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North America

Analysts: Sheldon McMeans, Rishabh Jain

Region Recommendation: B


  • U.S. fiscal stimulus providing solid short-term boost to domestic firms.  However, perceptions of increased wealth and political risk may neutralize the stimulus’s longer-term effect.

  • The United States is renegotiating NAFTA with hardball being played on both sides.  A breakdown of this deal will likely affect Canada more than the United States, especially if Trump executes his threat of a tariff on Canadian automobiles.  

  • The trade dispute between the U.S. and China has caught headline attention and caused market volatility.  While combined tariffs have totaled $260B in the past week of this report, fears have eased of a full-blown trade war.

  • The U.S. Federal Reserve is on track to normalizing its interest rates.  It is doing so at a faster rate than other developing economies who also had historically low rates after the financial crisis.  Increasing interest rate differentials, paired with solid growth and future increased deficits, are likely to cause an appreciation of the U.S. dollar up until mid-to-late 2019.  

  • Energy reform and a shift away from carbon-based sources in Mexico is a noble pursuit, however, corruption and a new executive is likely to hinder its execution.


Region Analysis:


Trend #1 – Trade War


By far the biggest topic in the North American market is the trade war. US had been fighting with almost all trading partners about the trade deficit. For now, it has solved a lot of issues with the EU, and the unresolved ones are Canada and China.


US has approximately $250 billion worth of tariffs on China imports, while allowing exceptions for firms like Apple. China has also replied back with tariffs on US imports, especially on the products that would hurt President Trump’s voter base. US has threatened China that it would put tariffs on $267 billion (remaining trade value with China) if China doesn’t back down and agree to favorable terms for US and China does not want to negotiate under threats. China has started a case against US in WTO.


Within North America, a favorable deal was struck with Mexico which was part of NAFTA, but negotiations are still going on with Canada. Trump is ready to move forward with just China but his representatives are not.


Overall, the US is trying to use its power as the major importer of goods to force countries to a deal in USs’ favor. A simple prediction would be that Canada will come through because Canada has a surplus, about C$5.35 billion (July 2018). This argument is also supported by the fact that representatives in Congress do not want a NAFTA without Canada.


Trend #2 – Hawkish Fed


The Fed has been bullish on the economy and has already raised rates twice this year, and according to markets, there are two more to come this year. Current target range is 1.75 – 2.00%, and by year end, it should be 2.25 – 2.50%. The Fed has two goals, create jobs and hit 2.00% inflation. Recent PCE (Personal Consumption Expenditure, a measure similar to CPI) reported was 2.40% which the Fed uses (not CPI) to measure inflation, and unemployment is at historically low levels of 3.90% which is considered full employment economically speaking. Bank of Canada is dovish in its approach and kept interest rates at 1.50% at its latest September meeting.

Business confidence has risen over time – even during trade wars – and stock prices are at all-time highs. The economy ‘might’ be overheating, which is at least what the Fed believes. Two theories: people are spending now because trade war will cause everything to be more expensive; deregulations and the TCJA (Tax Cuts and Jobs Act) are causing the growth. It’s hard to say which one has provided a stronger boost in the short term, but in the longer term the deregulations should help the economy. To take advantage of the rates but also to be cautious, investment in financial sector might be a good choice.


Trend #3 – Valuations


Stock market has touched an all-time this year. Growth strategies seem to be working far better than value ones. And current S&P 500 P/E is about 25x but historic mean is 15x. The valuations received a huge boost due to the TCJA because of record high of buybacks. Second quarter, 2018 buybacks totaled $436.6 billion, almost double of first quarter, 2018 buybacks worth $242.1 billion. Apple and Amazon broke through $1 trillion in market capitalization this year. The fact that high valuations can stay with the current volatile environment brought by trade wars and political risks is, in my opinion, ridiculous.


J.P. Morgan recently asked investors to reduce exposure to US equities due to risk of coming recession and put money in EM. But EM has recently been crushed by currency devaluations caused by the trade wars. In Turkey, the currency sell-off, down 40%, was obviously excessive and investors who realized that bought it at low levels and sold it when it rebounded. That’s just an example of how fragile the market is. Investors will keep supporting growth and valuations will keep growing until they don’t and there will be a correction of 10 – 20%. According to this analysis, short-term opportunities might arise and would be good to take advantage of. As for US, the best sector to be in would be consumer staples given its defensiveness.


Trend #4 – Bond Yields


The US 10-year Treasury recently broke through the 3% mark. For a while, the yield curve has been very flat and the spread between 2-year and 10-year note has reduced to its current level of 0.24%. After the 2008 crisis, when the interest rates essentially became zero, investors are now looking for higher yields. S&P small-caps has gained 14.32% YTD, and if you had held 5 – 10-year treasury, you would have made -3.14% (so you would have lost). Bond prices are going down for two reasons: one, investors are hungry for higher yields and are selling treasury to make room for corporate debt; two, sovereign wealth fund issues. In December 2017, Russia held $102 billion of US treasuries, and in May 2018 it had $14.9 billion. Russia sold them because of the sanctions put by US. Now, China holds $1.2 trillion of treasuries (Japan about $1 trillion) and China is realizing that it might not need US as badly as it thinks. China could sell US treasuries, which would cause a spike in bond yields. That surplus of supply would cause interest rates to skyrocket making it hard for US companies to borrow. Essentially, China could cause a major slowdown in US economy if it wished so. Current 3.00% yield on 10-year is a resistant number and it might be a while till that’s broken, unless China and/or Japan intervene(s). However, it would not be wise for China to sell US treasuries since that would cause the devaluation of dollar, making US look better for imports.

Sector Analysis:


Medical Supplies & Equipment - Buy


Two key trends in this industry are “Aging Population” and “Drug & Technology Advancements.” The key demographic calculation of “Seniors as % of Population,” where seniors are of age 65 and above, the proportion has been increasing consistently. In 2016, the number was 15.6% and is expected to grow to 20.6% by 2030 as baby boomers join the class. That is a CAGR of 2.1% approximately. An impact of this shift is the rising demand of medical supplies and equipment that keep people alive, like durable medical, respiratory, feeding, and voiding equipment.

Other health care sector trends like advancements in drugs, and growth in biotechnology, life sciences tools and services are major drivers. New equipment is in demand as patients prefer less invasive treatments and diagnostic products; and new pharmaceuticals and data driven approaches increase expectancy and diagnose people faster. Given the advances in biotechnology and life sciences, requirement of new innovative equipment and supplies has increased and will continue to increase in demand because of the nature and current situation of the industry.


Life & Health Insurance - Buy


“Health Care Costs,” “Life Expectancy,” and “Interest Rates” are the key trends that are affecting life and health insurance industry. In general, a rise in interest rates helps insurance companies to make greater returns on their investments. In 2018, Fed has increased rates three times, with another probable in December of 2018; and three more hikes are expected in 2019 which will certainly help push up yields on bonds, a major asset for insurance companies.

Health care costs are on a rise due to development of orphan drugs (treat a small population, like acute lymphoblastic leukemia). Orphan drugs fetch higher prices due to their specialty and are expected to have double-digit growth and become a major part of pharma companies’ revenues (about 20%). Advancements in biotechnology and life science tools and services also contribute to this cost, and will be a headwind to the industry. However, the rising rates should help offset the challenges by providing greater investment income. It would also depend on the industries’ ability to pass costs to consumers. IBIS World estimates that health insurance industry revenues will increase at 1.1% CAGR till 2023 to $991 billion.

Lastly the increase in life expectancy will provide insurance companies with additional time to payout insurance claims, and in some cases, collect premiums for longer periods. Current economic and demographic trends also support the health and life insurance industry. Employees usually get insurance as benefits; and with a tight labor market, firms are buying group insurances to attract and retain talent.

Two statistics: 81% of employees say that retirement benefits make up a major portion of a job search; 83% of employees say health insurance is very or extremely important in deciding whether to stay in or change jobs.


Consumer Staples – Buy


Consumer staples sector is home to essential products characterized by inelastic demand and therefore stable profits throughout the business cycle.  After the financial crisis of 2008, North America and particularly the United States (US) has experienced a significant albeit relatively slow recovery.  According to the National Bureau of Economic Research, the US experienced its trough from the crisis in June 2009. Beginning in the postwar period to 2009, the average duration of trough from previous trough of recessions is just under 70 months with the average expansion lasting 58.4 months.  This average expansion of the US business cycle has increased steadily since first measured in 1854 due to what is termed as the “Great Moderation,” which began in the 1980s. History is not always indicative of future results, however, the US is in its second longest expansion in history and the consensus is that the US is in late cycle.  The consumer staples sector is defensive in nature, providing low correlation relative to other sectors in the domestic economy.  When GDP growth is strong, the desirability for the defensive sector dwindles.  According to the Brookings Institute, global trade accounts for about 25% of global GDP and the research group stated that the trade dispute between China and the US is “Likely to have significant contagion effects around the world.”  In October, the International Monetary Fund (IMF) downgraded global GDP growth from 3.9% to 3.7% for 2018 as well as cut its outlook for 19 countries citing the trade dispute between US and China as a headwind. The IMF held its outlook for 2018 US GDP at 2.9%, however, forecasts a slowdown in growth in 2019 due in part to the diminishing effect of President Donald Trump’s tax cuts.  If this slowdown materializes, demand for the consumer staples sector will increase. In addition, the low correlation and defensive nature of the sector amidst global risk is attractive from a diversification and portfolio management perspective.





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