Analysts may be forecasting a stock market slowdown in 2019, but that may prove to be a good thing for savvy investors who know where to look, experts say.
"Often there are greater annualized gains during bear markets than you can achieve in bull markets, primarily since bear markets tend to develop much more quickly," says Steven Jon Kaplan, CEO at True Contrarian Investments. "Partly this is because … there aren't as many sectors which are rising, so investors tend to crowd into the relatively few winners and end up causing some huge percentage gains over a short time period of one year or so."
Perhaps the biggest reward will go investors who are willing to "do the work to invest in individual companies," says Nathan Rex, chief investment officer at Eigenvector Capital in Stamford, Connecticut.
That's because although some sectors may show strong earnings growth outlooks for the year, "Apple (AAPL) has already shown that challenges specific to the company can quickly change the earnings outlook for an entire industry."
In other words, if investors are willing to be choosy and well-researched, they can still make big returns. Watch the following types of stocks poised for above-average gains:
- Financial and banking stocks
- Emerging markets
- Small-cap stocks
- Energy stocks
Financial and banking stocks
Rising interest rates may not be great for consumers, but they are good for investors in banks, which will benefit from much larger margins of safety, says Robert Johnson, professor of finance at Creighton University.
Total deposits with the global financial industry will increase by 5.8 percent, with lending rising 6 percent, according to the Economist Intelligence Unit.
Larger banks like Citigroup (C), JPMorgan Chase & Co. (JPM), Wells Fargo & Co. (WFC) and Bank of America Corp. (BAC) are all selling at very attractive valuation levels – under 10 times forward earnings, and with attractive dividend yields when compared to government bond yields, Johnson says. They're also selling at attractive multiples of book value, which is the value of a company's assets minus liabilities.
Investors may also want to check out State Street Corp. (STT), a large custodian bank with about $8 trillion in assets under custody and is currently undervalued, says Michael Osteen, founder and chief investment strategist at Port Wren Capital. He says the firm has a one year cash flow growth of 291.10 percent, a price-earnings ratio of 11.22 that is close to a five-year low, and a price-book ratio of 1.27 that is close to a two year low.
Emerging market stocks provide exposure to countries such as Brazil, Chile, China, India, Mexico, Russia and Turkey, says John Essigman, managing member at John Essigman Wealth Advisors in Georgia.
"Expectations are that emerging markets will outperform other categories due to world banks keeping interest rates low and positive inflation resulting in negative real short-term interest rates," he says, and this will likely continue for the next decade.
But the sector is not without risks. Even those countries not directly affected by growing trade wars could be vulnerable to a change in business confidence in 2019, with the most likely impact being on emerging markets, according to the Industries 2019 report by the Economist Intelligence Unit.
And because of the sector's broad nature, potential political and economic instabilities, and irregular accounting methodologies, Essignman recommends purchasing exchange-traded funds or mutual funds to spread the risk and keep costs down.
The strong underperformance of small-cap stocks in 2018 makes them very attractive relative to their large-cap peers, Rex says.
"Specifically, small-cap pharma and small-cap tech have healthy growth rates and discounted valuations making them much more attractive buys to start the year," he says.
Some well-known small-cap ETFs in emerging markets dropped by more than one-third last year, Kaplan says, making them poised for the upswing. "Mid- and small-cap equities in general lost much more in 2018 than larger companies and will therefore probably rebound more in 2019 from irrationally low valuations," he says. But that doesn't mean you shouldn't exercise caution. About 50 percent of small-cap debt is variable rate versus only 10 percent for large-caps, so rising rates can be unfavorable for small companies this year, says Steve Chiavarone, portfolio manager at Federated Investors in New York.
Energy was among the sectors that fell more than 20 percent between the market high and Christmas Eve, essentially pricing in a recession, Chiavarone says. That makes energy an attractive sector for growth and gains this year.
"We think that the economy will not enter recession in 2019 and the Fed is likely to pause their rate hike cycle – both of which should be catalysts for (this) sector," he adds.
Energy shares and funds like the SPDR S&P Oil & Gas Equipment and Services (XES), VanEck Vectors Oil Services ETF (OIH), and First Trust Natural Gas ETF (FCG) have been winners since most of these had bottomed shortly after the opening bell on Dec. 26, 2018, after having lost roughly 60 percent from their peaks of early 2018, Kaplan says.
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