Equity sectors: divergence and opportunities

Although it may feel like US equity markets haven’t made progress since July, investment opportunities abound beneath the surface, where there has been much dispersion in returns. At the sector level, the difference between the best and worst performing group is close to 20% over the same period alone.

The same applies in Europe, with sector-level deviations of more than 25% year-to-date. Clearly, there is value to be added by being more selective than just “buying the market”.

Sector opportunities

When it comes to sector selection, we see two main medium-term opportunities globally: consumer discretionary and healthcare.

The former should, in our opinion, benefit from what remains the main (if not only) bright spot in most economies: the consumer.

While companies are battling with increased trade tensions and slowing growth, the impact on consumption has been minimal so far. It would be wrong to assume that consumers will remain insulated forever. It takes time for the economic uncertainty to filter through to chief executive officers’ sentiment and companies’ investment plans and hiring decisions. So we believe consumption is an attractive place to hide in the latter stages of an economic slowdown.

Turning to healthcare

On the other hand, the healthcare sector - after being a top performer last year - has been challenged lately. We attribute this underperformance to policy uncertainty ahead of the 2020 presidential election in the US, the largest and most profitable healthcare market. It is frequent for the sector to lag ahead of an election. Yet, we stick with our positive stance as we believe that healthcare – and in particular pharmaceutical companies – offer more attractive valuations and possibly better growth prospects than most of their “defensive” peers (such as utilities or consumer staples).

The road ahead will certainly remain bumpy for a few quarters, but the industry’s secular growth drivers should support long-term performance.

In the regions

At the regional level we see investment opportunities in communications services in the US. While regulation may dampen investors’ enthusiasm for companies that rely on private data to generate revenues, we believe that content creators can enjoy significant pricing power, even against what could become a difficult environment.

In Europe, where growth is hard to come by, our focus has been on sectors that we consider as are more likely to expand thanks to powerful long-term trends. Our preference here has been for information technology and industrials. Historically, these two industries have been disproportionately impacted by small variations in economic activity. However, as their business models evolve and become increasingly geared towards service-based revenues, we believe that growth profiles will become much more stable. This should attract investors in uncertain times.

Tactical plays

When it comes to tactical opportunities, we see value in energy, autos and European banks. Given the sectors’ current valuations, market expectations and positioning, any positive development around trade tensions or the global growth outlook could cause a significant rebound in valuations. But this can only be seen as a short-term trade in our opinion. Fundamentally, we believe these industries face challenges that will take years to address.

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