Rapid Pace of Change in Many Economic Sectors Creating Investment Challenges, Opportunities
In this commentary, Kim Scott, portfolio manager of the Ivy Mid Cap Growth Fund, discusses how the rapid pace of change currently in motion in many economic sectors is creating investment challenges and opportunities.
Where we have been
In the back half of 2015, the markets became more volatile and unsettled than we had seen in some time, and that volatility has been magnified in 2016. Weakness in commodity markets and dollar strength has threatened profitability for many companies in the energy, materials and industrials sectors, with risk of a wider impact based on related stresses in credit markets. Concerns about economic growth in emerging markets, including China, where there is considerable murkiness around the pace of growth and the functioning of the country’s capital markets has been a source of angst, as is the direction and level of conviction of the Federal Reserve (Fed) with respect to future interest rate increases.
A closer look at sectors, industries
Complicating the assessment of the current and future investing environment is the rapid pace of change that is in motion for many sectors of our economy. The technology industry is always rapidly evolving, but even there concentration of computing power in the hands a few big companies such as Amazon, Google and Microsoft is changing the economics and demand dynamics for many users and producers of equipment, software and services. The consumer discretionary sector is finding new fault lines in many sub-sectors as consumer migration to e-commerce and over-the-top media consumption upends brick and mortar retailing, the business models of cable television providers and their content partners, and advertising models at an accelerating pace. The success of technological innovation as applied to oil and gas exploration by frackers in shale formations in the U.S. has led to both a boom and a bust for an industry that is currently reverberating throughout domestic and world economies.
Transportation is another area that is benefitting from applied information and logistics, at the same time it is reeling from the downturn in energy and agriculture, not to mention the — we think — yet uncertain impact of the evolving brick and mortar retail landscape. The commercial real estate sector has yet to experience the full impact of many of these changes, but as evidenced by the restructuring announced by Macy’s in the first week of January, much change lies ahead for that area of the U.S. economy. The automobile industry is in the early stages of extreme innovation as it moves from focusing on improving fuel efficiency and controlling emissions to delivering fail safe driver assist safety features and autonomously operating vehicles. Semiconductor and software companies that can develop the operating systems and hardware that can lead these innovations will be huge beneficiaries.
In financials, regulation has brought many changes and unintended consequences for capital markets, much of which we have likely not yet witnessed, but technology promises to bring even greater change as payment systems and methodologies evolve to meet the demands of mobile consumers who want to shop and pay whenever and wherever, with great efficiency and the highest levels of security. The status quo will be challenged and today’s financial system giants will be tasked with maintaining relevance and profitability.
Health care is another important area where changes in product development, the delivery of care and the use of information to tie it all together and make it perform at an even higher level in the future have significant implications for patients, providers and investors. All of this, across all of the economy is just the beginning.
Where we are headed
As investors we must balance the stresses of the current environment with the challenges and opportunities of the future, even as the future seems to be speeding toward us at an unprecedented pace. The worry over the current state of affairs in the economy and the stock market, while appropriate, seems a little late to us. The hit to the U.S. economy from oil price weakness, dollar strength and emerging market growth difficulties began to develop more than a year ago, gaining strength and impact as 2015 developed. A recession has been at hand across much of our economy and stocks across the energy, industrials, materials and consumer discretionary sectors have logged significant losses relative to the broader stock market as measured by the Russell Midcap Growth Index. While the “all-clear” signal has yet to sound, opportunity is developing in the stocks of very good companies across all of these groups. Many market participants are loathe to risk finding that opportunity in such a rapidly changing and challenging environment, especially as the Fed has signaled that it will be less accommodative as the year progresses. In addition, there is risk that the stresses in the credit markets from the troubles in the energy sector will become more widespread, presenting a risk to broad economic activity.
We believe, however, that there are many encouraging offsets to the negatives we see in the economy, including low oil prices, which are a big benefit to consumers, solid job growth, encouraging wage gains, firmness in the service sector, several quarters of strong household formation activity, and growth in the housing market. We think many stocks have discounted serious concerns and are poised for better performance as investors look beyond the safety of consensus leaders in the market to find differentiated return opportunities. We believe a shift in investor perspective about real value in the market will be a benefit to the Fund, as we continue to invest in companies that present a balance of growth and valuation that can yield substantial return opportunities for our shareholders over time.
Current Fund positioning
We will continue to seek well-managed growth companies in the key growth areas of the U.S. economy, including health care, technology, consumer discretionary, financials, industrials and some aspects of consumer staples. Health care remains the Fund’s biggest overweight sector. In this sector, we continue to find many interesting investment opportunities in long-term growth companies, although pressure on the stocks related to worries over drug pricing make us reluctant to add to the current position, and we may reduce Fund exposure over time.
We are happy with the Fund’s current overweight position in energy, as we think oil prices are likely to trend higher based on downtrends in production and supply and growing demand. We are likely to add to the Fund weightings in the technology and consumer discretionary sectors, and possibly industrials, over the next three to six months.
