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
|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%.
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|
|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|
|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 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|
|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.
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.
Past performance is no guarantee of future results.
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