22 Jan 2019
We have seen volatility return to equity markets worldwide in 2018, after an unusually calm 2017. The synchronised global growth environment that prevailed for the last two years has started to show some cracks, with many global markets seeing growth moderate. The United States, conversely, reported the fastest rate of gross domestic product (GDP) growth in nearly four years in the second quarter of 2018 and remains in expansion, albeit at what appears to be a slower pace.
While impressive, the US GDP figures were helped by a combination of tax cuts and increased federal spending that may be difficult to sustain at a high level going forward. Still, when we look deeper at the two key pillars of the US economy—the consumer and corporate earnings—we still see a healthy backdrop. The consumer continues to benefit from a strong labour market, subdued inflation and low interest rates by historical standards. Lower tax rates for corporations have led to higher profits that, in turn, potentially can fuel capital spending and extend US economic expansion in 2019. Importantly, we have not been seeing any of the speculative excesses that usually herald a downturn in the economic cycle.
We continue to believe the economic backdrop provides a supportive environment for corporate fundamentals, as evidenced by revenue, earnings and cash flow growth across myriad industries. For US investment strategies, Franklin Equity Group seeks to invest in companies we consider innovative and that appear well positioned, with long-term growth prospects that are underappreciated or not recognised by the market. Our rigorous fundamental research focuses on companies that are not only growth businesses, but also meet our quality criteria in terms of strong competitive positions, great financials and forward-thinking management teams. We believe these select enterprises have the potential to outperform the market over the economic cycle and be structural winners over time.
Regardless, we are alert to several key risks for the equity markets in 2019 and would suggest that 2018’s volatility may recur as well. As disciplined, long-term investors, we believe volatility often presents compelling investment opportunities in strong companies that are being mispriced by the market over the short term.
Potential risks for the US economy in 2019 include tariffs and trade restrictions that could lead to trade wars—and an erosion in corporate fundamentals and investor sentiment, in turn. It is a complex issue that can have significant implications for global trade and economic growth. Currently, we are monitoring developments in this area closely in order to understand our investment exposure.
Another possible risk in 2019 is rising inflation and interest rates. As economic growth accelerated in 2018, we have seen a modest pickup in inflation and the US Federal Reserve (Fed) has grown more hawkish. Thus far, the markets appear comfortable with the current pace of rate increases given strong US economic growth, but there are concerns that the Fed could overshoot its targets, especially if growth moderates.
Among the big themes we will be watching in US equities during 2019 and beyond are cloud computing services, e-commerce and health care innovation. In our view, the US economy is in a period of unprecedented innovation that reaches across multiple sectors and industries, akin to the Industrial Revolution. We believe the long-term fundamentals supporting the information technology sector, which is well-represented within several of our strategies, remain constructive. We are seeing a continued ‘digital transformation’ theme, in which technology companies are increasingly impacting traditionally non-technology markets. This digital transformation, along with lower taxes and the need for greater productivity in a tightening labour market, should serve as key drivers for the sector’s continued growth.
For example, new developments in data analytics, automation and artificial intelligence are disrupting the industrials space. Electronic payments, blockchain and virtual currencies are transforming how financial companies and retailers do business. In health care, the use of robotics is allowing surgeons to perform complex procedures with more precision, while sequencing technologies have broken barriers in the area of personalised medicine. As active managers, we can focus on the long-term growth trajectories of many of these multi-sector, multi-industry themes. In doing so, we attempt to look through short-term market volatility and opportunistically take advantage of market weakness. Preparing for an economic downturn or market pullback is something that is done over time as we build our portfolios stock-by-stock, and we consistently revisit our positions to ensure our investment theses remain intact.
Author - Grant Bowers, Manager - Franklin US Opportunities Fund.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. Stocks historically have outperformed other asset classes over the long term but tend to fluctuate more dramatically over the short term. Investments in fast-growing industries, including the technology and health care sectors (which have historically been volatile) could result in increased price fluctuation, especially over the short term, due to the rapid pace of product change and development and changes in government regulation of companies emphasising scientific or technological advancement or regulatory approval for new drugs and medical instruments. Small- and mid-capitalisation companies can be particularly sensitive to changing economic conditions, and their prospects for growth are less certain than those of larger, more established companies.
IMPORTANT INFORMATION
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