Don’t Hit That Panic Button Yet
What once seemed like a forgettable summer has turned into a nervous transition into autumn as investor fear kicked up this month amid turbulent headlines. The dog days of August halted the market’s rally and upped the volatility as Wall Street grappled with geopolitical issues, turmoil in Washington and tragic events both home and abroad. With everything going on, it’s understandable that questions about where this market is going began to surface and that’s exactly why I wanted to get in touch now with this special report
There is a lot of speculation in the financial media and amongst investors that is just plain wrong, and I don’t want it to keep you from profiting in what is still a strong market. Yes, we’ve watched the S&P 500 flirt with support levels it hasn’t touched in months, but I continue to expect the index to move closer to 2,700 than 2,400 in the next year. That means that now is the time to use weakness to your advantage, and this report will outline exactly how to do that.
Let’s start by setting aside politics for a minute because that’s exactly what Wall Street is doing. While headlines out of the White House can still rock stocks on a day-to-day basis, people are doing an overall good job of discounting the chatter and watching Washington rather than trading on it. Of course, a political windfall would certainly be a bonus, especially in the form of tax reform. But for now, a flagging policy agenda is neither here nor there.
Instead, it’s all about the fundamentals and they are better than we hoped. Macro data shows that economy is staying on its post-2008 track, which isn’t a bad status quo to maintain. It has driven an eight-year bull market, and it’s definitely good enough for central banker. If the Federal Reserve wasn’t happy, they’d let us know.
We all know the basis for fundamentals is earnings, which is the biggest catalyst available for stocks, and second-quarter results were actually better than Wall Street dared hope. Targets for the rest of the year are set relatively low, so 10% corporate growth can continue for another quarter or two. That would give us 9%-10% richer profits to work with for the full year, which is more than enough to keep stock prices moving higher. After all, relief on the “E” side of the P/E calculations means the “P” side can ramp up without straining market credibility one cent.
I can hear many of you saying, “But Hilary, what about the high valuations?” This is a good point, and I can’t deny that stocks are rich and volatility is low. But stocks can stay rich and volatility can stay low for years before statistical means reassert themselves. As it is, the S&P 500 is tracking 20% cheaper on a trailing earnings basis than it did this time last year. Go back to 2015-era valuations and fair value on the big benchmark is actually closer to 2,900. If that doesn’t tell you the bulls can keep running, I don’t know what will.
Some folks have said this environment feels like 1999, when good feelings were riding high before the dot-com bubble burst. But I’d come back to them and say it’s hard to have a 2000-type crash until we live through the equivalent of 1997, when the realists truly lost their grip and irrational exuberance took over. If you bail out in anticipation of a crash before we see what we did in 1997, you’re cheating yourself out of 36 months of peak bull run.
There’s a similar correlation to what happened in 2008. We haven’t even hit 2005 yet, which is when the housing bust started poisoning credit markets. Even Robert Shiller admits that valuations can remain irrational for a long time before they crash, so we may be two or three years from that unsustainable peak. Let’s go back to P/E. The S&P 500’s trailing P/E is tracking around 19.4. That’s still fairly close to the historical norm, and not yet close to 1999 (32) or 2008 (21.4).
A similar argument can be made for the VIX (volatility index). Calm today doesn’t mean disaster tomorrow. Storms come and go but remember, VIX 20+ isn’t historically normal. It’s not the statistical mean that we’re ignoring or flouting in some way. If it got that wild, the market would already be under distress (see 2008).
How to Navigate Speed Bumps Ahead
With that long-term bull case in mind, we could still see some turbulence. But I don’t want that to scare you out of the game. When everyone else is passively sitting on positions, that’s exactly when you have to get active. The next few months are all about letting the bulls run on and picking up the treasure they leave behind.
What’s in store for investors during those months? Well, earnings are effectively over until early October so fundamental-driven models of what stocks are worth are locked in for another seven to eight weeks. As we already talked about, second-quarter numbers were better than expected and we’ve seen better-than-average preannouncements for the third quarter.
One question mark centers on the Fed, but Chair Janet Yellen is vanishingly unlikely to give Wall Street a boost before December. Any news from the central bank could actually be negative – balance sheet slimming hitting a snag, economy slowing too fast or inflation spiking – so quiet here is as good as it gets.
And of course, there’s always politics. However, news flow out of Washington has yet to provide any instant gratification. Tax cuts, foreign cash repatriation and infrastructure improvements can still happen, but the clock is ticking. In this case, quiet isn’t good but this is also where turbulence can open up opportunity.
As long as the fundamentals are strong (which they are!), news flow can push sentiment around but valuations will manage to recover. Now is the time to build a portfolio for the next time the bulls get a green light to run, so use dips in sentiment to buy up quality names.
How do you know which areas are quality and which aren’t? That’s exactly what we’ll talk about next!
Sectors to Overweight …
Financials: The banks are still cheap, trading at a net 14.5X trailing earnings. They’re also one of the fastest growing areas of the economy at 11% expansion this year and next. Sure, the Fed has slowed its agenda down, but we’ve known that for months. Sentiment around the financial sector is too negative given these conditions, creating an attractive chance to accumulate on the market’s tantrums.
Industrials: This sector is in line for some serious relief from currency markets. The U.S. dollar strengthened a harrowing 11% across the second half of 2016, and we’ve given all of that back so far this year. In the past, exchange rates at these levels have justified U.S. industrial stocks at 10%-15% higher valuations than what we see now. From where I’m sitting, it’s a good time to buy the exporters.
Aerospace: Within the industrial sector, aerospace deserves a special nod. War stocks are red hot right now and global tension isn’t going to ramp down any time soon. When headlines are calm, that’s the time to pounce because they aren’t likely to stay that way for long.
… And Sectors to Avoid
Big Tech: This group is taking the brunt of the turn in market sentiment. These were once the hottest stocks on their way higher, but now the mood needs to turn all the way around before money comes back into the FANG names in any real way. Even good earnings were punished in this sector – not a good sign! – and now that the latest season is over, there’s no real reason for these charts to recover until the next cycle starts in October. While there’s still long-term potential in Big Tech, you can probably get better prices in the next few months.
Oil: This sector may be getting support from the dollar, but the fundamentals still look terrible. Political disruption will have a bigger impact on global demand at this point than on domestic supply. That means that when U.S. producers start exporting, we’ll see current crude pricing turn into an effective ceiling – and the floor could be a long way down. The situation in Venezuela and the Persian Gulf haven’t helped, so I recommend caution here.
My Top Stock Picks Right Now
Now that you have the lay of the land, let’s get into specifics. Within the sectors I mentioned as good buying opportunities right now, I have a few names to share with you – plus, I have a couple bonus picks in the much-maligned retail sector!
Starting with financials, market turnover is finally picking up. We’re tracking above last year’s levels for the first time all summer, so I’d start with brokerage stocks like Charles Schwab (SCHW) and E-Trade (ETFC). Once those are making you money, the next Fed move will be getting close and that will open up opportunities in insurance and the money center banks. But for now, it’s all about the upswing in market action so stick with those two.
In the industrials, Caterpillar (CAT) has been unstoppable and I don’t see that changing anytime soon. For the niche aerospace theme, I also like Boeing (BA) and Raytheon (RTN) as plays on the export upside. Drilling down even further reveals some high-tech aerospace/defense names: KLX (KLXI), Textron (TXT) and Leidos Holdings (LDOS) are growing fast and priced right.
Now when it comes to retail, you need to be smart. I wouldn’t count out the U.S. consumer, but you need to be selective. I would avoid the malls and focus on competitive sizzle. Ralph Lauren (RL) is an interesting player in the retail landscape right now because it’s a luxury, multi-channel brand that’s not going anywhere no matter what Jeff Bezos does with Amazon (AMZN). Speaking of the online behemoth, I’d avoid AMZN until we see proof that Wall Street has fallen back in love with it – just now that it could take weeks or months.
My last pick may sound a bit out there, but avocado marketer and distributor Calavo Growers (CVGW) is on an earnings growth fast track. And with avocado fever hitting new levels with millennials, it’s in prime position to take off with this leading demographic behind it.
Ready for More
I hope this report cleared up any confusion or concern you may have had about the market, and provided direction for where you can take your portfolio in the coming months. I continue to see strong performance ahead, and I don’t want you to miss out on any of it. Stay tuned for more exclusive content, as I’ll keep you updated every step along the way.
Thanks for reading!