Market GPS 2019 UK
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 Charlie Awdry (China 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.
Macro events remain pivotal for Chinese equities
Portfolio Manager, China Equities
Two macroeconomic themes have dominated Chinese equity investing in the first half of 2019: the China/US trade war and, domestically, Chinese policymakers’ efforts to boost the economy with monetary and fiscal stimulus measures.
The China/US trade war is one very important part of the evolving global geopolitical picture, highlighting China’s increasingly fractious relationship with the rest of the world’s major economic and political powerhouses. While the tone of the trade discussions in general became more conciliatory over the first half of the year – with both President Xi and President Trump pushing for a pragmatic solution to boost their economies and provide more business and consumer confidence – the tone of rhetoric outside these talks became less tolerant. This has been playing out in both the corporate and personal arena around Chinese telecoms giant Huawei and its executives. Both themes are likely to remain at the fore of investors’ thinking, with hopes this will feed into a corporate earnings recovery.
Meanwhile, equity indices providers, such as FTSE Russell and MSCI, recognised the progress of Chinese and Hong Kong capital markets in terms of market access and reform and increased the weighting of domestic Shanghai and Shenzhen ‘A’ share markets in their global indices. China has been the largest single country in the MSCI Emerging Markets Index since 2007 and is likely to increase further in the coming years.
TAPPING THE INCOME STREAM
Featuring Nick Maroutsos (Global Bonds) and John Pattullo (Strategic Fixed Income)
Tapping the income stream
The importance of an active approach within fixed income
Income has always been in high demand but now more so than ever. Whether meeting the needs of investors collecting a regular income, or being rolled up as the backbone of accumulated total returns, this remains a key theme.
The expectation was that the low yield world would continue for the foreseeable future, with limited opportunities for price appreciation. Therefore “carry” (the excess income generated by a position) was expected to be the primary driver of fixed income returns with the need for a suitably high conviction approach to capturing them.
Tapping the income stream
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.
Tapping the income stream
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.
Tapping the income stream
Global titans and higher quality for H2 2019
Co-Head of Strategic Fixed Income
Ultimately, we want to be confident that bonds act like bonds and deliver the regular income and capital preservation throughout the cycle that investors expect. We often think of Margaret, a retiree in her seventies, who is representative of the median investor in one of the portfolios that we manage. We imagine Margaret when selecting bonds for all our portfolios and understand that she wants solid, dependable income prospects, not equity-type risk from her investment.
This has shaped our perspective on markets. There has been a broad-based weakening in global economic data, which, in our view, makes higher default risk high yield bonds vulnerable to price volatility. Structural constraints in the economy, including demographics, debt burdens and technological competitiveness, meant we were sceptical that inflation would break out. This created opportunities for investors in longer-dated corporates where yields were more attractive and the higher duration offered potential to profit from a decline in yields. The dovish pivot by central bankers since the start of 2019 means this has broadly worked through as interest rate expectations have retreated.
In sum, we believe that sensible income could be achieved by stretching for longer duration, quality investment grade bonds compared to going further down the (default) risk spectrum. This would mean favouring large-cap, non-cyclical, global titan businesses over small-cap, cyclical ones; for both investment grade and high yield bonds.
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.
Cloud computing: the next frontier for US equities?
Portfolio Manager, US Equities
We believe that there are still interesting stories within US equities at the present time.
The economic backdrop and current policy remain favourable for companies, while high employment levels are feeding through to wage inflation at a moderate level, which is supportive for consumer spending. We see the growth in global travel as an attractive area of opportunity, particularly in Asia.
The transition to cloud technology is a very economical move for enterprise applications.
Only a fraction of total enterprise spending is allocated to the cloud, so we believe this has genuine potential – not just for those companies providing cloud services, but also those firms behind the infrastructure and equipment that helps to facilitate the growth of the cloud.
Software as a service (SaaS) is also hugely interesting, and it is an area in which we see continued expansion of the market for companies that are offering subscription services.
UK equities: domestic bliss?
Portfolio Manager, UK Equities
We have made two significant positioning shifts in recent months. Firstly we have moved long UK domestic orientated companies, which compares to the net short position we have had in place since after the EU referendum in 2016.
Secondly we have also reversed our long standing long exposure to the US and now have a small short positioning.
We believe there is opportunity to be had in domestically-focussed UK equities given the combination of extreme valuations, weak investor sentiment, and the decreased likelihood of the more extreme Brexit scenarios.
Meanwhile, consumer facing segments of the US economy are grappling with potential protectionist headwinds and a strong dollar creates an earnings headwind for many internationally exposed companies.
We continue to note the market’s aversion towards financial leverage. The tide is turning for those companies – particularly in the US – that have been using financial engineering in the form of taking on cheap debt to buy back shares, rather than investing in their own businesses. In our view, these highly indebted companies, which are experiencing deterioration in cash flow and profitability, are vulnerable and could offer opportunities to short the stock, ie, take a position that benefits from a fall in the stock price.
The generation of people born between 1946 and 1964. The name refers to a huge surge in the birth rate after World War II.
Beware of the context in which ‘carry’ is used. The term is often used interchangeably for a number of things, from a simple reference to interest income on a bond, to the positive or negative return from holding a bond by earning yield on the bond versus holding cash (or the funding cost on borrowed funds).
Consumer Price Inflation
An inflation gauge based on baskets of goods and services in countries and regions covered by the index.
In this instance, refers to companies that sell discretionary consumer items, such as cars, or industries highly sensitive to changes in the economy, such as mining. The prices of equities and bonds issued by cyclical companies tend to be strongly affected by ups and downs in the overall economy, when compared to non-cyclical companies.
The failure of a debtor (such as a bond issuer) to pay interest or to return an original amount loaned when due.
How far a fixed income security or portfolio is sensitive to a change in interest rates, measured in terms of the weighted average of all the security/portfolio’s remaining cash flows (both coupons and principal). It is expressed as a number of years. The larger the figure, the more sensitive it is to a movement in interest rates. “Going short duration” refers to reducing the average duration of a portfolio. Alternatively, “going long duration” refers to extending a portfolio’s average duration.
The front end of the yield curve represents the shorter-dated maturities (1-5 years) and the back end is the longer-dated maturities (10-30 years).
Initial public offering (IPO)
When shares in a private company are offered to the public for the first time.
Real (interest) rates
The real interest rate is the rate of interest an investor receives after allowing for inflation.
A real estate investment trust (REIT) is an investment vehicle that invests in real estate, through direct ownership of property assets, property shares or mortgages. As they are listed on a stock exchange, REITs are usually highly liquid and trade like a normal share.
The activity of asking for a car and driver to come immediately and take you somewhere, such as through a ride-hailing app.
The additional return over cash that an investor expects as compensation from holding an asset that is not risk free. The riskier an asset is deemed to be, the higher its risk premium.
Shiller price to earnings (P/E) ratio
The cyclically adjusted price-to-earnings ratio (CAPE), Shiller P/E or P/E 10 is a common valuation measure, defined as the price of a stock divided by the average of the previous ten years of earnings, adjusted for inflation. The ratio helps to indicate if a stock is undervalued or overvalued, giving a better picture of a company’s sustainable earnings power over time, and reducing the impact of business cycles or other events on the price.
Long-term investment themes with strong growth potential.
Single-payer health care
A health care system in which one entity, typically the government, collects all health care fees and pays for all health care costs.
Relating to credit or loan arrangements for borrowers with a poor credit history and a greater risk of loan default than prime borrowers.
A change in the financial system as a whole, which would affect all markets and asset classes.
A unicorn is a privately held start-up company with a value of more than US$1billion.
A sharp decline followed by a sharp rise back to a previous peak.
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