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.
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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.
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