Cap. Small-caps are generally more sensitive to economic and political shocks than larger companies. So we find them less attractive than mid- and large-caps.
  • Emerging Markets. Despite recent stabilization in many EM economies, we are mindful of risks posed by North Korea and policy uncertainty in China and the US.

Alternatives

We continue to recommend liquid alternatives for downside risk management, diversification and potential return enhancement.

  • Hedge funds. In addition to their defensive qualities, hedge funds could see more attractive return opportunities as market volatility, interest rates, global currency fluctuations and economic activity pick up. Widening dispersion of equity returns across sectors and regions may also create more trading opportunities for capturing alpha.
  • Event-driven strategies. These strategies could benefit if tax reform and repatriation encourage companies to make acquisitions. Event-driven funds invest in securities of companies in the midst of bankruptcies, changes in capital structure and mergers/acquisitions.
  • Commodities. Despite recent volatility in commodity markets, sentiment surveys remain strongly positive in many parts of the world. But definite signs of an acceleration in activity have been scarcer, probably due to the structural impediments that have persisted since the global financial crisis.

This communication is intended solely to provide general information. The information and opinions stated are as of the dates specified, and may change without notice. The information and opinions do not represent a complete analysis of every material fact regarding any market, industry, sector or security. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

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