Outlook 2017: Global opportunities after a year of surprises

As 2016 winds down, global investors can reflect on a volatile year, full of surprises. A double-digit correction in the first six weeks welcomed investors into the new year, sparked by a December 2015 rate hike in the U.S., as well as concerns over the slowing Chinese economy. Post-decline, equities rebounded strongly, aided by global central bank support and surging commodity prices. Emerging -market equities benefited most from the rally in commodities. Central bankers – the Bank of Japan (BoJ), the European Central Bank (ECB) and the U.S. Federal Reserve – soothed investors’ nerves throughout the year with their accommodative policies and/or dovish rhetoric. Other factors driving investor sentiment included rebounding oil prices as well as a strengthening housing market in the U.S.

The surprises of the year, however, were driven by elections.  The United Kingdom’s Brexit vote to leave the European Union provided a brief, but sharp, sell-off mid-year. This was followed by a quick recovery, but ongoing uncertainty in terms of how such an exit will actually happen. Donald Trump’s November victory in the U.S. Presidential election led to a surge in the U.S. equity market, highlighted by rotation into previously out-of-favour segments such as health care and financials.

Despite these headlines and volatile price swings, as the year comes to a close, it appears that the markets have rewarded investor patience with a reasonable gain as payback for their perseverance.¹

What will drive performance in 2017?

Today, we face a world of growing divergences between corporate profitability, sector and industry cross currents, multi-asset complexities as a result of public policymaker actions, and inevitable disruption from the possibilities of the internet, all overlaid with regulatory risks in numerous sectors and countries. In the midst of this, the Invesco Global Core Equities team continues to anchor our global research capabilities in a disciplined investment approach to uncovering overlooked opportunities and assessing risks. We believe the factors driving the market – corporate earnings, interest rates, globalization and demographics, to name a few key issues – have increased the importance of differentiated, fundamental research. Select segments of the market, financials and health care for example, demonstrated meaningful earnings recovery in the third quarter of 2016. Looking at the bigger picture, health care companies offer investors exposure to two of the more intriguing and opportunistic longer-term global trends, in our view – aging, particularly in emerging markets, and an emphasis on healthier living.

Following their multi-year support of the markets, we anticipate central banks may rethink quantitative easing (QE) in 2017, perhaps expanding their current ultra-low interest rate policies to include infrastructure spending programs. We believe that by supplementing monetary-only stimulus (which has led to an extremely subpar recovery) with actual government spending, central bankers in the U.S., Europe, Japan and China could potentially spur improved secular economic growth.

We also believe the recent trend of central bank market support has been favorable to passive strategies. In general, the “rising tide lifts all boats” market backdrop has resulted in headwinds for active, research-oriented investment processes that are focused on individual company strengths and weaknesses. In turn, passive investing funds in the U.S. have benefitted from significant asset flows. However, the changes we anticipate should begin to reverse this tide as company fundamentals and an improving global economy should reward well-positioned management teams, in our view.

It’s important to note that our views are not built on short-term or even 12-month expectations. We search the globe and use multiple valuation criteria to find “growth-value anomalies” – companies that we believe have an attractive risk-reward profile over a time frame of three years or longer.

We complement our sector-based work with a geographic overlay so that we can better understand the macro picture and the issues facing the companies in which we invest. While the nuances of individual markets can be difficult to detect or measure, this is particularly applicable to the emerging markets. For example, the World Bank recently announced that in India, on average, it takes 26 days to start a business and 190 days to gain a construction permit. In Mumbai, it takes almost 13 days for imports to clear customs, versus an average of nine hours in countries that are part of the Organization for Economic Cooperation and Development.³ Local market characteristics are an extremely important factor in measuring a company’s potential and risk.

What we see across global markets

We research all sectors with a global view, and despite political rhetoric in some markets, especially the U.S. and U.K., we expect globalization to continue. As such, we believe that continuing pressure on prices, threats from innovation and regulation will require sharp research to identify and quantify profitable upside opportunities relative to the associated risk. As of early November, we continue to view several segments of the market as compelling opportunities. Within technology, we see prospects in the semiconductor-related industries, and within health care, our research has uncovered growth-value anomalies among select biotech-related stocks.

Our investment approach also leads us, however, to be quite cautious with some areas of the market, specifically the utilities and consumer staples sectors, which have been referred to as the “expensive defensives.” Investors’ focus in recent years on dividends and high-yielding stocks has led some groups, such as utilities, to be relatively expensive in our view, with unwanted risk due to valuation and the prospect of rising interest rates.

Conversely, we remain encouraged by the number of opportunities we are finding in the financials sector, specifically financial services. However, we do not view all financials similarly. For several years, we have been cautious on the banking industry, and even today, we find limited opportunities in this sector, particularly in today’s low-rate environment. Conversely, our research on financial service companies and insurance companies indicates the potential for continued upside in a number of companies, especially those that embrace innovation and are less subject to significant capital and regulatory constraints. In addition, we find several companies within this latter group of financials to be more attractively positioned from a valuation standpoint.

In conclusion

The existing gap between company stock valuations and their growth prospects – when uncovered by our team of high-conviction, fundamentally based analysts – offers  ample opportunity for long-term rewards, in our view. Our approach remains focused on finding these growth-value anomalies, and our disciplined stock research continues to identify the roots of change, disruption and innovation as these impact all companies in varied ways. We believe our approach is particularly well-positioned against the current market backdrop where we can use any increased volatility, especially when unrelated to company fundamentals, to potentially capture longer-term rewards for investors.