While wide‑ranging opportunities exist, selectivity is key.
- T. Rowe Price managers see a broad range of opportunity as well as risks in the volatile market environment.
- We highlight opportunities in the technology, health care, energy, and credit sectors as well as in Asia ex‑Japan.
- We are optimistic over the medium term that a new bull market can potentially be born from lower equity valuations as economies stabilize and normalize.
Investors face tremendous uncertainty and potentially more market volatility as businesses and consumers encounter continued economic disruption stemming from the coronavirus pandemic.
T. Rowe Price equity and fixed income managers are mindful that extreme market dislocations provide opportunities but also present risks, requiring careful analysis to seek out quality companies that have the financial strength, competitive position, and capable managements to survive the crisis and perhaps emerge even stronger. We’d like to share with you some of the more salient topics our managers are discussing.
Pandemic’s Global Economic Stimulus
(Fig. 1) Percent of gross domestic product (GDP)
As of April 30, 2020.
Source: Cornerstone Macro.
Digitization Gathers Steam
The digitization of a wide range of industries and markets has accelerated during the pandemic. As individuals around the globe work, shop, and consume entertainment at home, companies that provide the infrastructure for the online economy have seen demand for their services boom, allowing them to extend their dominance.
Alan Tu, manager of the Global Technology Equity Strategy, notes that in this new digitized world, scale is crucial. Companies with the most capital to deploy can invest in the latest technology, which in turn attracts more customers. The tech giants that have best embodied this phenomenon are the world’s leading platform companies—a list that typically includes Facebook, Alphabet (Google), Apple, and Amazon.com in the U.S. and Alibaba and Tencent in China.
The leading players in the semiconductor industry have also grown more dominant over the past decade. Growing demand for leading‑edge chips to power computing‑intensive workflows and the rising costs associated with producing these advanced semiconductors give an important potential advantage to a select set of leading firms.
Along with advertisers and retailers, the media industry has been upended by online platforms that offer an improved customer experience. The primary disruptor has been Netflix, which has rapidly been adding subscribers during the pandemic. Amid the shutdown of production sets, Netflix stands apart in being able to draw on its huge, multinational library of previously filmed content.
Alan says that while tech giants have played a prominent role in the digitization of the economy, smaller industry upstarts are also sources of innovation and disruption, exploiting emerging areas where online services are making communicating and transacting easier. Investors may find some of the best investment opportunities in these younger and smaller companies, which could become takeover targets of the industry’s giants.
Being on the right side of change means identifying and investing in companies that make it easier for businesses of all sizes and across the economy to expand their online presence, improve productivity, and engage customers across multiple channels. It appears that we are still relatively early in a golden age for technology innovation, as the extraordinary power of the internet has enabled unprecedented value creation for both companies and investors.
Health Care: Changing Perceptions
Ziad Bakri, manager of the Health Sciences Strategy, believes that the longer‑term impact of the pandemic will be that investors will likely put an even greater premium on innovation and novel drug platforms. This should result in an even wider spread in valuations between “high and low value” medicines.
The intense focus on the importance of drug development during this crisis is also likely to change public perceptions on the trade‑off between drug pricing and innovation. As the regulatory overhang diminishes, valuations in the sector are likely to benefit.
Likewise, diminished political risk of a drastic overhaul of the U.S. health care system may provide a tailwind for managed care companies, at least in the intermediate term. More health care will likely be conducted virtually now that telehealth has demonstrated its viability and cost savings.
Ziad says his investment philosophy hasn’t changed as a result of the crisis. In the therapeutics and medical device sectors, he’s looking to invest in medicines and products that can meaningfully improve the standard of care and represent important advances in medical practice. The portfolio is evenly split between therapeutics (biotechnology and pharmaceuticals) and non‑therapeutics (life sciences, medical devices, and services).
Energy: Expecting a Near‑Term Comeback Amid a Secular Bear Market
Shawn Driscoll, manager of the Global Natural Resources Strategy, sees the potential for a powerful, countercyclical rally in crude oil prices and energy stocks that could last between 12 and 24 months as low energy prices drive supply cuts and oil demand potentially recovers from an unprecedented shock.
However, his longer‑term outlook for oil and the energy sector remains less sanguine. He believes that ongoing productivity gains from automation and improved reservoir management techniques in U.S. shale fields, among other factors, should continue to make hydrocarbons easier and less expensive to extract.
Among exploration and production (E&P) companies, Shawn prefers low‑cost operators that boast good balance sheets and sizable inventories of quality locations to drill wells. Although he likes many of the oil majors’ strong balance sheets, he has become more selective in that industry, avoiding names where strategic shifts could result in identity crises that distract management teams and dilute returns.
Shawn also sees select investment opportunities among oil field services companies and believes that the likelihood of a wave of bankruptcies in the industry, coupled with the flight of labor, could enable the survivors to raise prices for the first time in a long while as demand recovers.
Ryan Hedrick, an associate portfolio manager on our Large‑Cap Value Equity Strategies team, is finding opportunities in energy stocks that offer attractive dividend yields, including select names that own pipelines and other energy infrastructure and that he believes should generate more durable cash flows than their peers. The major integrated oil companies also fit this profile to an extent. He agrees that the magnitude of pain has created some opportunities in the more cyclical parts of the energy sector, specifically E&P and oil field services companies.
Global Earnings Growth Estimates
(Fig. 2) One‑year forward earnings per share (EPS) growth
As of May 26, 2020.
Source: FactSet. Financial data and analytics provider FactSet. Copyright 2020 FactSet. All Rights Reserved
Indices: US: S&P 500, Europe: MSCI Europe, Japan: MSCI Japan, Emerging Markets: MSCI Emerging Markets.
The specific securities identified and described are for informational purposes only and do not represent recommendations.
Where Does Value Investing Go From Here?
U.S. value investing’s decade‑long underperformance versus growth investing has widened since the onslaught of the pandemic.
John Linehan, Chief Investment Officer, Equity, says our objective, as always, with value investing is to find stocks that are trading at a significant discount to their intrinsic value. The current cheapness of so many industries means that companies with low valuations are plentiful; the challenge is to identify those that are likely to make it through to the other side intact. This requires in‑depth analysis of companies’ balance sheets, liquidity, and access to credit markets.
The managers of our value strategies have been able to upgrade the quality of their portfolios while, with a keen focus on the balance sheet, shifting selectively to more cyclical sectors. They increased their exposure to real estate, looking to take advantage of lower valuations and investor sentiment. They also added to semiconductors as the current environment is expected to further accelerate the proliferation of the internet of things.
Tom Huber, manager of the US Dividend Growth Equity Strategy, has also been buying high‑quality cyclicals, especially information technology and industrial companies developing innovative products. Meanwhile, our US Large‑Cap Value Equity Strategy, has been adding to positions in the bank, food product, and consumer discretionary categories.
Ryan Hedrick sees a slate of opportunities for utilities, driven by some of the following secular tailwinds: the shift from coal to natural gas and renewables for electricity generation; a corresponding mandate to modernize transmission and distribution infrastructure; the need to invest in older infrastructure to improve safety and reduce downtime; and the push to harden these critical systems against wildfires, hurricanes, and other natural disasters.
Although utilities’ resilient cash flows and dividend yields give the sector its defensive reputation, we believe the outlook for earnings growth makes the group’s risk‑adjusted value proposition more attractive.
Opportunities in Asia ex‑Japan
Equity managers in Asia ex‑Japan strategies say the market downturn provided the opportunity to build positions in high‑quality companies that previously traded at prohibitive valuations.
Eric Moffett, manager of the Asia Opportunities Equity Strategy, sees the best potential opportunities in southeast Asia and India. In China, the A‑share market of domestic stocks has held up relatively well. His focus in China remains on two big areas where the tailwinds have only strengthened, partly as a result of the coronavirus.
The first is consolidating industries dominated by a few big players among many competitors. Whether that is in property development, retail, or certain industrials, Eric expects consolidation to accelerate, creating attractive opportunities. In industrial technology, for example, there are many good Chinese companies serving the domestic market—including factory automation, industrial motors, or components used in electric vehicles— that could become global competitors.
The other area is import substitution. As a result of the trade war with the U.S. last year, many Chinese companies wanted to avoid dependence on U.S. suppliers, so there was a move toward import substitution and less reliance on global supply chains. That trend is accelerating this year. Many of these companies are focused on the domestic market but could become competitive global players over time.
The specific securities identified and described are for informational purposes only and do not represent recommendations.
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