Investors should be confident in the outlook for healthcare, shale gas and technology but more cautious when it comes to the energy sector as a whole, according to Fidelity’s head of equity research.
Globally there seems to be a complex mix of tailwinds and headwinds flying at stocks in all directions, which is why a steer from the vast analyst team at the asset management house can put things into perspective.
Taking a huge array of geopolitical and economic factors into account, 159 equity and fixed income analysts at Fidelity Worldwide Investment revealed their predictions in a global survey released this week.
In the below article, Henk-Jan Rikkerink, head of equity research, discusses which sectors he expects to fly and which ones he expects to flop over the next few years.
Healthcare
Healthcare was the sector which achieved the highest ‘global sentiment score’ of 6.8 per cent in Fidelity’s sector, with 60 per cent of analysts noticing improved management confidence in the last year.
What’s more, 60 per cent expect an increase in capital returns within the sector and half predict an increase in dividend pay outs.
“Globally, the management teams of healthcare companies are the most confident of all the sectors on growth and returns, and there’s a combination of reasons for that,” Rikkerink said.
“Number one, they have strong structural demand. In essence, there’s more old people globally and of course it’s old people who are the key users of healthcare products.”
“In addition to that there’s very strong innovation and, in Europe and the US in particular, we’re coming into a period of very strong new drugs coming into the pipeline, which should be very generative for the top-line of the listed healthcare sector.”
Performance of MSCI World Health Care vs MSCI World over 3yrs
Source: FE Analytics
Rikkerink and his team believe that over the next few years the industry could enter a “golden period” for drug approvals, not unlike the surge that occurred in the early 1990s.
“That’s really based on the view that the number of drugs that are going to be approved for use in Europe and the US has been very low for the last five or 10 years,” he explained.
“Our expectation is based on seeing what’s in the phase three pipelines of the drug companies both in Europe and the US, and that number is going to go significantly higher over the next five to eight years than it has been.”
Rikkerink emphasised that healthcare is one of the sectors which has been best at corporate renewal as a whole, in terms of asset swaps and divestments which have strengthened their market positioning.
However, many investors have been discouraged from investing in such a high-cost sector.
“Yes, healthcare is expensive versus recent history,” Rikkerink admitted. “But it’s not that expensive given the quality of the fundamentals.”
“Our belief would be that healthcare as a sector globally over the coming one, two and three years will continue to outperform.”
The global analyst team at Fidelity have tipped Roche, a Swiss global healthcare company which is an industry leader in oncology research, as a stock to watch.
Rikkerink added: “Novartis would be another one. They’ve got a strong R&D [research and development] pipeline, mostly small molecule, and that’s across a range of different therapeutic areas.”
Novartis is a Swiss multinational pharmaceutical company which manufactures a range of drugs and was ranked as number one in sales among the industry globally in 2013.
Energy
The energy and raw materials sectors have been hard hit by the weakness in oil price and other commodities, both of which the Fidelity team believes are likely to persist.
The sector received the lowest global sentiment score of all sectors at just 2.1, ranking it last by a long way.
Performance of MSCI World Energy 10/40 vs MSCI World over 3yrs
Source: FE Analytics
Approximately 85 per cent of analysts have found a decrease in management confidence over the last year and every energy analyst predicts a reduction of capital expenditure in the sector.
Some 92 per cent of analysts also predict a decline in equity returns.
“The energy sector’s performance won’t surprise you, given the headlines you’ll have seen over the last few months. It’s a sector which, on all counts, management confidence comes out lowest in,” Rikkerink said.
“Energy globally represents 30 per cent of global capital expenditure, and of course management teams are expecting to have to reduce that and we expect that to continue through this year.”
“This leads to earnings downgrades, puts pressure on balance sheets, puts pressure on dividend payments, etc, so that’s a sector which is going to struggle from fundamentals for quite a long period of time.”
Rikkerink notes that the global capex survey would look far better if you were to remove the energy sector from it completely.
“This gives you a sense of how divergent energy is and, to a lesser degree, commodities in general from the broader space,” he added.
US shale
But Fidelity analysts are not worried about the performance of the US shale industry.
“At the moment US shale is spoken about as a high-cost producer, but we believe that production costs will fall very strongly here and efficiency gains will be significant,” Rikkerink said.
“The weaker players won’t make it, they’ll probably be bought out by the stronger players with stronger balance sheets.”
Rikkerink adds that a key thing to understand is the relative youth of the shale industry.
“The technology there is relatively new in terms of extracting the shale to create energy, and every time our analysts go out to the US to visit the companies, speak to the management team and see the fields, what’s clear is that there are very significant advances in the quality of the supply chain, in the technology of both vertical and horizontal drilling.”
Fidelity analysts acknowledge that the industry is going to have a tough time over the next six to 12 months, but they believe that the US shale industry will move further down cost curve significantly over the next three, five and 10 years.
Rikkerink said: “There should be opportunities [for a bargain] there. The key thing for the investor is to stay away from those companies that will go bankrupt, because there will be some that do, but the high-quality players over time, especially for a patient investor, should provide good investment opportunities.”
He prefers not to disclose any specific stocks at the moment, as Fidelity is currently in the process of building positions within these companies.
Information technology
IT also did well in the survey, coming in second place behind the healthcare sector in terms of its global sentiment score.
The team believe that high levels of disruption in this sector make stock selection critical. However, Rikkerink says that there is a positive demand environment currently which creates appeal.
“In general, companies are looking to spend more on their IT budgets over the next 12 months than they have spent over the previous one, two or three years. That’s the arising tailwind for many IT companies globally,” he explained.
“Within that, IT is very much a stock-specific story – it’s all about sub-sectors. Cyber security is a sub-area which would come out as somewhere [companies] would look to spend more within their IT budgets, for instance.”
“Generally, software gives you more pricing power than hardware. It’s all about individual winners and losers.”
“An example of a company that we like, is SAP. That’s a company in this environment that should benefit from this improvement in corporate spending.”
SAP SE is a German multinational software company that makes enterprise software for customer relations management business operations management. Its headquarters are in Walldorf, Germany, with other offices in 130 countries.
Performance of MSCI World IT 10/40 vs MSCI World over 3yrs
Source: FE Analytics