MARKET COMMENTARY

Equity Outlook

With equities continuing to break new ground, Carin L. Pai discusses themes and opportunities for 2017.

12.23.2016 - Carin L. Pai, CFA

KEY TAKEAWAYS
  1. Focusing on long-term growth themes
    In this shifting landscape, we are looking for companies that offer the potential for capital appreciation without a surging economy or cheap financing. Information technology and healthcare are key targets.
  2. Millennials are changing everything
    A new generation of 83 million consumers is reshaping the world and influencing the way we invest.1 Areas of interest include online shopping, on-demand entertainment, cloud computing and socially responsible investing.
  3. Corporate and government spending could pick up
    Improvements in the US economy could encourage businesses to spend more on equipment and technology, while the federal government appears ready to boost infrastructure spending.

View Our Full 2017 OUTLOOK


As we look across the global equity markets, we see a world in transition in 2017.

In the US, a new presidential administration offers the possibility of corporate tax reductions, regulatory relief and other pro-business reforms, as well as the potential risks that may come along with an ‘America First’ trade policy.

As the economy strengthens, the Federal Reserve appears eager to bring interest rates back to more normal levels, carefully balancing the desire to promote economic growth against the need to prevent runaway inflation. And developed markets around the world appear to be shifting away from near-zero interest rates and government austerity in favor of expansionary fiscal policies—a boost in government spending to spark economic growth.

All of these developments will have implications for equity investors.

Our Goal: Growth at a Reasonable Price

As we move through this period of transition, we will continue to look for growth at a reasonable price in 2017. As fundamental investors, we have always taken a bottom-up approach to our research, looking for companies with strong balance sheets, attractive growth potential and reasonable valuations. Our Asset Allocation Committee helps us examine our investment ideas in a broader context by providing an assessment of global macroeconomic trends, including monetary policy, fiscal policy, interest rates and other economic indicators.

Taken together, our fundamental research and macroeconomic analysis indicate that equity market returns are likely to be modest in 2017, as the US appears to be in the late stages of an economic recovery that began after the 2009 financial crisis. International markets may offer opportunities to capture growth in the earlier stages of recovery, and the possibility of more attractive valuations than US stocks, but geopolitical risks remain high following the Brexit vote in June.

Our top themes this year include:  

  • Companies that consistently increase their dividend payouts.
  • Technology firms that are meeting the rapidly changing demands of individuals and enterprises.
  • Healthcare companies focused on medical conditions the FDA considers high priorities.
  • Alternative investments that offer performance not closely correlated to the S&P.
Will Rising Rates End ‘Financial Engineering?

Record-low interest rates created significant distortions in the equity market in 2016. A flood of cheap financing allowed many companies to buy back their own shares, pushing up stock prices despite the fact that corporate earnings continued to decline and economic growth was weak. In many cases, investors appeared to push multiples higher as long as they expected interest rates to remain low.

But this type of financial engineering, and the wedge it drove between corporate fundamentals and stock prices, is likely to fade in 2017. As the cost of borrowing increases, financial engineering loses much of its appeal. The question is: What happens to companies that have relied on cheap financing to strengthen their balance sheets and lift their stock prices?

In our view, they may have to focus on fundamentals—somehow finding a way to improve their top-line sales numbers and bottom-line profitability in a relatively slow-moving economy. Investors are likely to follow, paying less attention to interest rates and more attention to corporate balance sheets in 2017.

Millennials Are Reshaping Consumption and Investing

On a broader scale, we see demographic trends revealing interesting opportunities over the next several years.

Millennials are the first generation to grow up with technology at their fingertips, so they demand uninterrupted connectivity across all aspects of their lives. This demand for constant communication has implications across the economy, but it may be particularly meaningful for companies that own and operate communications networks. Companies that rent out space on wireless communication towers, for example, have been generating strong cash flows.

In the entertainment field, millennials are strong proponents of streaming video and other forms of on-demand content delivery. They typically prefer to order these services a la carte or at least with some degree of flexibility in menu selections and pricing. So media companies with full content libraries could be well-positioned for growth in this environment.

Social media platforms have become a primary source of news and information for millennials, forcing advertisers to adjust their budgets accordingly.

In the retail market, an estimated 35% of millennials already spend most of their clothing budgets online. The challenge for retailers is meeting their high expectations: flawless website design, expansive inventories, expedited delivery and competitive prices (they prefer value to brand-name recognition). The most tech-savvy retailers are also using technology, such as special promotions on smartphone apps, to bring millennials back into their brick-and-mortar stores.

In general, any industry trying to reach millennials needs a technology platform that is accessible anywhere, at any time, on any device. Companies focused on this demographic group have been migrating from on-site network servers to remote servers, commonly referred to as cloud computing. We expect this migration to put pressure on traditional hardware suppliers but open up new windows of opportunity for semiconductor and chipset manufacturers.

Finally, we see a wave of demand from millennials driving the growth of Environmental, Social and Governance (ESG) investing. At Fiduciary Trust, we incorporate ESG factors in our bottom-up investment process to create a more comprehensive view of the value, risk and return potential of our investments. We also measure ESG factors on a portfolio level as part of our risk-management process, using a third-party screening process and a team of dedicated analysts at Franklin Templeton, our parent company. 

Spending Patterns Reveal Areas of Growth

Consumption patterns play an important role in the direction of the economy and the health of the equity market.

On the consumer side, we will be looking for any signs of pent-up demand that could precipitate an uptick in discretionary spending over the next 12 to 18 months. While broader measures of personal consumption have been relatively strong, a sizeable portion of household budgets is being absorbed by healthcare, leaving less money for other goods and services.

Consumers may have also been postponing large purchases and financial commitments until the policies and priorities of a Trump administration become clear.

On the other hand, we have seen some encouraging signs for the housing market, such as household formation figures, and we expect to see opportunities in home improvement stocks.

In corporate America, a lack of confidence in the economy and more burdensome government regulations have discouraged capital investment. Many manufacturers are already operating at excess capacity levels as a result of weak demand and improvements in productivity (driven by technology). So the incentive to improve and expand has been lacking. But that could also improve under Trump’s pro-growth policies.

On the government side, spending is likely to accelerate in the US and Europe as policymakers look beyond monetary policy for more creative ways to revive their economies. Infrastructure is high on the list of priorities, and was mentioned specifically by Trump in his acceptance speech, although it will take some time for lawmakers to approve spending packages.

1. Source: US Census Bureau as of June 2015.





This communication is intended solely to provide general information. The information and opinions stated are as of December 2016, 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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