As global outlook brightens, financials, tech, EM present opportunities

We believe that the global economic outlook is improving.

From 2015 through early 2016, the indicators that I monitor to recognize potential turning points in macroeconomic cycles were in a rut, as the key data points that Wellington Management calls the Global Wave consistently pointed to low growth. In this environment, our process emphasized companies that we viewed as high quality and those that generate substantial free cash flows, maintain strong balance sheets, and return cash to shareholders in the form of dividend payments and share repurchases.

In mid-2016, incremental improvements in global growth began to emerge, and this modest recovery exhibited staying power entering the fall. We gradually shifted our approach, moving from a neutral stance that assigns roughly equal emphasis on stocks' relative quality, growth, valuation, and total capital return characteristics to one that puts a higher weighting on growth and valuation characteristics relative to the other two traits.

In the wake of the U.S. presidential election and given the modest improvement in U.S. and global economic data, we expect continued strength in the global economy and the U.S. dollar, at least through the first half of 2017. We may see U.S. policies that lower corporate tax rates and reduce regulatory burdens, providing support for industrial and consumer sentiment. Outside the United States, political momentum has shifted in favor of easing regulatory restrictions and implementing economic reforms that support growth.

Investment implications of an improving global economy

The bottom-up securities analysis that we perform as managers of international and U.S. equity strategies has identified a number of stocks in these two asset classes that appear to be well positioned for today's positive growth environment; several of these stocks are in the financials and information technology sectors, while a number of others are domiciled in the emerging markets. Here's a look at these three market segments and the macroeconomic trends that we believe are creating tailwinds:

Financials—Generally, banks and insurance companies are likely to benefit from a more favorable global economic environment, and, in the United States, from rising interest rates and pro-growth policies to lower corporate tax rates, increase infrastructure spending, and reduce regulatory burdens. The regulatory climate also appears to be shifting in a favorable direction for financials across much of Europe as a result of lower capital requirements there. These factors, combined with the improved growth outlook, bode well for an increase in credit availability and improved financial results for banks and insurers.

Information technology—The improved outlook for global growth could serve as a catalyst for increased tech spending, especially for semiconductors that are essential components of electronic circuitry and for enterprise software and related tech services that can help corporate clients increase productivity.

Increased demand for semiconductors is likely to be driven by the growing use of electronics in cars and by the Internet of Things (IOT)—emerging technologies that connect everyday objects so that they can send and receive data. As for software and services, we see a number of companies that appear well positioned to address the needs of corporate clients looking to reduce costs by outsourcing services such as customer relationship management or customer billing. These contracts are often long term in nature, generating recurring growth in revenue for software and services providers and putting these firms in a good position to potentially enhance shareholder value through dividend payments and share repurchases.

GLOGROW-BLOG chart

Emerging markets—The improved outlook for global growth has contributed to better earnings revisions across emerging markets (EM) as a whole, enhancing the potential for upside appreciation in EM equity prices, in our view. While we continue to monitor China's overleveraged banking system, we see positive trends overall in the largest EM economy, and the equities of selected services companies in China's information technology and consumer discretionary sectors appear to offer attractive upside potential. These sectors are benefiting from structural tailwinds as China's middle-class population grows and its economy undergoes a transition from dependence on exports to a greater focus on domestic services. We are also encouraged by recent developments in India, including reforms that have opened up the banking system to increasing numbers of lower- and middle-class citizens, bringing in more capital to banks.

A selective approach to realizing today's global equity opportunities

We will continue to seek opportunities in U.S. and international stocks—whether in these three market segments or elsewhere—that offer a combination of high quality, strong growth, and capital returns to shareholders. In today's market, such stocks can be purchased at reasonable valuations, in our view, provided you know where—and how—to look.