global sector views report... · china’s weakness with the fall in oil is a problem for u.s....

Global Sector Views ReportA sector-by-sector outlook from the Janus Equity Team

OCTOBER 2015

GLOBAL SECTOR VIEW

2 | Global Sector View

For four decades, fundamental, bottom-up research has been at the core of the Janus investment process. Our deep team of analysts covers approximately 1,500 stocks around the globe. Each takes a do-it-yourself, unconstrained approach to research. We believe this differentiates us from our peers and drives results for our clients and the investors they serve.

Every quarter, our seven global sector teams share their bottom-up perspective on key themes in the equity markets and how those themes impact their sectors and areas of coverage.

The opinions are those of the authors as of September 2015 and are subject to change at any time due to changes in market or economic conditions. The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes.

TABLE OF CONTENTS

> Communications 4

> Consumer 6

> Energy + Utilities 8

> Financials 10

> Health Care 12

> Industrials + Materials 14

> Technology 16

Global Sector Views from the Janus Equity Team | 3

Like an extended vacation, markets started the summer in Greece and ended in China. Greece was exciting but in the end uneventful. China thus far has been much more exciting, a bumpy journey with stormy weather. While it may take some time, we think things will clear up.

The market turmoil amid the focus on the Chinese economy somewhat caught us by surprise. It was not that we did not see that China’s economy was slowing, particularly in the industrials sector, as the government tries to orchestrate a shift to a consumer-driven economy. We had seen the signs of transition and indeed welcomed it. We thought – and still do think – that a restructuring of the economy would lead to more efficient and sustainable long-term growth. We also saw, as did many others, the worrying bubble of local share stock markets. And we recognized that the currency was under pressure given the massive devaluations of the yen and euro to the dollar.

What we didn’t take into account was the global market scare that followed this well-signaled slowdown. While we don’t see the A-share market as a leading economic indicator of China’s economy, we recognize that economic developments in China are significant and that market watchers, including Janet Yellen, will keep an eye on progress. We think, however, that China’s uncertainty only changes how you invest in equity, rather than whether you invest in equity.

There are some difficult equity issues to consider. China’s weakness with the fall in oil is a problem for U.S. industrial and energy companies, especially as the dollar strengthens. We expect that volatility will remain higher in the coming months. Market volatility, measured by the standard deviations of returns, is rising but only to a level just above historical averages. The last months of the third quarter pulled us out of the doldrums.

Nevertheless, we believe Chinese consumer spending remains steady. That and other monetary tools, including further devaluations, will keep the economy from a hard landing. When investing in China, we prefer holdings that are exposed to the strength of the consumer. We are avoiding stocks tied to Chinese construction, infrastructure and capital spending. China’s weakness, as it turns out, could be a boon to the U.S. consumer with cheaper import prices. Already benefiting from lower gasoline prices, the consumer is stronger and smarter. Consumers are spending more, but in a way that favors some retailers over others. Over time, however, the opportunities in stocks and from stock picking will win out. A combination of innovation and demographics drives the health care sector. China’s economic outcome won’t stop us from getting older or treatments for diseases from getting more effective.

The move to cloud computing that is driving so much of tech doesn’t stop because the Chinese manufacturing index is low. And so on for many sectors and more importantly for many, many more stocks.

We look at consumer trends and other sector strategies in our review in the following pages.

It is worth remembering that the world’s economies are decoupling. While China pulls back, the U.S., and to a lesser extent, Europe, are still growing and investing. We think that Europe is seeing the benefits of an improving economy. Industrial companies can grow margins and banks with improved balance sheets can now increase dividends and returns. We do not believe that China – or Volkswagen – will squelch the growth in these regions. The world remains in a slow-growth environment conducive to stock picking.

Overall, valuations this quarter came down to more reasonable levels. Price-earnings ratios (P/Es) are down to historical averages, price to cash flow is below average and dividend yields for many indices and companies exceed 10-year bond rates. Markets are not giving many companies credit for their growth potential. The best opportunities are specific companies that are growing through capital allocation or by gaining market share. These companies can grow with a backdrop of slow global economic growth.

We think we will get past this China-centric crisis. As with Greece, the economic issues from China won’t suddenly go away, but to markets they will seem more manageable. Of course, China matters far more than Greece on a global scale, but it is not as important as the current market turmoil reflects.

“Having a great time. Wish you were here,” reads the typical travel postcard. No global equity investor is having a great time today but we think those who stay calm and look at stocks individually will be rewarded out of this chaos. You cannot easily time emotional markets, but when you look back a year from now, we think you will wish you were here.

Adam Schor, CFADirector of Global Equity Strategies

Carmel WellsoDirector of Research

4Q: Wish You Were Here


Trends & Opportunities > The share of advertising spending on digital platforms continues to accelerate.

The shift comes as the large-scale digital ad platforms have done a better job of linking what a consumer does on their mobile device to offline purchases and decisions.

> A “content anywhere” environment is creating heavy bandwidth demands.

> Consumers are viewing more content than ever, but viewing habits are shifting. An increasing amount of content is viewed on demand. Younger audiences are also gravitating toward short-form, digital native content. These trends have positive and negative ramifications within the sector.

> Distributors are curating, organizing and packaging digital native content for inclusion onto their platforms. The goal is to drive usage and increase relevancy with younger audiences. Providing niche content also may improve the distributors’ bargaining power over large media companies.

Risks & Headwinds> Future advertising revenues for content companies are harder to predict.

Changes in television viewing habits toward online and on-demand viewing are happening faster than distributors and content companies can develop advertising and measurement models to monetize that viewing.

> There is risk that a slow decline in subscriptions for the traditional cable bundle could accelerate as audiences turn to Internet services such as Netflix or skinnier content packages.

Investment Implications> Our largest holdings are in Internet services companies offering digital

advertising platforms. The companies are winning advertising market share as they allow for better targeting and higher conversion rates.

> We have reduced our exposure to media companies. We are avoiding companies whose content could be easily substituted online. Such companies are at greatest risk of losing share if the traditional cable bundle changes significantly.

> We are investing in a limited number of cable distributors that can offer video services bundled with robust broadband offerings. The revenue streams of these companies are more insulated from the risks of substitute video services, because those services require strong broadband capabilities.

> We are also investing in mobile tower companies, which provide the infrastructure that allows for more video viewing on smartphones and tablets.

COMMUNICATIONS

Advertising

spending is

quickly shifting to

digital platforms.


Mobile ReachU.S. Mobile Ad Spending, 2014-2019

Source: eMarketer. As of 9/1/2015.*Projected

2014

$19.15B

2015*

$30.45B

2016*

$42.01B

2017*

$50.84B

2018*

$57.95B

2019*

$65.49B

10.9% 16.6% 21.6% 24.9% 26.9% 28.9%

% of Total Media Ad Spending

Advertising spending is quickly moving to mobile platforms, where specific customers can be better targeted.

Amount of U.S. Mobile Ad Spending


Trends & Opportunities > U.S. home improvement spending continues to be strong. Rising home values are

incentivizing households to invest in home improvement projects.

> Restaurant sales are improving broadly, but the fast-casual segment is taking market share. A format offering higher-quality food at reasonable prices with quick checkout times is resonating with busy but health-conscious consumers.

> Spending power is improving for consumers with lower incomes. Wage increases and lower gas prices are benefiting consumers with tighter budgets.

> Consumer wallet share has shifted in recent years toward experiences and away from physical goods. The change happens as social media enriches experiences by facilitating greater sharing with friends and family.

Risks & Headwinds> A strong dollar and weak emerging market growth continue to be headwinds

for many multinational consumer staples companies.

> Consumer preferences are migrating toward natural and organic foods. The switch poses a structural risk for larger name-brand packaged food companies.

> Retail and apparel companies are in the early days of investing to improve the multichannel shopping experience. The impact these investments will have on margins is still largely unknown.

Investment Implications> We are investing in several companies whose chains of stores primarily serve

lower-income consumers.

> We continue to hold home improvement retailers. These companies benefit from increased spending on home improvement projects. The products from these companies are also harder to ship and often require a consultative sale, which makes them more protected from insurgent e-commerce competition.

> We are avoiding large-cap U.S. packaged food companies and own a few select grocers that benefit from the migration toward organic and natural foods.

> At the margins, we have gravitated our portfolio toward companies that derive a greater portion of earnings from developed markets. We have not made wholesale changes because we do not think the headwinds facing multinationals with a large footprint in emerging markets will last forever.

> We are investing more heavily in restaurants and other leisure and entertainment companies. Such companies benefit from the gravitation toward spending on experiences.

CONSUMER

Home

improvement

spending has

been a bright

spot for the sector.


Sharing ExperiencesQuarterly Personal Consumption Expenditures (PCE) Change in Things vs. Experiences

Source: Bureau of Economic Analysis, Janus. As of September 2015.

Aided by the ability to share through social media, consumer spending has shifted in recent years toward paid experiences and away from physical goods.

0%

1%

2%

3%

4%

5%

6%

7%

8% ExperiencesThings

2.42%

6.75%

2Q151Q154Q143Q142Q141Q144Q133Q132Q13

Year

-ove

r-ye

ar p

erce

ntag

e sa

les

grow

th o

f thi

ngs

and

expe

rienc

es



We expect oil

prices to remain

low through the

first half of 2016.

Trends & Opportunities > Growth opportunities in the energy sector remain hard to find in the current

backdrop of low oil prices. We believe oil prices could remain low through at least the first half of 2016.

> We believe the groundwork is being laid for an improved oil price environment in 2017 and 2018. Companies appear likely to reduce operating budgets in 2016. As fewer wells are completed, it will reduce U.S. supply. The market will still need to work through elevated storage levels in the first half of 2016.

> The next OPEC meeting in December could change the oil outlook. The consensus view is that OPEC nations will hold production steady. However, national budgets of OPEC nations depend on higher long-term oil prices, so this is not a given. This is the one variable that could cause a rise in prices sooner than expected.

> Energy service industries could be poised for consolidation. Service companies have been forced to make major price concessions and many smaller players will go out of business. The remaining players could see considerable pricing power when oil prices do rebound.

Risks & Headwinds> There is no margin of safety in the valuations of most U.S. exploration and

production companies. Current valuations of many energy companies imply a more near-term rebound than we expect.

> Oil demand could soften in the fall and winter. Weakness in China could soften demand. Seasonal maintenance at U.S. refineries in the fall could also impact demand.

> Oil from Iran or Libya could oversupply markets. As we mention above, oil storage levels are high across the globe and it will take time to work through that storage. At the same time, the lifting of sanctions against Iran and the potential for Libya to come back on line could add significant supply to the market.

Investment Implications> We are generally avoiding exploration and production companies.

Current valuations still do not represent an attractive buying opportunity.

> We have invested in select, dominant service companies. We are taking a longer-term view with these companies. As select service industries consolidate, we believe the dominant service players will be in a favorable position when oil prices rebound.

> We still see opportunity in a number of pipeline companies. These companies were part of the indiscriminate sell-off in energy stocks, but the contracts of many pipeline companies are tied to the volume of oil flowing through their pipelines, rather than the price of the underlying commodity.

ENERGY + UTILITIES


Still OversuppliedU.S. Ending Stocks excluding Strategic Petroleum Reserves (SPR) of Crude Oil

Source: U.S. Energy Information Administration. As of 9/18/2015.

The market will need to work through elevated storage levels before oil prices improve.

200,000

300,000

400,000

500,000MedianU.S. Ending Stocks excluding SPR of Crude Oil

Thou

sand

s of

Bar

rels

9/18/159/30/119/28/079/26/039/24/999/29/959/27/919/25/879/30/83



Trends & Opportunities > The regulatory environment, long a headwind for European banks, is finally

beginning to moderate. After a backlash against financial institutions coming out of the financial crisis, political leaders are now more aware of banks’ role as a finance transmission mechanism that is vital to improving the economy.

> Many European banks appear poised to move into a phase of higher dividends. Improving asset quality, stronger capital positions and modest credit growth have put banks in a better position to distribute surplus cash flow.

> Rising household wealth in the U.S. and parts of Asia is creating demand for investment advice and insurance products that preserve newfound wealth.

> A switch from cash to plastic and electronic payments remains a long-term secular growth opportunity. While the trend has been in place for some time, the penetration of electronic payments remains one of the strongest growth opportunities within the sector.

Risks & Headwinds> Persistently low interest rates in Europe are a headwind for insurance companies.

> A lower-for-longer rate environment in the U.S. is also a headwind for many financial companies.

> So far, we are only seeing early-stage delinquency impacts from the massive credit expansion in China. China’s bank debt to gross domestic product (GDP) ratio has soared in the last several years, and the likelihood of nonperforming loan acceleration is high. However, since China’s banks are largely domestically deposit-funded, we do not expect a liquidity shock.

Investment Implications> We see opportunity for banks operating in Italy, Ireland, Belgium and the

Netherlands. Banks in Italy are due for potential consolidation and cost rationalization. Ireland is enjoying a strong cyclical recovery, while the Low Countries are high-profitability banking markets, underpinning high cash flow and dividend potential.

> We continue to have large holdings in payments companies.

> We are investing in companies that can take market share in the growing wealth management industry. We are focusing on select companies offering innovative products and services in wealth management.

> We are also investing in global insurance companies with a large presence in Asia. Brand recognition should help these companies take market share from smaller, local competitors as demand for insurance grows.

FINANCIALS

The backdrop for

European banks

is improving.


Bank DependentSources of Corporate Borrowing in the U.S. and Europe

Source: International Monetary Fund and central banks.

0%

20%

40%

60%

80%

100%

SecuritiesOther LoansBank Loans

201420080%

20%

40%

60%

80%

100%

20142008

U.S. Europe

Perc

enta

ge o

f Tot

al C

orpo

rate

Bor

row

ing

Perc

enta

ge o

f Tot

al C

orpo

rate

Bor

row

ing

Bank loans have remained a much larger source of corporate lending in Europe compared to regions like the U.S. Regulators and politicians are realizing banks’ importance to economic growth, setting up a better regulatory environment in Europe.



Trends & Opportunities > We believe the regulatory environment for health care companies has never

been more favorable. Drug approval rates are well above historical norms. The regulatory review and approval process for medical devices is also speeding up dramatically.

> Drug pipelines look promising. Innovative treatments have recently launched for lung and kidney cancer, heart failure, psoriasis, cystic fibrosis and high cholesterol. New therapies are also advancing for the treatment of Alzheimer’s, Crohn’s disease, severe asthma, hemophilia and osteoporosis.

> Techniques for treating disease are evolving. We are moving from chemical pills taken daily to new therapies that can directly target genetic defects or unlock the potential of our immune system to fight cancer.

> High-impact research translates into significant pricing potential. A number of new drugs are being developed to treat rare but devastating diseases with few available options. This allows companies with innovative therapies to withstand pricing pressure.

> The merger and acquisition market remains strong. Stocks of both acquirers and targets have been rising on announced deals. As long as acquirers are rewarded for making acquisitions, we expect activity to remain elevated.

Risks & Headwinds> Biosimilars could threaten sales of some biotech treatments. The risk is stock

specific and we believe well anticipated by the market.

> A strong dollar remains a headwind for many multinational companies. Some large-cap pharmaceutical companies derive as much as 15% to 25% of their revenue from emerging markets.

Investment Implications> We own a number of pharmaceutical and biotech companies developing

promising therapies for unmet medical needs. We are closely evaluating the science behind each therapy to determine its likelihood for clinical success. We also conduct our own analysis to determine the potential market size of new drugs, which we believe the market frequently gets wrong.

> We own several specialty pharmaceutical companies whose management teams have an established track record of making value-enhancing acquisitions. We also own innovative specialty pharmaceutical companies we believe could be future takeout targets.

> We are investing in medical device companies using advanced medical technology to create differentiated, life-saving products.

HEALTH CARE

Innovation in the

sector remains

high, with new

treatments poised

to launch for

many high, unmet

medical needs.


Device InnovationPremarket Approval (PMA) Volume of Medical Devices (January-July)

Source: FDA.gov. As of September 2015.

Volu

me

of M

edic

al D

evic

es A

ppro

ved

0

5

10

15

20

25

30

35

40

Panel-TrackOriginal PMA Approvals

201520142013201220112010

The regulatory environment for medical devices and technology is becoming more favorable.



Trends & Opportunities > The U.S. construction environment remains strong. Construction was slow to pick

up after the financial crisis, but we are seeing a rebound in both residential, and, finally, nonresidential markets.

> The outlook for automobile sales continues to be favorable. Sales trends continue to be strong in the U.S. and are turning more positive in Europe. In China, summer sales declined unexpectedly, but auto suppliers are seeing orders in the region pick back up, indicating weakness could be related to a temporary drop in consumer confidence as Chinese equity markets corrected.

> M&A activity and share buybacks within the sector are high. Faced with sluggish economic growth but strong balance sheets, these capital allocation decisions are helping many management teams continue to drive growth.

> The potential for margin expansion in Europe looks particularly compelling. European industrials were slower to react to the financial crisis than the U.S., and are only now seeing improved cost structures through cuts and restructuring. Lower costs, combined with higher volumes as the European economy gains steam, could have a significant impact on bottom-line growth.

Risks & Headwinds> A strong dollar remains a challenge for U.S. companies with high exports and

imbalanced transactional exposure. Moreover for these companies, the translational impact from foreign currency remains a headwind to reported earnings.

> Weakness in the energy sector is negatively impacting revenue streams for U.S. industrials serving energy end markets. Companies’ direct exposures to energy are well understood. We are paying close attention to the indirect exposures industrial companies may have.

> Emerging market industrial and infrastructure spending remains subdued. Capital expenditure budgets for Brazilian and Chinese companies look particularly weak.

> The appetite for new capital expenditures in the U.S. remains low. Shareholders have generally been skeptical of industrial companies making major internal investments over returning cash to shareholders. There is a risk that many U.S. companies are underinvesting and may not be able to react fast enough to an improving economy.

Investment Implications> We own a number of multi-industrial companies that have large parts of their

business exposed to the construction industry.

> We are investing more heavily in auto suppliers than automakers. Many auto suppliers have higher margins, less competition and more product differentiation than automakers. Auto suppliers benefit not only from strong auto demand, but content growth within the automobile.

> We continue to hold a number of European companies that have gone through major restructuring efforts. Examples include companies in the freight forwarding and aerospace industries.

> We are looking beyond currency headwinds and taking a long-term view of the U.S. companies we hold with international exposure.

> However, we are avoiding pockets of the chemical complex and metals and mining companies. If China devalues its currency further, non-Chinese companies in these industries could become less competitive.

INDUSTRIALS & MATERIALS

U.S. construction

and strong auto

sales are two

of the most

positive trends

to the sector.


Getting ConstructiveAIA Architecture Billings Index (ABI)

Source: The American Institute of Architects, Janus. As of 7/30/2015.

30

40

50

60

70

80 ABI Index

Arch

itect

ure

Billi

ngs

Inde

x Le

vel

7/1/157/1/127/1/097/1/067/1/037/1/007/1/97

The ABI is a common leading indicator for U.S. nonresidential construction. U.S. construction has been a bright spot for the sector.



Trends & Opportunities > Businesses are increasing the speed of their transition to the cloud from

on-premises data centers.

> Enterprises are also beginning to shift from virtualization to containerization. Virtualization helped companies run and share applications off one server, but that server became more expensive over time. Containerization is a less expensive way to share applications because it allows shared applications to run off one operating system, saving memory costs.

> IT costs and spending are shifting from broad IT departments to individual business units. Increasingly as cloud-based applications proliferate, lines of business such as marketing are becoming more important buyers of technology.

> The semiconductor industry is consolidating. As the industry matures and growth rates slow, companies are looking to build scale and trim research and development departments.

Risks & Headwinds> The market for desktop computers is rapidly declining. The fact that desktop sales

are decelerating is no surprise, but the rate at which sales are declining is faster than many expected. Further, the tablet market has peaked and is in decline as well.

> The market is overlooking the risks to legacy tech companies. Many legacy tech companies tied to desktop computing or enterprise hardware trade at high valuations, due to the perceived safety of large cash reserves or dividend payments. Profit pools for these companies are shrinking and we think there is a limit to how long financial engineering can hold them up.

> Enterprise hardware companies are slow to react as businesses move to a software-designed data center operating in the cloud. With enterprise hardware becoming commoditized, management teams have been reluctant to consolidate and trim costs.

Investment Implications> We are invested in several IT services and consulting companies. These services

are in higher demand as IT departments seek help in transitioning their data centers to the cloud.

> We have large positions in some of the semiconductor companies that are consolidating the industry. We also have smaller positions in companies that operate in industries where semiconductor demand is growing. Such companies are likely future acquisition targets.

> Many of our holdings in cloud-based companies offer an array of solutions to a specific business department, rather than offering a single, cloud-based solution.

> We continue to be underweight large, legacy tech companies. In our view, risk for these companies is underpriced.

TECHNOLOGY

The market is

overlooking risks

to many legacy

tech companies.


0%

2%

4%

6%

8%

10%

12%

2018*2017*2016*2015*20142013

To the CloudsPure-Play Cloud Leaders, Projected Share of Total Enterprise Application Software Spend

*Estimates based on revenue projections for the four largest Software as a Service (SaaS) companies by market capitalization. Source: Janus estimates. As of 9/1/2015.

Estim

ated

Mar

ket S

hare

of T

otal

Ent

erpr

ise

Appl

icat

ion

Softw

are

Spen

d*

Businesses are quickly migrating to the cloud from on-premises data centers.


> Invest with our clients’ interests first.

> Develop a deep understanding of the companies we research.

> Employ a strong valuation discipline focused on quality growth.

> Develop independent and differentiated views on our companies, supported by in-depth primary research.

> Spend as much time thinking about what could go wrong as about what could go right.

> Take a long-term view.

> Seek to anticipate change, don’t just analyze it.

> Attract the best and brightest analysts in the business, and foster an environment in which they can succeed on behalf of our investors.

GUIDING PRINCIPLES OF JANUS RESEARCH



JANUS GLOBAL EQUITY SECTOR TEAM LEADERS

T E C H N O L O G Y

Garth Yettick, CFA

F I N A N C I A L S

John JordanH E A LT H C A R E

Andy Acker, CFAH E A LT H C A R E

Ethan Lovell

E N E R G Y + U T I L I T I E S

Kris Kelley, CFAC O M M U N I C AT I O N S

Jean Barnard, CFAC O N S U M E R

Jeremiah Buckley, CFA

I N D U S T R I A L S + M AT E R I A L S

David Chung, CFAT E C H N O L O G Y

Brinton Johns

Janus Distributors LLC

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In preparing this document, Janus has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources.

Statements in this piece that reflect projections or expectations of future financial or economic performance of the markets in general are forward-looking statements. Actual results or events may differ materially from those projected, estimated, assumed or anticipated in any such forward-looking statements. Important factors that could result in such differences, in addition to the other factors noted with such forward-looking statements, include general economic conditions such as inflation, recession and interest rates.

Janus makes no representation as to whether any illustration/example mentioned in this document is now or was ever held in any Janus portfolio. Illustrations are only for the limited purpose of analyzing general market or economic conditions and demonstrating the Janus research process. They are not recommendations to buy or sell a security, or an indication of holdings.

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C-0915-101465 10-30-16 388-15-15012 09-15

global sector views report... · china’s weakness with the fall in oil is a problem for u.s....

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