Reflections on Growing Economies and Fading Stimulus

2018 Global Investment Outlook

US Growth Team Sees Innovation-Driven, Secular Tailwind AheadDec 1, 2017

2018 OUTLOOK: “Looking ahead to 2018, we expect the continued positive backdrop of tame inflation, low interest rates and modest growth to remain in place and be supportive of growth equities in the United States and globally.”

As we look back on 2017, it will likely be remembered as an exceptional year for many investors, specifically those who owned equities and other risk assets. Through November 2017, US and many global equity markets were up double-digits, and broad corporate and emerging-market debt indexes posted strong returns as well. Investors who were positioned for growth in the United States and globally likely enjoyed a strong year. The backdrop that set the stage for these results, and for the ongoing bull market in stocks more generally, has been in place since the global financial crisis—tame inflation, historically low interest rates and moderate economic growth in the United States have all been supportive for growth investing.

Looking ahead to 2018, we expect the continued positive backdrop of low inflation and interest rates along with modest growth to remain in place and to be supportive of growth equities in the United States and globally. However, we are mindful of some reasonable risk scenarios—such as the US economy overheating, possibly in combination with interest-rate and inflation surprises to the upside—that might lead to market volatility and investors focusing on cyclical, value-oriented investment approaches. Nevertheless, as long-term investors, we believe that while macro factors can be volatile in the short to medium term, there is an innovation-driven, secular tailwind for growth. This technology-driven tailwind is disrupting industries and transforming many companies into engines of growth and creators of shareholder value.

Secular Drivers of Growth in 2018 and Beyond

While disruption is a term often used when discussing the technology sector, in recent years the application of data analytics and automation, combined with the power of cloud computing, has driven secular changes in numerous other industries, such as health care, industrials and retail. As we look at the investment landscape, we are identifying companies embracing innovation and/or leveraging new technologies that disrupt traditional business models. These companies are implementing cutting-edge ideas that are as broad-based and open-ended as the shifting competitive landscape.

For example, in health care, technology is revolutionizing drug development with computer-simulated clinical trials that have the potential to improve research and development, reduce costs and speed time to market. There are also new gene sequencing platforms and cancer treatments that are synthetically engineered to personalize patient care. In industrials, manufacturers are increasingly employing automation, robotics and artificial intelligence. On the factory floor, artificial intelligence is changing the role of the human workforce to improve productivity and minimize production costs.

Since the advent of online retailing over two decades ago, brick-and-mortar retail has been disrupted by e-commerce, which has expanded globally at an average annual rate of 20%.1 The internet has changed not only the way we shop, but also the way individuals collaborate and connect. This, in turn, has allowed companies to track customers and collect marketing data to personalize and enhance their product offerings and target advertising to drive revenue growth. While the growth in e-commerce has been explosive, the penetration rate of this transformative technology suggests it is still in its infancy—e-commerce still represented only about 9% of US retail sales as of June 2017.2 Likewise, while paying for purchases using credit and debit cards grew by 5.8% in 2016 worldwide, cash still accounts for 85% of global consumer transactions.3 In this context, we believe there are many years of secular growth for companies benefiting or enabling the shift away from cash to electronic payments.

2018 Will Not Be Without Its Challenges

One challenge to our growth investing strategy in 2018 may be the high level of investor skepticism surrounding current valuations for US equities in general, and for technology in particular. While valuations have risen post-global financial crisis and are no longer considered inexpensive, valuations as of late 2017 did not appear to be unsustainable, in our view. Looking at valuations in a broader context, we see them as a reflection of a strong economy, an improving corporate earnings outlook and prospects for pro-business policy reform from Washington DC. In the technology sector, for instance, valuations as of mid-2017 gave the sector a 24% share of the S&P 500’s total market capitalization, in line with its contribution to earnings. This contrasts sharply with past valuation/earnings divergences, such as during the Dot-Com Bubble, when valuations for technology stocks disconnected from earnings and reality.

Evolution of Information Technology since the Dot-Com Bubble

Contribution of Information Technology Sector to S&P 500 Market Capitalization and Earnings
June 1998–June 2017

% of S&P 500 Earnings

% of S&P 500 Market Cap

Source: Morningstar, Strategas, as of 6/30/17. Past performance does not guarantee future results.

We Will Look beyond Near-Term Market Gyrations

In 2018, we believe a synchronized global recovery should have meaningful and positive effects for US growth, and US equity markets in turn. As active managers, we view any near-term market gyrations or short-term politically induced market upheavals as opportunities to buy high-quality companies at more attractive prices. So we are apt to see any short-term volatility in 2018 not as an obstacle, but as an occasion to potentially add quality names to our portfolios. As always, our focus remains on companies that we believe will benefit from multi-year secular tailwinds and can generate solid risk-adjusted investment performance over the long term regardless of shifts in the markets.

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