10 February 2017
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Scott Berg (pictured) is portfolio manager of the T. Rowe Price Global Growth Equity Fund.
The election of Donald Trump has caused a significant change in sentiment for equity markets. While uncertainty reigns on any specifics, markets have voted quickly and aggressively that growth, inflation, and US interest rates will rise, giving a shot in the arm to some deep cyclical segments of the market.
This shift has led to broad-based and significant outperformance of ‘value’ over ‘growth’. Indeed, the relative strength of global value stocks versus growth equivalents in 2016 is such that the trailing five-year picture now resides in a neutral position. This obviously caused a significant headwind to growth-oriented investors.
However, we believe less has actually changed fundamentally than is currently being priced into the markets and would caution against chasing a cyclical bounce to avoid disappointment.
Given this, we are focusing intensely on stocks we own and those stocks we would seek to own on any weakness. For us, it is important to distinguish between meaningful change and market noise.
Hope is trumping reality in energy and materials
We have been underweight energy and materials and remain so, despite the position being a headwind to performance near term.
We believe the world remains oversupplied with oil in the medium term, and if the US is successful at extracting more of its reserves as per early rhetoric around energy independence, this should ultimately put a ceiling on oil prices and the earnings power of much of the energy complex.
Even near term, with oil pushing into a $50 to $60 per barrel range, we are likely to see more mothballed US drilling sites coming back online.
The nature of technological change makes supply growth more likely and involves a magnitude of near-term supply change that the market is currently underestimating.
Materials stocks having rallied from a deep trough is perhaps understandable, given low expectations set in late 2015. However, the market has begun to price the reality of fiscal stimulus before any policy has been formed.
While the probability of an improving economic environment is higher, a package of US fiscal stimulus via infrastructure spending is unlikely to move the needle as much as many investors are anticipating.
The potential impact will not succeed in offsetting the structural declines in China’s demand for base commodities. The battle between hope and reality means a bumpy ride ahead for commodity-oriented sectors.
We have also seen significant movement in industrials stocks. We are neutrally weighted versus the index, in part because valuations look expensive in the near term.
With much of the earnings impact of any improving growth a medium-term story, and with low year-on-year earnings comparisons fading in the next few months, selectivity and patience will be essential.
Why we are adding to banks and innovative tech
While we are cautious on the commodity complex and stocks solely reliant on meaningful and near-term macro improvement, we have been active in financials, maintaining or increasing our positions in US banks and US capital markets.
We already believed before the election that some magnitude of interest rate rise cycle was likely and inflation was on the rise – partly given the bounce in oil prices, but also given the modest wage inflation cycle has been building over the last year.
While we have been active in the US, we continue to favour emerging market banks in domestically-driven growing economies over many developed market counterparts. This is especially true when considering the fundamentals of banks in Japan and Europe, where we remain sceptical on earnings power as well as balance sheet quality.
Meanwhile, while the market focuses on the pro-cyclical theme, we have been actively adding to stocks in the technology sector. We have targeted companies displaying long-term and standalone earnings power in a modest growth world.
But we have also added to stocks that could benefit from a growth surprise if we see acceleration in consumer spending or US corporate tax harmonisation.
What remains certain, in an uncertain world, is that innovation, disruption, and the growing use of technology has not stopped as a result of political events in 2016. We continue to like e-commerce, social media, and cloud software companies over the long term as a result.
