Stock stars

Independent research firm S&P Capital IQ suggests tilting toward stocks with rising relative strength.

  • Consumer Discretionary Sector
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Stocks have fought back since the market melted down from "Brexit". While stocks are still in the red post-Brexit, and uncertainty remains regarding the potential investing implications, one result of the Brexit vote seems clear: According to Fed funds futures, a rate hike in 2016 now appears unlikely.1 If this is the case, earnings may shift back into focus for most investors.

Despite four straight quarters of negative earnings growth—mostly attributable to the energy sector—U.S. stocks are flat over the past year on a price return basis, and are up roughly 1% on a total return basis (total return includes dividends).2 With interest rates remaining very low (the 10-year Treasury yields about 1.5%, as of mid-June, and negative interest rates are a reality for several countries), many investors continue to seek out stocks for both and capital appreciation. As of mid-June, the S&P 500® is yielding 2.3%, and is just 100 points away from its all-time high.2

Earnings in focus

It is a tenet of active management that stock prices follow earnings. The table below highlights independent research firm S&P Capital IQ’s earnings estimates for each sector for the upcoming second quarter earnings (Q2) as well as for the full year.

Expected earnings per share (EPS) for S&P 500 sectors
EPS growth %
S&P 500 sector
Q1 2016
Q2 2016e
2015e 2016e
Consumer discretionary
21.3 9.5 10.9 13.3
Consumer staples
0.8 (3.8) 0.4 3.4
Energy (106.6) (78.9) (61.4) (70.0)
Financials (8.6) (7.0) 6.5 1.0
Health care 8.0 3.0 14.0 8.0
Industrials (3.3) 8.1 3.9 2.1
Information technology (4.0) (5.4) 5.2 (0.6)
Materials (11.4) (6.6) (4.2) 1.4
Telecommunications services 9.1 (2.3) 13.4 1.0
Utilities (1.5) 2.6 2.7 2.0
S&P 500 (5.4) (4.9) (0.5) 0.2
Source: S&P Capital IQ, as of June 22, 2016. Note: “e” is expected earnings. Quarterly growth rates are measured year over year.

As the table illustrates, energy has been the major drag on S&P 500 earnings over the last several quarters. The upcoming quarter is expected to be negative for the energy patch as well, although earnings are forecasted to improve quarter over quarter. However, energy is not the only sector to suffer earnings declines. Materials, financials, technology, industrials, and utilities all reported negative earnings last quarter, and S&P Capital IQ expects many of these sectors to report another quarterly decline by the end of the upcoming second quarter earnings season.

On the bright side, health care and telecom recorded strong earnings growth last quarter, and S&P Capital IQ expects health care to post the strongest earnings growth for all of 2016, at 8% growth. For the full year, S&P Capital IQ thinks the S&P 500 will see positive growth, if only by 0.2%.

Sector expectations

Factoring in these earnings expectations, along with other economic, fundamental, and technical factors, S&P Capital IQ currently recommends marginal overweights for health care and consumer discretionary sectors, along with marginal underweights for energy and utilities, vis-a-vis market cap weighting of each sector within the S&P 500 (see the table below). Of course, your sector allocations may differ from these weightings, based on your specific investing objectives, risk constraints, and tax considerations.

Sector performance, P/E and PEG ratios, and S&P sector weightings
% Change
S&P 500 sector Jun YTD 2015 P/E on "16e EPS '16e P/E to proj. 5-yr EPS grth. Sector % weightings S&P sector emphasis Over/under weight
Consumer discretionary (0.8) 0.4 8.4 18.2 0.9 12.4 Overweight 0.3
Consumer staples 2.3 6.4 3.8 21.7 2.5 10.4 Marketweight 0.0
Energy 2.8 13.8 (23.6) 100.6 11.8 7.4 Underweight -0.2
Financials (3.3) (4.0) (3.5) 14.1 1.8 15.8 Marketweight 0.0
Heath care (1.2) (2.5) 5.2 15.7 1.4 14.5 Overweight 0.3
Industrials 1.0 5.4 (4.7) 16.7 1.6 10.2 Marketweight 0.0
Informational tech. (1.9) (0.2) 4.3 17.0 1.3 20.1 Marketweight 0.0
Materials 1.2 8.7 (10.4) 18.2 2.0 2.9 Marketweight 0.0
Telecom services 5.1 17.1 (1.7) 14.4 2.9 2.8 Marketweight 0.0
Utilities 3.2 16.4 (8.4) 18.2 3.3 3.5 Underweight -0.4
S&P composite 1500 (0.3) 2.6 (1.0) 18.0 1.6 Sector recommendations are market-cap weighted, influenced by economic, fundamental and technical considerations.
S&P 500 (0.4) 2.2 (0.7) 17.8 1.6
S&P Midcap 400 0.1 6.9 (3.7) 19.5 2.1
S&P Smallcap 600 0.4 5.4 (3.4) 20.5 1.6
Source: S&P Capital IQ, as of June 22, 2016. Note: “e” is expected earnings.

This table also includes the performance of each sector from June 1 to June 22, year to date, and last year. Defensive sectors telecom and utilities have been the performance leaders thus far in 2016, with energy not far behind thanks to oil prices rising from about $40 per barrel at the beginning of the year to currently right around $50 per barrel. This follows a tough 2015 when energy was the clear market laggard, losing 23.6%.

Additionally, the table shows the S&P 500’s 2016 forward price-to-earnings (P/E) ratio (based on S&P’s expected 2016 earnings per share) of 17.8. Several sectors trade at a discount to the S&P’s forward P/E, including financials, telecom, health care, industrials, and technology.

Finally, the table shows expected 2016 P/E to projected 5-year EPS growth—commonly referred to as the PEG ratio. Generally, a lower PEG ratio implies greater value. Consumer discretionary has the lowest PEG ratio, followed by health care, information technology, and industrials.

Stock stars within the sector world

Sam Stovall, U.S. equity strategist for S&P Capital IQ, believes there are pockets of opportunity within each sector. Specifically, he notes that eight of the sub-industries within the larger S&P Composite 1500® universe saw an improvement in their 52-week relative strength in recent weeks (see the table below).

“We have found that it is better to favor groups with stronger relative strength,” Stovall notes. “Since January 1996, the average forward 52-week price change for sub-industries ranked ‘5’ or ‘4’ in our relative strength rating system was more than 400 basis points higher than the S&P Composite 1500’s return, and these high-momentum groups beat the market more than 70% of the time.”

S&P industries with improving 52-week relative strength rankings and component stocks with highest S&P STARS
Rel. strength rank S&P Composite 1500
Sectors Return Now 4-weeks ago Component name Ticker Price $ S&P STARS
Food distributors 21.7 5 4 United natural foods UNFI 45 4
Electric utilities 19.2 5 4 Excelon corp. EXC 35 5
Multi utilities 20.8 5 4 TECO energy TE 28 3
Integrated oil & gas 4.1 4 3 Occidental petroleum OXY 75 4
Technology distributors 8.6 4 3 Arrow electronics ARW 66 4
Oil & gas equipment & services (13.2) 3 2 FMC technologies FTI 27 4
Steel (2.8) 3 2 Nucor corp. NUE 50 5
Broadcasting (14.0) 3 2 Discover comm. "A" DISCA 26 4
Source:S&P Capital IQ, as of June 23, 2016.

Half of these eight sub-industries land in the energy and utilities sectors. The table highlights a stock from each of these eight sub-industries that has the highest S&P Global Stars rating.3 Three of these sub-industries carry S&P’s highest relative strength rank of "5"—food distributors, electric utilities, and multi utilities.

Investing implications

Reports from third-party research providers can provide a valuable launch point to conduct your own research and analysis. Be sure to focus on your individual objectives and constraints when making any investing decision, and stay abreast of what is happening in the broader investing universe. While the Fed chose to stand pat on rates in June, the U.K.’s decision to leave the European Union sent a tremor through global markets. When you are deciding which stocks to try to brighten your portfolio with, you may also want to keep an eye on the horizon.

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Past performance is no guarantee of future results.

The views and opinions expressed by the speakers are their own and do not necessarily represent the views of Fidelity Investments or its affiliates. Any such views are subject to change at any time based on market or other conditions, and Fidelity disclaims any responsibility to update such views. These views should not be relied on as investment advice, and, because investment decisions are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity product.
As with all your investments through Fidelity, you must make your own determination as to whether an investment in any particular security or securities is consistent with your investment objectives, risk tolerance, financial situation, and evaluation of the security.
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S&P 500 is a registered service mark of Standard & Poor’s Financial Services LLC.
1. Source: CME Group, as of June 28, 2016.
2. Source: Fidelity.com, as of June 23, 2016.
3. Source: S&P Capital IQ. S&P Capital IQ is an independent research firm that incorporates macro and economic analysis with its bottom-up company fundamental and valuation analysis and is not affiliated with Fidelity Investments. Approximately 1,500 stocks are ranked using S&P Capital IQ's analyst-driven Global STARS (Stock Appreciation Ranking System). 5-Stars (Strong buy) implies a total return that is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis. 4-Stars (Buy) implies a total return that is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis. 3 Stars (Hold) implies implies a total return that is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.
Fidelity Portfolio Advisory Service® is a service of Strategic Advisers, Inc., a registered investment adviser and a Fidelity Investments company. This service provides discretionary money management for a fee.
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Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.
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