From Outlook to Allocation as Post-Election Rally Continues

Looking at the U.S. market as a whole, we remain skeptical of near-double-digit earnings-per-share (EPS) growth forecasts.  Analysts’ S&P 500 EPS estimates for 2017 are heavily skewed by the Energy Sector.  Energy Sector 2017 EPS growth estimates of roughly 300% account for over three percentage points—nearly a third—of the expected earnings growth for the S&P 500.  We have been cautious on the outlook for the Energy Sector and oil markets for some time.  Risks to the sector include a combination of modest oil demand growth, potential U.S. dollar strength, and an increased supply in response to rising oil prices.  Our analysis suggests Energy Sector earnings estimates and valuations continue to assume significantly higher oil prices, which seem unlikely in the near-to-intermediate term.

We continue to expect U.S. sectors that are not highly dependent on economic reacceleration will outperform.  The Information Technology and Health Care Sectors, in particular, have strong secular fundamentals that should support attractive earnings growth, even in the moderate economic environment ahead.  Information Technology should benefit from continued adoption of cloud computing and online advertising.  Potential corporate tax law changes could also spur increased demand for enterprise technology investment and repatriation of overseas capital, which could be deployed for additional investments in growth or for shareholder-friendly measures such as share repurchases and dividend increases.

The Health Care Sector is heavily weighted to pharmaceutical, biotechnology, and medical device companies, which should show attractive earnings growth tied to new drug innovation and device roll-outs, regardless of changes to the Affordable Care Act.  Meanwhile, Health Care currently trades at an atypical valuation discount versus the broad market. We believe this fact, coupled with the sector’s stable earnings growth, presents one of the most attractive return opportunities in the environment ahead.

These fundamental sector views are key outputs from our macroeconomic research, which supports our investment process as we seek to take advantage of the economic variation among sectors and, in turn, the performance variability among sectors of the stock market.  We contend that the economic backdrop gives us a guide for sector allocation in not only the current environment, but also over the longer term as our outlook evolves.

Important Disclosures:

WestEnd Advisors is an SEC-registered investment adviser. Registration of an investment adviser does not imply any level of skill or training. The firm is an independent investment management firm, 100% owned by its active principals. WestEnd manages both equity and fixed-income assets for individuals and institutional clients.

The investment processes, research processes, or risk processes shown herein are for informational purposes to demonstrate an overview of the process. Such processes may differ by product, client mandate, or market conditions. Portfolios that are concentrated in a specific sector or industry may be subject to a higher degree of market risk than a portfolio whose investments are more diversified. 

This report should not be relied upon as investment advice or recommendations, and is not intended to predict the performance of any investment. The information contained herein is not intended to be an offer to provide investment advisory services. Such an offer may only be made if accompanied by WestEnd Advisors’ SEC Form ADV Part 2. All investments carry a certain degree of risk including the possible loss of principal, and an investment should be made with an understanding of the risks involved with owning a particular security or asset class. Past performance is not indicative of future results. It should not be assumed that recommendations made in the future will be profitable. These opinions may change at any time without prior notice. While every effort has been made to verify the information contained herein, we make no representation as to its accuracy.

The Standard and Poor’s 500® Stock Index includes approximately 500 stocks and is a common measure of the performance of the overall U.S. stock market.  An index is unmanaged and is not available for direct investment.