Consumer staples

Rising costs are the focus of responses from analysts covering the consumer staples sector, with sentiment falling sharply from 2.1 to 0.7. The Sentiment Indicator, an aggregate measure of corporate confidence through the eyes of our analysts, remains positive, just about, showing analysts expect little change in 2019. Almost a third of analysts observed a reduction in the optimism of management teams to invest in their businesses this year while only 14 per cent of analysts report an increase. The confidence of the consumer, particularly in the US, has been hit by trade wars and volatile politics and markets.

More than three-quarters of analysts covering the sector say they expect costs to rise, with a total of 64 per cent noting these will be passed on to consumers, against a global average across other sectors of just 30 per cent. Increasing freight costs have become a serious headwind for some US retailers, our analysts report, particularly for budget clothes resellers, which have a harder time passing those costs onto consumers. The thin margins and heavy reliance on domestic transport networks that characterise the business also increase their sensitivity to freight costs. Oil prices have come down, but wage costs for lorry drivers have risen, offsetting any potential benefit from cheaper petrol prices.

Indeed, the sector is particularly vulnerable to wage rises. All consumer staples analysts say wages are on the up in their companies, partly due to increasing political pressure on the issue of low pay. Regulation is also a source of concern, with 86 per cent of respondents expecting more in 2019. Internet companies are in the crosshairs of regulators and analysts report that this has the potential to limit monetisation of some parts of consumer staples firms’ business models.

Chart 1: Wages push up costs for consumer staples companies

What is the sector outlook for wage cost inflation over the next 12 months versus last 12 months?

Source: Fidelity Analyst Survey 2019.

Consumer discretionary

Our consumer discretionary analysts are the most pessimistic in this year’s survey. The sector’s sentiment indicator is at -0.5 with almost two-thirds of analysts reporting that management is less confident than last year. Almost half say the sector is in the slowdown phase of the cycle, a greater proportion than for any other industry, while more than half see declining returns on capital. Sluggish demand is weighing on companies’ pricing power, analysts report. However, these conditions aren’t necessarily all bad news for big firms in their fight against smaller companies.

The business environment has served to increase barriers to entry and make life hard for companies with fewer resources to draw on. Within the luxury industry, for example, the bigger brands have managed increase the frequency of new product releases compared to their smaller competitors.

While costlier, this approach has helped established firms capture the imagination of younger consumers, who demand frequent product drops and a high degree of customisation. “Millennials make up 35 per cent of luxury consumers and they have high expectations for service,” an analyst covering the sector said. Meanwhile the shift from bricks-and-mortar stores to online retailing is spurring more capital expenditure in the form of tech investment as shop foot-fall declines.

Chart 2: Consumer discretionary cycle moves to slowdown

What stage of the cycle is your sector currently in?

Source: Fidelity Analyst Survey 2019.

Healthcare

Healthcare is a rare ray of light this year - the only sector to show an improvement in sentiment, increasing from last year’s reading of 1.1 to 1.4, making it the most optimistic of all. Healthcare also stands out for its overall location in the business cycle. Not a single analyst thinks the sector is in slowdown, against an overall average of 30 per cent, while one in five is witnessing a mid-cycle expansion.

Analysts report healthcare CEOs are the most confident on developing new markets and this optimism is also reflected in expected returns on capital, which half of our respondents view as increasing, driven by new technology and products. For example, the biotech industry is eyeing sales gains of around $3-5 billion from expanding the application of a new type of minimally invasive heart surgery, an analyst reports.

The positivity is spurring investment across the sector. M&A activity is expected to pick up, particularly in the pharmaceutical industry, and companies across healthcare industries are also becoming more ambitious on R&D spend, our analysts report. Management optimism has been buoyed by the US Federal Drug Administration’s more relaxed approach to drug approvals under Commissioner Scott Gottlieb, which is helping to fast-track some new cancer treatments and spur innovation.

The aging cohort of baby boomers makes for a powerful demographic tailwind, and healthcare is the only sector where analysts see increasing life expectancies as a benefit. Ninety-three per cent of healthcare analysts report a major positive impact from the ageing of the population, against a global average of 25 per cent. The hearing aid market is due for a growth surge as more people pass 72 years old, the average age at people first seek hearing help. These consumers are eager for innovation and are prepared to pay more for products equipped with the latest technology, such as “Bluetooth music streaming,” according to a biotech analyst.

Chart 3: A wave of optimism in healthcare

What is the confidence level of the management teams in your sector to invest in their businesses versus 12 months ago?

Source: Fidelity Analyst Survey 2019.

Financials

Financials recorded its first fall in sentiment in three years, but the overall measure remains positive and the drop itself is, at half a point, the smallest among the sectors. This is due to a lack of pessimism rather than any buoyant optimism, according to our analysts.

The financial sector was shaken by volatile markets in 2018. Analysts report a significant move into the latter stages of the business cycle, with more than 80 per cent of respondents noting the end of expansion and the start of a slowdown. Three quarters of analysts say their companies are reacting to the indicators associated with the end of the market cycle, compared with just 31 per cent last year. In Europe, macroeconomic factors such as the European Central Bank’s hesitation around hiking interest rates has dampened confidence in the sector, according to analysts. The net margin on retail deposit taking and lending, which is heavily influenced by the base interest rate, contributes up to 80 per cent of revenue for some retail firms in the region.

Financial stability is chief among concerns of the sector’s supervisors, and, as a result, analysts report balance sheets are conservative. Banks are continuing to refine their risk management systems, putting the days of over-stretched and under-capitalised business models behind them, with around a quarter expecting leverage to decrease further. Some of this is self-imposed rather than coming from supervisors, according to our analysts, and managers are still reacting to the trauma of almost going under in 2008.

However, analysts are also seeing the early signs of a trend towards deregulation, with 18 per cent expecting less regulation in 2019, the highest among all sectors. For example, the US is reassessing its Dodd-Frank legislation, enacted in the wake of the financial crisis, with a view to reducing the regulatory burden on banks. The pendulum is swinging back towards deregulation, just as the banks that survived the 2008 financial crisis get used to a more cautious approach to risk-taking.

Chart 4: Financials analysts see the end of the cycle fast approaching

Are your companies reacting to end of cycle indicators?

Source: Fidelity Analyst Survey 2019.

Industrials

The industrials sector is a broad one, covering everything from recruitment consultants to air freight companies. But that diversification does not save it from a precipitous drop in sentiment, from 1.6 in 2018 to a barely positive 0.1 in 2019. Companies have little room for further expansion this cycle, and almost half of analysts expect declining returns on capital while only 6 per cent report a more confident management at their companies.

More than half, or 55 per cent, of industrials analysts expect funding costs to increase. Most at risk from this trend are the “M&A-driven growth stories,” according to one analyst, as well as companies that lease their products. This is because higher interest rates may have to be passed on to the consumer, dampening demand.

The sector, relying on delicate supply chains that are coming under pressure from tariffs and trade wars, is sensitive to geopolitical tensions. A full two thirds of analysts expect a negative impact on investment from geopolitics.

The sector is also second only to healthcare in the proportion of respondents expecting a negative outcome from Brexit. Analysts note that companies were awarded a limited number of service contracts while Brexit paralysed the political infrastructure. They cited this as a reason for industrial companies to scale back exposure to the UK.

Chart 5: Industrials analysts report an increasingly negative Brexit impact on UK investment

How has the Brexit referendum impacted the willingness of your companies to invest specifically in the UK?

Source: Fidelity Analyst Survey 2019.

Utilities

The outlook for utilities is under pressure again. After two consecutive years of gains, our gauge of overall sentiment towards the utilities sector has fallen to a reading of -0.3 index points last year, down from 0.8 points in the 2018 survey. It is one of only two sectors where sentiment is firmly in negative territory (the other is consumer discretionary).

One core reason is our analysts’ expectations for declining returns on capital in the sector. A key factor weighing on return expectations is the regulatory environment, according to the survey, but the impact varies across subsectors. Utilities providers - which include grid operators or networks and power generators, and retailers that sell to households are divided into two main groups - those subject to regulated returns or pricing and those where the market has been liberalised.

In markets where returns to utility providers are regulated, as is commonly the case with grid operators, those returns are often benchmarked against bond yields. As bond yields have been declining for most of the past decade, this has hurt returns on capital across the sector. Among retailers in Europe, returns are under pressure from intense price competition, driven in part by the rise of online comparison websites and the emergence of smaller companies with leaner cost structures and better IT. The UK is unique in that retail tariffs have been capped by the regulator following pressure from the government.

By contrast, in markets where pricing has been fully liberalised, like Germany, it has tended to track the price of coal and gas as the key sources of fuel for power producers. Broadly declining coal prices through late 2016 put pressure on power prices, which led to lower earnings for utilities firms. But the picture now is mixed. As coal and gas prices have rebounded, returns are expected to rise for most traditional power generators - such as coal, nuclear or gas generators in Europe that don’t rely on subsidies or contracted sales.

Chart 6: Utilities overall sentiment most negative since 2016

Source: Fidelity Analyst Survey 2019.

Energy

Sentiment within the energy sector is down in line with the oil price slump towards the end of 2018. According to our analysts, aggregate sentiment of the energy companies they cover dropped to 0.5 points heading into 2019, marking a steep step down from 2.1 points a year earlier. That’s one of biggest sentiment swings for any sector in the survey this year - a decrease matched only by the drop in sentiment toward technology.

Brent crude fell swiftly by more than 40 per cent, from a peak of more than US$ 85 a barrel in October 2018 to a low in late December of just over US$ 50 per barrel. Heading into 2019, our analysts are forecasting oil prices to average US$ 72 per barrel over the full year, according to follow up interviews conducted separately from the analyst survey questions. That’s slightly higher than consensus but it isn’t driven by expectations of resurgent demand; instead, they view supply side dynamics as the biggest influence. A squeeze by OPEC is expected to be the main driver of supply tightness, which could potentially be weighed down further by nonvoluntary falls in production from other producer nations such as Venezuela and Iran.

Other factors to watch in the year ahead include currency volatility, which is expected to affect energy more than any other sector in the survey - even if the magnitude of that impact is expected to be generally moderate. Energy prices are dollar-denominated but big producers in emerging markets such as Russia, South Africa, Brazil, Canada and China face costs in their local currencies. If the Federal Reserve hikes interest rates this year, against current market expectations, it could strengthen the US dollar causing a headwind for global oil prices and demand.

Chart 7: Management confidence is waning in the energy sector

What is the confidence level of the management teams in your sector to invest in their businesses versus 12 months ago?

Source: Fidelity Analyst Survey 2019.

Materials

Which way China goes in 2019 will have an outsized impact on the materials sector. The world’s most populous country and second biggest economy is also the biggest consumer of a number of commodities and base materials, everything from copper (for electrical wiring in buildings) and iron ore (for steel) to coal (for power plants).

Analysts no doubt had management concerns over China’s economic slowdown in mind when responding to this year’s survey, as overall sentiment within the sector has declined to 0.5 points this year from 1.7 points in 2018. Almost half (45 per cent) said the sector is already in the slowdown phase of the industry cycle, up from 13 per cent a year ago. But materials is a broad-bucket sector that encompasses mining, building materials and chemicals - so there is divergence as you drill down into the findings. Seventy-three per cent of our analysts say the management teams of the companies they cover are expecting a deceleration in China growth this year, up from 40 per cent when we asked the question a year ago.

For many commodities companies, the biggest swing factor for the sector would be a potential stimulus package by Chinese authorities that prioritises infrastructure spending, but the timing and scope of such a move is uncertain. Policymakers in Beijing have a clear desire to avoid a hard landing for the economy but are limited in the scale and nature of stimulus they can provide by China’s already massive debt load.

In the absence of a large stimulus campaign from China the survey results underscore how the materials sector will face the sharpest declines in returns on capital among all sectors. Margins have also been high in recent years, and so have further to fall if they regress to their longer-term norms. Fully 86 per cent of materials analysts said the sector will face declining returns on capital in 2019, up from only 20 per cent last year. The reasons cited for this are rising costs, slower end demand, and declining pricing power.

Chart 8: Analysts report China’s growth slowdown is hitting materials companies

What are your management teams expecting for economic growth in China?

Source: Fidelity Analyst Survey 2019.

Tech/IT

The technology sector has fallen a long way in 2019, declining to 0.5 points from 2.1 points a year earlier. Our analysts report that only 17 per cent of company managements are more confident to invest in their businesses than last year, compared with 84 per when we asked the same question in 2018.

What changed? One of the big challenges facing the sector is that of growth upon growth. The US is by far the biggest spender on IT across all geographies both in terms of penetration and absolute dollar amounts, and companies there benefited last year from major tax cuts and other incentives that greatly boosted the sector.

At the subsector level, there is quite a bit of nuance within the sector. For example, while hardware spending is expected to fall, it’s a different picture for software and the cloud, where spending looks set to continue to rise, according to our analysts.

Chart 9: IT company capex expectations drop off a cliff in 2019

How do organic capex plans for your companies over next 12 months vary vs. last 12 months?

Source: Fidelity Analyst Survey 2019.

Telecoms

When asked whether their companies were reacting to indicators associated with the end of the economic or market cycle, all of our telecoms analysts said no - putting the sector in a class of its own.

That’s not to say the sector is without challenges. In the words of one telecoms analyst, “They’re broadly stable if slightly declining businesses without pricing power thanks mainly to competition, but definitely in a recession or downturn they would be more attractive as they aren’t subjected to as many downgrades as other sectors.”

Overall sentiment within telecoms declined moderately, to a reading of 0.8 points in 2019 from 1.4 a year earlier. In addition to intense competition, telecoms firms face challenges including duplicate networks and a struggle to monetise the vast amounts of data they possess.

On the contrary, one area where there are expectations for further increases is capital expenditures. Capex is forecast to rise notably in 2019; in follow up interviews, one analyst cites rising spending on 5G spectrum options as a key factor here.

Chart 10: Not a single telecoms analyst reports their companies reacting to a slowdown

Are your companies reacting to indicators associated with the end of the economic or market cycle?

Source: Fidelity Analyst Survey 2019.

Currency volatility

According to our analysts, the impact of currency volatility will slightly increase this year. However, given the recent fluctuations in some emerging market currencies and dollar strength, and the continuing uncertainty around Brexit, it is surprising that the increase is so marginal. Only 15 per cent of analyst expect a ‘high’ impact this year, up a fraction from 13 percent in 2018.

Technology analysts expect less of a currency impact this year, with 44 per cent viewing it as ‘low’, up from 17 per cent in last year’s survey. Our analysts anticipate that the euro/dollar, which is the most important pair for North American software companies, is likely to be more stable this year, after a volatile period in the first eight months of 2018.

While the eventual outcome of Brexit continues to weigh on sterling, a good deal of negativity is already priced in to the currency. UK clothing retailers in particular were hurt by sterling volatility after the Brexit referendum in 2016. One analyst reports that at the time many retailers had hedges in place to reduce their currency exposure risk, but the majority of these hedges only ran until late 2017 and 2018. When they lapsed, the falling value of the pound inflated the cost of imported goods and put pressure on margins. The analyst adds that the year-on-year impact of this is expected to be smaller in 2019 compared with 2018, as the effects of the expiry of the hedges wash out of the data. As a whole, 40 per cent of analysts covering consumer discretionary, which includes retailers, expect a ‘low’ impact from currency volatility, up from 30 per cent in 2018.