Macq-ro Insights-Global Services:A New Economic Order

Services are slow & steady … and are winning the race

The industrial sector has traditionally been the primary focal point for mostevaluations of the economic cycle. This is for good reason. Its employment andoutput tend to be volatile and have historically gone a long ways towardsexplaining shifts in economic activity from quarter to quarter.

In contrast, the service sector has been understudied due to its relative stability.

This is despite the increasing role it is playing in the global economy as its shareof output has grown steadily. Understanding the implications of the structuralshift towards services is critical and will only increase in importance over time.

The rise in services is likely to continue …

Over the past quarter century ~1 billion new jobs have been created globally;~75% of these have been in services. This has caused services employment torise from ~34% of the global total in 1991 to ~46% in 2016, a gain of half apercentage point per year. Output data tells a similar story, with the servicesshare of GDP having risen steadily in both developed and emerging marketsover the past four decades.

These trends are likely to persist. Growth in per-capita incomes (particularly inEMs), demographics (aging populations), and firmer relative trends in servicesinflation all suggest services will form a greater share of consumer spending andtotal output in the years ahead.

… and have profound implications for investment decisions The rising importance of services has played a key role in our team’s view(see The Global Macro Outlook – the long grinding cycle) that the currentexpansion should continue to be characterized by structurally lower growth rates,but also by incredible persistency and resiliency. We see five major implicationsfor investors from the ongoing shift towards services:1) Lower economic volatility2) Continued central bank policy divergence and less inflation volatility3) Trade that is increasingly concentrated in services4) Investment increasingly centred in IT and intellectual property5) Low productivity growth and low equilibrium real interest rates In aggregate, we see these impacts as a long-term positive for equity markets.

In particular, i) lower economic volatility is likely to mean lower volatility in earningsgrowth, a development that should justify higher PE multiples; ii) lower inflationvolatility should make central bank policy less likely to surprise; and iii) low realinterest rates can mean monetary policy can remain broadly supportive.

For broad-based exposure to the rise in services see our team’s stock list(page 5). Top picks include: salesforce.com (CRM US), Servicenow (NOW US),Nielsen (NLSN US), Priceline (PCLN US), Tata (TCS IN), and Hitachi (6501 JP).