OCEAN CITY — Make no mistake: The global economy is in the midst of a major transformation. The U.S. economy is joining much of the rest of the world in shifting into investment-spending-led growth.
According to David Bianco, chief U.S. equity strategist at BofA Merrill Lynch Global Research, emerging countries will be leading this growth.
"In that environment," says Bianco, "we like sectors that are exposed to healthy global business spending, tend to benefit from higher commodity prices and are less dependent on consumer spending in the U.S., Western Europe and Japan." To take advantage of these developments, Bianco suggests that equity investors consider the technology, industrials, materials and energy sectors. They constitute a group — and an approach — that Bianco likes to call "TIME."
Large technology companies currently offer some of the strongest growth prospects worldwide, as well as some of the stock market’s most appealing valuations. A confluence of trends is working in their favor: explosive increases in mobile broadband and cloud computing, powerful growth in emerging market economies, and pent-up business demand following the economic downturn. Meanwhile, the sector has been neglected in recent years in favor of foreign stocks, small stocks and commodities, among others, says Bianco, which has resulted in what he feels are unjustifiably low stock prices. "We think the greatest opportunity is in the more value-oriented side of large-cap tech," he adds. "We’re seeing contracting price-to-earnings ratios, coupled with double-digit earnings growth and strong balance sheets."
The valuations for the 10 largest tech companies, which represent 85% of the sector’s profits, speak for themselves. Shares of these mega-cap firms trade at just 13 times 2011 earnings, their lowest average price/earnings ratio since 1995.
"Companies around the world want to work with one big provider that can serve all of their information technology needs," he says. "That gives the titans of tech likely control over the business relationships with multinationals. They are crowding out small, local players, and they have huge amounts of cash with which to acquire almost any new company at favorable terms. Their stocks might not double. But in our opinion, their price/earnings ratios should be more like 15 or 16, and we could see 10% annual earnings growth for several years to come."
A million new people are pouring into the cities of emerging nations in Asia, Africa and Latin America each week. That will require major infrastructure spending.
As a result of challenges like these, emerging-market countries are expected to spend $6 trillion on infrastructure projects over the next three years. Much of that money will purchase machinery for extracting raw materials, heavy equipment for building highways, airports, dams and other projects, and large-scale urban essentials.
Producers of raw materials also are likely to benefit from this same trend toward urbanization and infrastructure growth. Bianco divides the sector into two groups: companies that provide highly cyclical construction materials such as copper and iron ore, and those that deal in more stable commodities such as chemicals and seeds. He thinks the latter group offers the more compelling balance of risk and potential reward, in part because agribusinesses and producers of such chemicals as industrial gases, which are commercially manufactured and used for industrial processes, enjoy good repeat business.
Valuations in the commodities sector are comparable to those of industrials stocks, with price/earnings ratios in the midteens. Bianco says that’s reasonable for companies that have relatively steady and predictable revenues, such as chemical and seed companies, and stand to benefit from growth in the emerging world.
"Energy is perhaps the easiest story to tell about investing in the global economy," says Bianco. "If you believe that oil should be priced at between $80 and $90 a barrel, as we do, then the price/earnings ratios of energy stocks based on ‘normalized’ oil prices is about 13 — lower than it should be based on the fundamentals.”
The risks in the energy sector tend to be specific to individual companies, so you might consider investing in the sector as a whole via a mutual fund or an exchange-traded fund (ETF). "It’s increasingly expensive and risky to make oil," says Bianco, "meaning big problems can occur at even the largest companies."
(A Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)