While technology stocks should continue to outperform if bull market conditions continue, other sectors such as industrials could come to the fore, although car manufacturers and certain retailers remain structurally challenged, according to analysts at asset manager Quilter Cheviot.
The S&P 500 hit an all-time high last Tuesday – after going 3,460 days without a drop of 20 per cent – signalling the longest bull US run in its history.
As such, the Quilter Cheviot analysts team said they not only believe that the US-led bull run in equity markets will continue but that economic indicators point at sectors other than technology will gain in importance over the coming months.
Indeed, the post-global financial crisis environment has been characterised by exceptionally strong performance from an economic and markets perspective.
Performance of index over 10yrs
Source: FE Analytics
So far, the main beneficiary has been the technology sector, which has continued to rally fuelled by president Donald Trump’s tax cut programme and strong earnings growth.
Ben Barringer, technology analyst at Quilter Cheviot, is positive on the current sector’s backdrop and believes this is going to continue over the coming months.
“The technology sector – and US tech names in particular – have continued to perform well over the course of 2018, helped by strong earnings growth and structural themes like cloud computing, artificial intelligence, cybersecurity and electric vehicles,” he said.
“We think these trends can continue, with technology companies spending significant sums on research and development to maintain and enhance their offerings.”
Barringer highlighted Amazon as the best example of this, with the company spending close to $23bn on R&D in 2017 – a sum that made the e-commerce and cloud-computing giant the global leader in R&D spending.
“Amazon looks well placed to maintain this status, with its cloud computer business growing at double-digit rates and the company enjoying good pricing power with its Prime service,” he noted.
The industrials sector hasn’t shared the same fortune this year, as it can be seen from weaker key leading macroeconomic indicators such as the purchasing managers index (PMI). Trade tensions aren’t helping the sector either, which remains sensitive to higher tariffs.
However, as Quilter Cheviot’s industrials analyst Sanjay Patel pointed out – although the narrative will change quickly if trade disputes escalate – the industrial cycle remains healthy, with continued growth in sales and profits.
“The industrials sector serves a large number of end markets, so even if some areas are slowing, others are ready to start growing again,” Patel said.
“We see opportunities for the leadership of industrials performance to change into companies that provide capital equipment into areas such as marine, oil & gas and mining sectors that have been depressed for many years,” he added.
Performance of sectors YTD
Source: FE Analytics
Siemens AG, the largest industrials manufacturing company in Europe, is one example of those businesses the analyst believes are undergoing positive changes.
“Siemens is a global engineering company but many of its world class businesses have been undervalued in a conglomerate structure,” he said.
“They are now shedding this structure to focus on three leaner operating businesses and wish to fundamentally improve the operating margins of these industrial businesses, which will include cost cutting but also increasing digitisation and software integration of their key assets, leading to more ambitious financial targets post-2020.”
However, the analysts also believe there are some sectors that will continue to face structural challenges, including car manufacturers and some retailers.
According to autos analyst Dominic Reeder, despite looking cheap at face value, this factor alone is not enough to be positive on the sector.
“Global car sales may have peaked given the extended nature of the economic cycle, and these fears are compounded by trade tariffs, rising input costs and tightening emission standards,” Reeder explained.
“Over the medium-to-long term, there is also the disruption from electric vehicles and autonomous driving, with these developing areas requiring significant investment.”
Despite these challenges, Reeder noted there are also structural winners and certain companies that will navigate the “bumpy road ahead”.
Irish auto parts company Aptiv, that benefits from both electric and autonomous themes, is an example.
According to Reeder, Aptiv benefits from two areas of structural growth: advanced driver assistance systems and autonomous driving, and electrical architecture.
Performance of stock YTD
Source: Google Finance
“The first area is essentially about making cars safer by reducing the reliance of people driving and responding to changes on the road,” he said. “The second might sound more esoteric, but it’s actually vital to the future of electric cars: there is a big need for the electrical wiring in cars to be redesigned now, as car manufacturers simply won’t be able to add the new features consumers are demanding otherwise.”
Another area facing these challenges is the retail sector, where changes in the way consumers shop are forcing companies to adapt in order to survive.
As Quilter Cheviot’s retail analyst Amisha Chohan noted, some of the main reasons for those changes in the way people shop include technological advancements, the need for convenience and improvement in logistics.
Potential ‘winners’ have either a unique selling point, agile operations or an extra level of insight into their customers, she said.
“Consumers favour retailers or brands with a unique selling point nowadays, and that often includes luxury,” Chohan said.
“We think companies like Kering can benefit from this trend. While it’s not a household name, you will have heard of its brands, which include Gucci amongst others.
“The company has strong operating margins, and we expect strong sales growth going forward which should outperform the luxury sector as a whole.”