Energy and supply-chain investments could shift economic power

The global energy transition and a move to more resilient supply chains could cause the U.S. to lose its earnings leadership, says James Sutton, portfolio manager with J.P. Morgan Asset Management’s International Equity Group.

Sutton said earnings leadership typically changes from cycle to cycle, and an opportunity is emerging for firms in Europe, Australia and Asia to shine as world attention revolves less around the “intangibles” of technology and more around the tangibles of energy and supply-chain infrastructure.

“That means sectors like industrials, materials and energy are likely to be where we might see earnings leadership,” he said on the latest Soundbites podcast. “There is a big opportunity in global-ex-U.S., versus just the U.S.”

The U.K.-based portfolio manager pointed out that, on a forward P/E multiple basis, the S&P 500  index trades at 19 times earnings, while the MSCI EAFE index trades at 13.4 times.

“That’s a nearly 30% discount,” he said. “The U.S. should trade at a premium, given the different sector composition — particularly more technology — which means it has a higher growth rate and higher return on equity. But that discount is double the historical average, which we think is the wrong number.”

Sutton said the MSCI EAFE index boasts a sector composition that has become much more like the U.S. and is likely to participate strongly in the coming shift to renewable energy and optimized supply chains.

“After taking a knife to earnings predictions last year, they’re nudging those numbers back up as companies hint at stronger earnings than anticipated,” he said. “We’re hearing from companies that operating conditions are still very robust.”

He has identified a couple of sectors that offer strong possibilities in the current economic climate. Despite recent turbulence in the banking sector, Sutton said the financial industry looks strong, particularly in Europe.

“We think European banks have been properly regulated over the last cycle to prevent the interest-rate mismatch and liquidity mismatch that we’ve seen with some of the U.S. regional banks,” he said. “We also think the market is pricing in a rapid normalization of net-interest margins for the banks. Banks should be able to make more money next cycle than the previous cycle, and valuations don’t reflect that.”

Another area he likes is semiconductors, although it is not without its complications.

“There’s a classic inventory correction going on at the moment — and indeed it looks worse than the last cycle, in terms of the severity of that correction and the amount of inventory which is lying around,” he said. “But that is providing a good entry point for long-term investors.”

With the growing integration of computer chips into industrial end-uses, and the enormous memory demands of generative AI, he said exceptional companies such as Taiwan Semiconductor Manufacturing Co. Ltd. and Netherlands-based ASML Holding are poised to outperform.

“These are the very dominant companies within the semiconductor sector,” he said. “They’ll be big beneficiaries of growth in that industry. And they’re not trading [at] expensive valuations today.”

Sutton also suggested the luxury-goods market and beauty industry could prove recession-proof, particularly for companies with strong consumer brands.

France-based companies LVMH Moët Hennessy and L’Oréal S.A. “would be two names that would stick out there,” he said. Their brand caché gives them the ability to take a huge markup on costs, he added.

And branding of another sort should help some Asian banks, he added.

“Having a brand of being conservatively run is key to building an effective deposit franchise,” he said. “It’s a very strong competitive advantage for companies like HDFC Bank [Ltd.] in India or [PT] Bank Central Asia [Tbk] in Indonesia.”

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.