GLO

BAL

SEC

TOR

VIE

WS

Autumn 2017

A Spotlight on Industrials & Materials and Highlights from other Sectors

Page 1 of 10

Welcome to the Janus Henderson Global Sector Views, where our analysts share insights on the six sectors they assiduously follow. Also included is an in-depth analysis of key trends in a single sector, with this quarter focusing on how a strengthening global economy and innovation is improving the prospects of industrials. In addition, we cast a spotlight on the contributors to the piece: who they are, how they analyze stocks and bonds, and a bit about their life outside the office. We invite you to explore these views on the following pages.

INTR

OD

UCTIO

NSector Overview 2

Consumer

Energy & Utilities

Financials

Technology

Health Care

Sector Spotlight 5

Industrials & Materials

Contributor Profiles 9

Consumer

Consumers’ Changing Shopping HabitsE-commerce has accelerated in recent months, accounting for approximately 55% of core U.S. retail sales growth in the trailing three-month period. This shift in the shopping habits of U.S. consumers is greatly impacting the sector, leading to slower sales growth in physical stores. In response, some retailers are expanding their digital capabilities, shoring up balance sheets and taking other steps to remain relevant. Likewise, some shopping centers are adding more “experiential” tenants to draw in foot traffic. Despite these moves, we remain concerned about the outlook for legacy brick-and-mortar stores.

Equity Investment ImplicationsWe generally prefer to invest in “brands” rather than “boxes.” A brand can be sold online or in stores – it is not dependent on a specific channel. Additionally, stable brands can shift distribution away from troubled channels (i.e., brick and mortar) toward those mediums capturing a growing share of consumer attention, such as digital.

Fixed Income Investment ImplicationsA retailer’s demise can take years, if not decades. In the meantime, select retailers are deleveraging their balance sheets, refinancing debt and maintaining free-cash-flow cushions, all attractive qualities from a fixed income perspective. Companies with liquidity levers can also be appealing. Firms, for example, might own their storefront real estate, which could be sold for additional sources of cash.

Energy & Utilities

Surprises in the PermianCrude oil prices have remained relatively range bound as the Organization of the Petroleum Exporting Countries (OPEC) and certain non-OPEC countries maintained production cuts, which are expected to continue through March 2018. Given the rising importance of the Permian Basin in meeting marginal oil demand, shares of operators in the area were negatively impacted by reports that several wells had higher-than-expected gas-oil ratios (GOR) – typically suggesting a well is near the end of its life – and that unexpected changes in pressure levels within the field would require additional engineering. However, we do not believe that higher GORs present a near-term threat to producers active in the area. We will continue to monitor service capacity and pricing in the Permian, and how industry tightness may weigh on profitability as less-efficient crews and machinery are reactivated.

Equity Investment ImplicationsWe continue to focus on names that have some type of business model or stock-specific catalyst that isn’t a binary call on crude oil prices. We favor high-quality exploration and production companies that are well positioned on the global cost curve. Should North American production growth continue to be strong, we favor midstream names with infrastructure accessing the Permian and other attractive oil fields.

Fixed Income Investment ImplicationsWe favor companies with high-quality assets, capable managers, a good liquidity runway, near-term deleveraging catalysts and a good margin of safety in bond valuation. We believe these issuers are better positioned to succeed in varying oil price environments.

SEC

TOR

OV

ERV

IEW

Page 2 of 10

Page 3 of 10

Financials

Economic Growth to Benefit BanksThe Federal Reserve (Fed) has announced plans to shrink its balance sheet as early as this fall, while the European Central Bank has signaled that it may begin reducing asset purchases as early as next year. Any curtailment in central bank balance sheets could drive up term premiums and thus improve the profitability of financials. U.S. firms could also benefit from the potential loosening of regulation. Moreover, with all banks passing the Fed’s annual “stress test” in June, the sector could once again become a reliable source of dividends. Dividend payout ratios and yields have been rising at banks, and going forward, dividend growth at many banks should be able to at least keep up with earnings growth.

Equity Investment ImplicationsWe continue to like financial stocks exposed to structural growth opportunities. For example, Asian insurers stand to benefit from the region’s rising middle class and the desire of consumers in those countries to protect newfound wealth.

Fixed Income Investment ImplicationsWe expect U.S. banks to profit from rising interest rates. Regulatory rollbacks, if executed thoughtfully, could improve the earnings and therefore credit profiles of these companies. However, we are mindful that an excessive loosening of regulations could reverse creditor-friendly directives implemented in the wake of the financial crisis.

Technology

Transition to the Cloud and Digital AcceleratesCompanies are increasingly moving workloads from physical servers to the cloud and deploying programs such as Software as a Service. This has resulted in impressive growth rates for industry leaders. The same dynamic, however, has placed legacy software and hardware companies under increasing pressure. This is a mega theme and a global phenomenon that will be increasingly enhanced with artificial intelligence and machine learning.

Equity Investment ImplicationsGiven the strong growth trends, we are comfortable with valuations across much of the sector. We focus on individual companies tied to secular growth themes that stand to play out over years, not quarters. For example, the transition to the cloud and mobility helps inform our favorable view toward semiconductors. We continue to avoid larger legacy companies that have not adequately adapted their business models to meet the transition to the cloud.

Fixed Income Investment ImplicationsThe business model disruption is pressuring earnings of some legacy companies and driving them toward acquisitions in reaction to the changing landscape. We continue to avoid companies that will see balance sheet deterioration as a result of debt-funded acquisitions and those at risk of credit-rating downgrades.

Health Care

Concerns about Reform DissipatingRegulatory uncertainty has weighed on the sector, but the Senate’s failed attempt to repeal the Affordable Care Act suggests any future legislation will have to be limited in scope. Some changes could even benefit the sector. A recent draft of an executive order from President Trump, for example, proposed easing regulations for pharmaceutical companies and limiting out-of-pocket costs for patients – both potential positives for the industry. The Food and Drug Administration also announced plans to make the regulatory process more efficient. We believe these efforts could improve flexibility and lead to faster approvals for new medicines.

Equity Investment ImplicationsDe-risking on the regulatory front has allowed investors to refocus on company fundamentals. Throughout the regulatory uncertainty, we have remained committed to identifying innovative companies addressing high, unmet medical needs. It is shaping up to be another banner year for new drug approvals, with 31 novel therapies approved year to date (through August), compared to 22 in all of 2016.

Fixed Income Investment ImplicationsMany investment-grade pharmaceutical companies are merging in an effort to augment research and development pipelines and offset drug pricing pressures. We are identifying opportunities in companies that are allocating capital to reduce leverage after engaging in debt-funded acquisitions. We are avoiding names in need of a more robust drug pipeline that are likely to increase leverage to obtain it.

We are also finding opportunities in certain highly levered hospitals, many of which are opting to conserve capital and pay down debt as they consider the implications of still-undecided reforms.

Page 4 of 10

SEC

TOR

SPO

TLIG

HT Industrials & Materials

The performance of the industrials sector tends to ebb and flow with economic growth. So it may come as no surprise that as the global economy has strengthened over the past year, the sector has turned in positive results. President Trump’s election and the prospect of pro-growth initiatives helped kick-start returns. Since then, a number of factors, including improved business confidence, a weakening dollar and steady oil prices, have helped propel industrials companies, say the equity and fixed income analysts at Janus Henderson who cover the sector. “We’ve seen modest improvements in economic growth and people have confidence that it will continue to get better,” says David Chung, CFA, lead research analyst for the equity industrials sector team.

Of course, such optimism is tempered by worries about the aging bull market. Further, Trump’s much-anticipated reforms have yet to come through. Says William Palamet, a securitized products analyst on the fixed income team, “Some companies are thinking about growth but not pursuing it because they don’t have a clear view of what’s coming.” But our analysts believe this type of caution could help insulate industrials from the worst effects of a potential downturn. In addition, they argue new secular growth drivers could allow the sector to shine, regardless of what happens next in the business cycle.

Slow and Steady GrowthAn improving global economy has led to greater demand for the types of goods and services that industrials provide. For the first time since 2007, all 45 countries tracked by the Organisation for Economic Co-operation and Development are expected to deliver positive economic growth this year. The impact of this growth is showing up in industrials: Utilization rates for many industrial supplies have rebounded since the financial crisis, as demand for materials such as cement and wallboard has climbed. In the U.S., the Institute for Supply Management’s Purchasing Managers’ Index (PMI), a monthly measure of manufacturing strength, has remained solidly in expansionary territory since September 2016. PMI for the eurozone recently hit its highest level in more than six years, while a measure of China’s factory activity has mostly been positive over the past year.

Global PMIs Trending in Positive DirectionImproving manufacturing surveys point toward synchronized global growth.

Source: Bloomberg. Data as of 7/31/17

ISM Manufacturing PMI SA (U.S.) Markit Eurozone Manufacturing PMICaixin China Manufacturing PMI Nikkei Japan Manufacturing PMI

45

50

55

60

Jun-17Apr-17Feb-17Dec-16Oct-16Aug-16

Expansion

Contraction

Page 5 of 10

The industrials team says rising confidence is one reason for the sector’s growth. Despite dysfunction in Washington, corporations remain optimistic about a pro-business president, Mr. Chung says. Consumers are also generally upbeat, which is benefiting industries such as homebuilding, says John Lloyd, co-head of credit research. He notes that low unemployment rates and tight housing stocks are encouraging homeowners to spend on renovations, giving a lift to companies such as Masco, which makes home improvement and building products, and Sherwin-Williams, the paint supplier.

Better-than-expected growth in China has also contributed to the sector’s strength. Last year, investors fretted over the potential for a “hard landing” of China’s economy following the end of the commodities super-cycle (which had been fueled by China’s enormous demand for raw materials) and Beijing’s efforts to curb speculative investments. But China has defied expectations. During the second quarter this year, the country’s economy expanded by 6.9%, higher than most forecasts. Industrial output and fixed-asset investment were particularly strong. “It wasn’t so much a hard landing for China’s economy as a controlled decrease in demand,” says Mr. Palamet.

China’s Industrial Sector Proving More Resilient Than ExpectedUsage of machinery utilized in construction has registered several successive strong months.

Japan is the swing manufacturer for a lot of the world because the country has spare capacity. When you see an upswing in global industrial production, Japan tends to benefit disproportionately.” Julian McManus, Research Analyst and Assistant Portfolio Manager

The impact of China’s strength can be seen in Japan. During the second quarter, earnings before interest and taxes for Japanese manufacturers accelerated 17% on average year over year, compared with only 4% for non-manufacturing industries. The country’s GDP also jumped by a surprising 4% during the April-to-June period, fueled in part by corporate investments. Julian McManus, an equity research analyst, argues that Japan’s success is a sign that industrials broadly are doing well. “Japan is the swing manufacturer for a lot of the world because the country has spare capacity,” he says. “When you see an upswing in global industrial production, Japan tends to benefit disproportionately.” He notes that Japanese industrials companies such as KEYENCE, which develops and manufactures factory automation products, and FANUC, one of the largest producers of factory robots, highlighted Asia as a major driver of sales recently.

Keeping PerspectiveThe question now is whether economic growth – and therefore demand for the industrials sector’s products and services – is sustainable. The current bull market is more than eight years old, compared with an average of roughly four and a half years in the post-World War II period. The timing is making some companies hesitant to commit to long-term capital expenditures (capex), Mr. Palamet says. “A lot of these capex projects take years to deliver and the last thing you want to do is bring on capacity in a down market,” he says. In addition, skepticism exists about whether China’s economy can maintain its strength, as the country tries to rein in debt and tighten monetary policy. Indeed, the Chinese government has stated that its economic growth target for 2017 is around 6.5%, below the country’s latest GDP figure.

Source: Komatsu

Mon

thly

Ave

rage

Hou

rs

of M

achi

ne U

nit o

f KO

MTR

AX

-In

stal

led

Equ

ipm

ent

40

80

120

160

Jul-17Mar-17Nov-16Aug-16

Page 6 of 10

Almost every one of the homebuilders now has an entry-level segment, which is what the industry needs to continue driving solid growth.”John Lloyd, Co-Head of Credit Research and Portfolio Manager

I think a lot of industrials CEOs are praying for Trump ‘animal spirits’ to come through in orders. If reform does happen, there could be a lot of room to grow.”David Chung, CFA, Research Analyst

Aware of these risks, some firms are pursuing measured growth. In the construction aggregate space, management teams are exhibiting discipline as they think through the business cycle, says Mr. Lloyd. Those looking for growth are doing so by conducting smaller acquisitions, taking on less debt and deleveraging quickly. “These deals should expose the companies to less risk in the long term,” he says. Other firms are focusing on the next leg of growth. Single-family home construction, for example, remains below its long-term average, thanks to a dearth of first-time home buyers. However, Mr. Lloyd argues the trend could change once millennials, now in their late 20s and early 30s, begin to have families and put down roots. Homebuilders, as a result, are starting to target entry-level housing projects. “Almost every one of the homebuilders now has an entry-level segment, which is what the industry needs to continue driving solid growth,” Mr. Lloyd says.

In the meantime, industrials are benefiting from a few economic tailwinds. The dollar’s decline against the euro this year was a boon to U.S. multinationals competing with European counterparts. It also made commodities, which are priced in dollars, more attractive to international buyers. “The weak dollar has been a big benefit to metals and mining companies,” Mr. Palamet says. The stabilization of oil prices also helped the sector. Industrials tend to be concentrated in midstream operations (the transportation and storage of oil) and downstream services (refining and distribution of oil-related products). These firms were able to ramp up production as crude prices rebounded from lows hit in 2016. Plus, Mr. McManus says, costs continue to come down: “It’s still early days for fracking. The more efficient these companies become, the more that crude activity will be supported.”

Finally, Mr. Chung notes that while business investment has increased since the end of the last recession, it still has not fully recovered. “I would say the perception is that the capex cycle has been pretty good since 2009, but the reality is things have not been that great for the general industrials sector,” he says. Indeed, business spending as a percentage of GDP, while improving, is still below levels hit a decade ago. The passage of pro-growth reforms could change that. “I think a lot of industrials CEOs are praying for Trump ‘animal spirits’ to come through in orders. If reform does happen, there could be a lot of room to grow,” Mr. Chung says.

U.S. Business Spending as a Percentage of GDPAfter dipping during the financial crisis, businesses have invested. What was initially driven by replacing equipment could get boosted by business-friendly reforms.

Source: Bureau of Economic Analysis. Data as of 3/31/17

Non

resi

dent

ial F

ixed

Ass

et In

vest

men

t as

a P

erce

ntag

e of

GD

P Pre-Crisis Cycle Peak

8%

10%

12%

14%

16%

4Q164Q154Q144Q134Q124Q114Q104Q094Q084Q074Q06

Page 7 of 10

Secular Growth DriversBut the sector does not have to rely on Trump for growth, says the industrials team. They believe technological innovation is helping create new long-term investment opportunities. “As technology advances, new markets emerge and the demand for industrial inputs shifts,” Mr. Palamet says. Take electric vehicles (EV). Although EVs have been in existence for decades, improved technology and lower costs are making it possible for EVs to potentially supplant the dominance of internal combustion engines. That is creating demand for different resources, such as cobalt and lithium (both used in EV batteries) and aiding the growth prospects of specialty industrials and miners, such as Albemarle, FMC and Freeport-McMoRan. “Metals that historically have not had as much demand are now becoming some of the most sought-after projects,” Mr. Palamet says.

Electric Vehicle and Component Metal Estimated DemandThe transition of the global auto fleet to electric vehicles could spur massive demand for lithium and cobalt.

As technology advances, new markets emerge and the demand for industrial inputs shifts.”William Palamet, Securitized Products Analyst

Factory automation is another area seeing a surge in growth. Mr. Chung believes these technologies, which help companies manage supply chains and produce goods more efficiently, could have a 20- to 30-year tailwind. Mr. McManus points to machine vision as one area of particular opportunity. Machine vision is allowing robots in factories to make “smart” decisions and distinguish between parts on an assembly line. As the technology improves, “The scope where automation can be used begins to expand,” Mr. McManus says. And companies that specialize in machine vision, such as FANUC and KEYENCE, could enjoy a long runway of growth.

Other technology could prove to be disruptive for the sector. For example, 3-D printing – the process of making three-dimensional solid objects from a digital file – could eventually be used to construct bridges, engines and other capital goods. The process typically requires less labor and fewer parts: Using 3-D printing, GE reduced the number of components in a turboprop engine from 855 to just 12. As the technology gains ground, suppliers could come under pressure. “It’s an Amazon.com-like force that could disrupt the industry drastically,” Mr. Chung says.

In the meantime, though, such innovation is also helping create a competitive moat for the industrials sector. Amazon already has upended a number of business models, but Mr. McManus believes the online giant will struggle to compete in specialized industrials services, such as machine vision. There, he says companies such as KEYENCE enjoy a significant head start in technology. KEYENCE also deploys its sales force to factories to learn in real time about customer needs. Says Mr. McManus: “The higher-touch areas are not where Amazon is equipped to win.” In industrials, he says, “I think that’s where you want to be.”

Source: Bloomberg Intelligence

Ann

ual C

obal

t & L

ithiu

m D

eman

d(1

,00

0 m

etric

tons

)

Glo

bal E

lect

ric V

ehic

le S

ales

(mill

ions

)

Projected Global Electric Vehicle SalesProjected Cobalt Demand Projected Lithium Demand

0

150

300

450

2040E2035E2030E2025E2020E2017E0

10

20

30

40

50

Page 8 of 10

David Chung, CFAResearch Analyst

What is your favored metric for analyzing a stock? It depends because I think there are significant nuances in the industrials and materials subsectors. If I had to choose one, though, I’d pick free-cash-flow yield. I think it’s important for a few reasons. First, capital allocation is a critical driver of value creation within industrials (i.e., mergers and acquisitions, divestitures, dividends and share buybacks). You can’t do any of those without having cash, so cash is king. Second, companies in our space do a lot of adjustments to earnings for restructuring, acquisition accounting and one-time charges. So, I’ve found free cash flow to be a good metric for apples-to-apples comparisons across companies.

Talk to us about the formative experiences of your career or how you got started in the industry. I have long had an interest in economics (my dad is an economics professor in Korea) and have thought of this as the perfect job: meeting with world-class business leaders and trying to figure out how the world is changing never gets old.

What are you passionate about outside the office? My family is my passion, especially my two-year-old daughter. I’m also a huge college sports fan, especially my beloved Duke Blue Devils basketball team.

Julian McManusResearch Analyst and Assistant Portfolio Manager

What is your favored metric for analyzing a stock? Return on invested capital (ROIC) is the first thing I look at when analyzing a stock. It quickly gives you an idea of how profitable a company is relative to how much capital the business needs. Generally speaking, the higher the ROIC, the stronger a company’s competitive position.

Talk to us about the formative experiences of your career or how you got started in the industry. I started out working for Lazard Asset Management in Tokyo and learned to pick stocks from some very experienced old hands during Japan’s bear market. That taught me a lot about looking for resilient business models that can grow in both good times and bad, as well as the importance of valuation.

What are you passionate about outside the office? I am passionate about anything to do with the outdoors, particularly sailing in the summer and skiing in the winter.

CO

NTR

IBUT

OR

PRO

FILE

S

Page 9 of 10

John LloydCo-Head of Credit Research and Portfolio Manager

What is your favored metric for analyzing a bond? My favorite metric is free cash flow to debt. The ratio demonstrates a company’s ability to repay its financial obligations. It also shows how much cash the company is generating that can be used to create incremental returns for shareholders.

Talk to us about the formative experiences of your career or how you got started in the industry. I started as an investment banker in leverage finance at Deutsche Bank, with the goal of transitioning to the buy side as soon as possible because I’ve always been interested in investing in companies to create value. After two years in leverage finance, I transitioned to the private equity market. Leverage finance and private equity taught me the value of investing in firms that have good management teams, sustainable returns on invested capital and the ability to generate strong free cash flow.

What are you passionate about outside the office? I like to spend time with my wife and three kids. I also enjoy outdoor activities, including skiing, mountain biking and golf.

William PalametSecuritized Products Analyst

What is your favored metric for analyzing a bond? I also like free cash flow to debt as a metric for analyzing bonds. I think it is a good indicator of a company’s current ability to generate cash to service its debt, as well as the company’s financial flexibility. I like to run the metric at both spot pricing and various stress levels for the underlying commodities.

Talk to us about the formative experiences of your career or how you got started in the industry. I studied finance at the University of Colorado and first entered the industry as an equity analyst at Goldman Sachs. There, I covered property and casualty insurers and metals and mining companies before moving to the fixed income team at Janus.

What are you passionate about outside the office? I enjoy playing sports. I actively participate in CrossFit and play football.

Page 10 of 10

For more information, please visit janushenderson.com.

The views presented are as of the date published. They are for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security, investment strategy or market sector. No forecasts can be guaranteed. Opinions and examples are meant as an illustration of broader themes, are not an indication of trading intent, and are subject to change at any time due to changes in market or economic conditions. There is no guarantee that the information supplied is accurate, complete, or timely, nor are there any warranties with regards to the results obtained from its use. It is not intended to indicate or imply that any illustration/example mentioned is now or was ever held in any portfolio. Past performance is no guarantee of future results. Investing involves risk, including the possible loss of principal and fluctuation of value.In preparing this document, Janus Henderson has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources.This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission.Janus Henderson is a trademark of Janus Henderson Investors. © Janus Henderson Investors. The name Janus Henderson Investors includes HGI Group Limited, Henderson Global Investors (Brand Management) Sarl and Janus International Holding LLC.C-0817-12185 09-15-18 188-15-14919 09-17