2019 Global Investment Outlook

Competition and Reinvention Help Broaden Digital Transformation Globally

"2019 Outlook: As businesses look to engage with their customers in a more service-oriented and data-centric manner, we see significant investment opportunities in the leading 'digital transformation' platform companies, as well as technology vendors that enable their customers to digitally adapt and transform. We believe digital transformation should drive strong revenue and earnings growth across the technology sector for many years to come.”

Jonathan T. Curtis
Vice President, Portfolio Manager, Research Analyst
Franklin Equity Group®
Jonathan T. Curtis

Digital Disrupters Force Legacy Businesses to Adapt

Virtually all sectors are reshuffling their business models around information technology (IT) initiatives to remain competitive. We believe digital-centric businesses are more valuable than their legacy peers because they build service-oriented, recurring customer relationships informed by novel, organized and well-curated datasets. Non-digital businesses are waking up to the perils they face at the hands of digital disrupters, and many are now in the early stages of reinventing themselves through the adoption of digital tools such as artificial intelligence (AI) and machine learning (ML), cloud computing, data analytics, software-as-a-service (SaaS), e-commerce and fintech (technology-driven financial products and services, including digital payments), next-generation internet infrastructure, new media, robotics and the Internet of Things (IoT). In the near future, software applications and smart devices across all industries are likely to feature some form of embedded AI in them.

We believe that digital transformation (DT) and its supporting sub-themes will drive consistency in secular growth trends for many years to come. Bottom line: DT is not something that many companies can afford to delay.

Some examples of industries currently driving noteworthy DT initiatives include:
  • The legacy taxi industry, which is attempting to compete against popular ride-hailing services with their own mobile apps and software-centric dispatch services.
  • The brick-and-mortar retail industry, which has embraced e-commerce techniques to better service and understand their customers’ needs and streamline their inventory/distribution.
  • The music industry, which is more widely implementing music subscription services following years of resistance.

Key Risks amid the Opportunities We Are Monitoring

At the same time, we are cautious about investing in what we see as cyclical and or structurally impaired technology industries, some of which are being negatively impacted by DT. These include legacy IT services, legacy systems software, branded enterprise IT hardware, and several categories in the consumer electronics domain. Outside of the pending 5G wireless upgrade cycle for mobile networks, we hold a negative view on telecommunications equipment companies due to end-market headwinds, a sharp increase in competition, and what we view as a poor market structure.

Overall, we remain positive on the IT sector. First, enterprise IT spending is already quite robust. We see a path for that continuing into at least mid-2019, which will be the first full year of budgeting that takes into account a robust economy and the recent US tax cuts. Second, consumer IT spending appears stable amid expansion in services, new media and gaming offset by tepid growth in hardware such as smartphones and consumer personal computers. Third, many of the world’s largest cash-rich technology companies headquartered in the United States are still in the early stages of increasing their capital return programs as a result of US corporate tax reform.

We are also closely monitoring the following items for potential signs of trouble:

  • The magnitude and pace of interest-rate changes. If the US Federal Reserve moves too aggressively, the economy could decelerate or even enter recession. While this would be negative for nearly all sectors, including IT and communication services, we see less fundamental risk among the secular growth technology businesses tied to DT that we have identified.
  • The impact of the US-China trade war. If the situation intensifies, we see the greatest risk to enterprise IT hardware companies, which build their offerings in China for import into America. We believe there will be efforts to pass tariff impacts on to end users and or to move IT hardware manufacturing capacity out of China.
  • Headwinds to China’s economy, as it appears to be slowing modestly. This will be a negative for domestic Chinese technology companies and could be an issue for global technology vendors with significant exposure to domestic consumption in China.
  • Cyclicality in cloud-based capital expenditures. We remain quite positive on the cloud computing opportunity; however, capital investment in this category can be highly cyclical. There is some incremental uncertainty for select IT hardware, semiconductor and contract manufacturing companies following weakening capital expenditure investing in the second half of 2018.
  • How the regulatory landscape evolves for big internet companies possessing vast consumer datasets. Key to DT is the ability to collect and use rich data to better understand and serve customers. However, it may be harder to get big, bipartisan data usage legislation through a divided US Congress, particularly as it relates to user privacy and data sharing with companies and government entities. We also see very little risk of major tech firm breakups by regulators.