Market GPS 2019 Australia
Which themes are shaping the 2019 investment landscape? Read the thinking of our investment teams in the Janus Henderson Mid-Year Market GPS.
AN UPDATE ON OUR 2019 OUTLOOK
Featuring Richard Clode (Technology) and Andy Acker (Life Sciences)
Keep up with the pace of change
Disruption is being felt across industries and geographies and proving to be a differentiator in the long-term performance of investors’ portfolios. Such rapid and widespread change is creating new investment opportunities but also significant risks. Technology and health care are among key sectors, with tech serving as the engine of the digital economy and health care experiencing unprecedented levels of innovation.
2019 so far
- Disruption continued as progress in drug development led to a wave of mergers and acquisitions in health care and secular tailwinds drove growth in technology
- Even so, both sectors showed they were susceptible to short-term volatility. In April, health care stocks retreated in the face of a proposal to eliminate private insurance in the US. Inventory and trade concerns initially weighed on semiconductor stocks, while Internet platforms faced increasing scrutiny over privacy.
- Demand for cloud computing has been particularly strong with spending expected to grow markedly in the years ahead.
- The Internet of Things, artificial intelligence and the roll out of 5G remained dominant forces for change.
Tread carefully as disruption continues
Portfolio Manager, Global Technology
Macroeconomic pressures and trade wars continue to drive volatility in global equity markets. In these more uncertain times, the secular growth trends that disruption creates in the technology sector have remained very much intact, even accelerating in some areas.
Cloud demand has been incredibly strong; the recent ride-hailing initial public offerings (IPOs) are evidence of the disruption of the transportation sector. Initial forays into 5G indicate that another wave of disruption is about to take off while payments and financial services globally, particularly in emerging markets, are experiencing dramatic evolution.
Most but not all of the new wave of disruptive technology companies have been well received by the market. Currently, there is a huge amount of investor appetite – from both private and public markets – chasing small pockets of growth and this is supporting many unsustainable business models. Should the interest rate environment become less supportive and investor appetite dwindle then the market is unlikely to be as supportive of these cash-burning, loss-making companies. We believe investors should begin to be much more selective when looking at some of these growth assets and we will continue to navigate the hype cycle.
Healthcare innovation and rising M&A activity
Portfolio Manager, Global Life Sciences
Healthcare continues to experience rapid innovation, thanks to advances in genetic sequencing, new modalities for targeting disease and accommodative regulatory paths. Increasingly, small- and mid-sized companies are behind today’s medical breakthroughs.
Consequently, we have seen a surge in mergers and acquisitions (M&A), often at significant premiums. Year to date (YTD), more than US$151 billion in biotech and pharmaceutical deals have been announced, already more than half the total for all of 2018. At the same time, the 2020 US presidential election campaign has created volatility as some candidates push for a single-payer healthcare system. However, we believe the odds of such proposals becoming reality are low, while volatility has helped make valuations of many healthcare stocks more attractive.
Innovation looks set to continue. We expect results from landmark studies for cancer-fighting immunotherapies in the coming months, while in medtech new technology is emerging, such as continuous glucose monitoring systems and robotic-assisted surgeries. Meanwhile, progress continues in the fields of gene and cell therapies, both of which show promise in treating a number of intractable diseases. In our view, these advances could lead to significant growth for the companies developing the products, as well as fuel additional M&A.
Featuring Michael Ho (Multi-Asset/Alternatives) and Paul O'Connor (Multi-Asset)
Delayed for now but still on the table
Expectations at the start of the year were for further divergence of returns in 2019 with the US moving in a more aggressive monetary policy direction compared to other markets.
The pivot by the US Federal Reserve (Fed) towards a more dovish stance largely dampened these expectations and a rally followed in both riskier and safe-haven assets. This does, however, leave many segments of the market appearing fairly or fully priced with divergence potentially ahead. Where there was divergence, however, was in asset class flows.
2019 so far
- Rather than seeing further divergence in global monetary policies, the Fed’s dovish pivot gave the green light for still-struggling economies to extend their accommodative approach.
- While both riskier and safer assets rallied in the aftermath of the Fed’s reversal, subtle divergences emerged. US stocks outpaced global shares and growth stocks generated higher returns than value.
Investment-grade corporates and government bonds were the most direct beneficiaries of lower interest rates, but with the risk of hawkish policy error off the table, high yield corporates outshone other segments of the fixed income market.
Investors’ enthusiastic chase for yield, and caution over the strength of the global recovery, saw a sharp divergence in flows into fixed income and equity products (see chart ).
Perhaps a further sign of caution; the US dollar continued to strengthen over the period, given its relative safety compared to export- and commodities-oriented currencies.
In times of uncertainty, focus on fundamentals
Global Head of Multi-Asset and Alternatives
How likely is a bear market in the near future? This is the question on everyone’s mind, with concerns over equity valuations persisting since 2010. Shiller’s cyclically adjusted P/E ratio currently stands above the 30 mark. The last two times it reached this level were 1929 and 1998, just prior to the Great Depression and Dot-com burst. This is therefore an uncomfortable place for investors, especially when more boomers are retiring and cannot withstand capital loss from a large market fall. What is one to do?
Should we follow and react to complex changes in monetary policy, macro indicators and sentiment scores? While these are important for refined asset allocation, we believe the main focus should be on earnings growth. After all, stocks are claims on dividends that come from earnings. If investors bought stocks when realised earnings grew over the prior year, but switched to 10-year duration Treasury bonds when there was no growth, then much of the medium-term market turmoil could have been avoided.
So what is earnings growth telling us today? Realised earnings per share of S&P 500 Index companies are still growing, although arguably too quickly. This suggests that long-term investors should not be overly concerned by macro uncertainty today. However, we should be watchful of any sign that earnings growth starts to flatline.
Fixed income confidence vs equities caution
Head of the UK-based Multi-Asset Team
While multi-asset investors have enjoyed a broad-based rally in all the major asset classes this year, divergence is still a striking phenomenon in many markets. The most notable trends here stem from the fact that investors have been enthusiastically chasing yield in all assets in 2019, convinced that interest rates will stay low, but remain very cautious about the strength of the global recovery. This sentiment can be seen clearly in fund flow data showing that investors have poured about US$245bn into fixed income and money market mutual funds and ETFs this year but have withdrawn US$134bn from equities (see chart in section introduction).
After more than a year of downgrades to global growth and inflation, equity markets and other risk assets remain very sensitive to confidence in the global recovery. While, just a few weeks ago, investors were beginning to focus on the green shoots of global recovery, the outlook is now overshadowed by the threat of a prolonged trade war between China and the US. We believe that some form of de-escalation or compromise will ultimately be found here, but it is far from obvious that this will occur before economic confidence and market sentiment are further damaged.
Featuring Jim Cielinski (Fixed Income) and George Maris (Global Equities)
Filter the noise when navigating the geopolitical environment
While some tensions such as the US/China trade talks, Brexit and oil-related issues were anticipated, the expectation was that these would be accompanied by additional unforeseen challenges.
While there have been pockets of turbulence elsewhere, the three issues flagged remain dominant. As ever, the challenge for investors is being able to filter meaningful signals from the noise and capture opportunities suited to long-term investment horizons.
2019 so far
- As attitudes towards globalisation shift, geopolitics has reemerged as a significant factor to consider when making investment decisions today.
- Populist opinion manifests on both ends of the political spectrum and has spurred a number of events globally, including Britain’s decision to leave the European Union and its ongoing ramifications.
- Trade tensions between the US and China continue to cause uncertainty in markets.
- Populism has promoted the push towards regulation of tech giants in matters related to privacy and mental health.
It doesn’t matter until it matters
Global Head of Fixed Income
Geopolitical risks have a habit of making investors look bad. Nothing reveals behavioural flaws like true uncertainty. Geopolitical risk lulls investors into complacency before suddenly, and without much warning, erupting and causing overreaction.
Investors must know their risks. First, geopolitical risks are not always negative. Fading global tensions were key to the global risk rally in Q1.
Second, risk can be defined by volatility, or the probability of losing money. For most, permanent money loss is what matters. The key to navigating geopolitical risk is to separate truly systemic events from those that are merely noise.
This is easier said than done, as the nature of these events ensures that they surprise markets and dominate headlines.
The list of geopolitical threats is long and getting longer (see chart on previous page). Of these, only the first two are likely to create true systemic global risks. The probability of navigating 2019 without one or more of these threats erupting is low. Most of these will dominate markets but then quickly fade, presenting investors with opportunity. But avoid getting caught out. One of these times, a major global threat will go awry, and investors will need to know when to take cover.
Supportive backdrop but trade talks remain key
Co-Head of Equities - Americas
We have seen some easing of geopolitical tensions since the end of 2018. Although trade negotiations between China and the US have not been smooth as of late, talks are continuing, with President Donald Trump set to meet with President Xi Jinping at the end of June. At the same time, the US Federal Reserve and other central banks have decided to keep monetary policy accommodative, a reversal from what was signalled last year. Meanwhile, earnings growth remains strong, US GDP accelerated faster than expected during the first quarter and stimulus from Beijing has helped to lift China’s economy, all of which contributed to a sharp rally in global equities early this year.
We think trade remains one of the most important issues for the second half of 2019. As the US/China trade spat continues, the Trump administration is also threatening tariffs on goods from Europe, a significant economic and trading partner. In addition, Brexit remains an open question, and we are witnessing extreme policy proposals introduced by candidates in the 2020 US presidential election. Against this backdrop, we believe central banks will remain accommodative to support the global economy and backstop volatility. We also think US corporate and household strength could continue to positively surprise, thanks to subdued inflation, strong employment, low interest rates and ongoing innovation.
Featuring Nick Maroutsos (Global Bonds) and Colin Fleury (Secured Credit)
Incorporate an active approach to fixed income in a low yield world
At the start of the year the expectation was that the low yield world would continue, with limited opportunities for price appreciation, leaving carry as the primary driver of fixed income returns. Understanding where to look for the best carry opportunities, while being mindful of fixed income’s role as a portfolio diversifier, was expected to be critical.
2019 so far
The US Federal Reserve (Fed's) willingness to pause its rate hike cadence and its balance sheet run-off has helped to keep Treasury yields capped and risk asset valuations climbing early in 2019.
In response to slowing global growth, many of the developed world central banks have followed in the Fed’s footsteps, adopting a more dovish tone and further supporting risk assets.
Yields on corporate bonds over the yields of their comparative risk-free benchmarks have tightened back in line with long-term averages, limiting opportunities for price appreciation.
Credit spreads in many international developed markets tend to be wider than those of North America but have notably converged.
Greater dovishness crystalises bond investors’ choices
Co-Head of Global Bonds
Our view that – when faced with a choice – the US Federal Reserve (Fed) would opt for greater dovishness was resoundingly validated by the central bank’s December pivot. While the market may have gotten too aggressive in pricing in interest rate cuts, we believe the Fed’s next move will be down – albeit in 2020. Against a backdrop of lower rates and continued US economic expansion, we believe bond investors should favour the front end of the US yield curve and look globally to meet their objectives.
While favourable for risk assets, lower rates likely limit the opportunity for capital appreciation on longer-dated bonds. Shorter-duration securities, on the other hand, present the best chance for gains, given our expectation of a steepening yield curve as policy rates eventually fall. For income-seeking investors, we do not believe the marginal gain in carry justifies the additional interest-rate risk undertaken with longer-dated bonds.
The Fed’s pivot also gave cover for other central banks to continue – or increase – their accommodative stance. For countries reliant upon global trade or commodities, slowing growth makes rate cuts all the more likely. We also consider foreign-domiciled investment grade issuers to be attractive sources of carry, given their relative yields, strong competitive positions, and in some cases, implicit government backing.
Be selective and leave flexibility for more attractive entry points ahead
Head of Secured Credit
Looking in isolation at the returns from fixed income markets since the start of this year, the theme of income-driven markets appears not to have played out. Through end April, global high yield and global investment grade returns were 8.3% and 5.3% respectively, of which 6% and 3.8% were down to market price gains*. But what was the primary catalyst for these gains?
Many would argue that it was central bankers signalling a more accommodative policy environment, which reignited investor appetite for fixed income after the volatility at the end of 2018 and drove down government bond yields, producing market price gains.
Over the 12 months to end April however, 100% of the global high yield and 74% of global investment grade index returns came from income. The importance of income driving returns has also been high across a broader range of assets classes such as secured loans and asset-backed securities.
So does this mean that it is all about seeking to maximise current portfolio carry for the balance of 2019? We think not. We believe the global growth and credit cycle is at a point where caution remains paramount and while it may be tempting to seek to enhance portfolio yield, investors will be better served adopting a selective approach and having flexibility to take advantage of more attractive entry points. That is certainly the approach we are taking.
*Source: Bloomberg, ICE BoAML indices, hedged to US$ as at 30 April 2019
The themes that we believe have the potential to rise in importance for investors in the second half of 2019 and beyond.
Sustainable investing: micro trends behind the macroeconomic veil
Head of Sustainable and Responsible Investing (SRI)
We remarked earlier this year how the slowing macroeconomic environment disguised a divergent micro reality where some companies continue to grow while others struggle to navigate disruptive forces. Our focus on sustainability helps us to identify companies on the right side of secular trends.
The two generational investment trends upon which we are focused are the transition to a low carbon economy and the fourth industrial revolution. Thus far in 2019 we have seen evidence that both are driving investment returns. Many companies in the information technology sector have posted strong growth while many companies exposed to fossil fuels have underperformed. Our outlook for the year remains constructive with loose monetary policy supportive of higher valuations for those companies that are growing. On a longer term view, we believe a sustainable approach to equity investing will continue to grow in importance.
Not all property is created equal - it pays to dig a little deeper
Guy Barnard and Tim Gibson
Portfolio Managers, Global Property Equities
Investors can access commercial real estate, the third largest financial asset class, through a range of products: non-traded, unlisted Real Estate Investment Trusts (REITs); open-end direct funds; private equity funds; and publicly-traded, listed REITs. A key question for investors is the best route in.
Unlisted REITs have attracted strong demand in recent years, by targeting high yields and offering low reported volatility, but these vehicles can have low liquidity and inefficient cost structures. Listed REITs – our area of focus – trade daily on major stock exchanges, offer regulated and transparent financial disclosure, and are incentivised to create shareholder value on a perpetual basis.
We believe increased demand for the listed REIT market will be an ongoing theme. As well as having historically higher returns it allows active investors to target several more difficult to access sectors. These sectors, which are currently enjoying secular growth, include age-restricted manufactured housing, self-storage, data centres and cell towers, as well as areas like logistics where private real estate vehicles have difficulty accessing quality properties in scale.
Hedge fund strategies go mainstream
Head of Diversified Alternatives
There is a natural evolution in both finance and technology – complex becomes simple – as participants and infrastructure grow more sophisticated. For example, Warren Buffett’s long-term success can be retrospectively explained by his exposure to low beta and value factors combined with leverage. However, these factors are now well-known and widely available, causing their results to lag. Meanwhile, many differentiated and opportunistic strategies are outperforming in this changed landscape. Consequently, publicly available alternative products are evolving to include strategies that were previously only accessible via hedge funds.
To provide unified solutions, we have integrated our alternative risk premia and hedge fund teams into a single platform to enable the sharing of ideas, resources, and technology. This is based on the view that bringing complex strategies to more investors can reduce fees, improve returns, and provide true diversification. Rather than relying on a single static factor, we believe a good alternative strategy in the future will need to construct a solution that blends different sources of return and lowers overall portfolio risk.
The chart shows the range of factors that we believe alternative solutions of the future should provide access to in order to best meet investor objectives.
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