Fidelity Viewpoints 5: April themes

Housing-related investments, telecom, technology, and gold may present opportunities.

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On April 18, the Dow Jones Industrial Average topped 18,000 for the first time since July 2015. The market volatility that was so prevalent at the start of the year has subsided. The CBOE Volatility Index is at a very low reading, near 13. (The VIX is a measure of the market’s expectation for stock market volatility over the next 30 days.)

With first-quarter earnings season beginning in earnest, as most major financial companies reported better-than-expected bottom-line results, there are a variety of reasons to be cautiously optimistic about the now seven-year-old bull market. In particular, Fidelity’s Asset Allocation Research Team continues to believe that the United States, the world’s largest economy, remains in mid-cycle, with a low possibility of a recession.

Yet risks remain. Several signs are pointing toward an eventual transition to late cycle, and valuations appear high for the S&P 500® Index—based on a 17.5 P/E ratio using next-12-month earnings per share, compared with an average and median ratio of 16.2 and 15.5 since 2000, respectively.

Looking ahead, June brings a vote on whether the U.K. will choose a Brexit (an exit from the European Union), and the Federal Reserve could raise rates again this year (Fed fund futures are currently pricing in a 20% probability of a rate hike in June and a 63% chance of an increase in December).

With all this in mind, here are five themes within the stock market—recently highlighted in Viewpoints—to consider as you assess your portfolio.

1. Housing-related investments could gain.

Financials have been the worst-performing sector year to date (down more than 2%, as of April 19, 2016). Several factors prevented financial stocks from turning positive after the negative start to the year: sluggish global growth prospects, a flattening yield curve, and significant exposure for some financial companies to the debt of energy companies whose balance sheets were upended by lower oil prices.

With the timing and pace of rate hikes by the Fed acting as a significant factor for the financial sector, Christopher Lee, manager of Fidelity® Select Financial Services Portfolio (FIDSX), thinks that lenders that depend on “spread-based” revenues, which are revenues earned on the difference between what they pay out on deposits and earn on loans, may struggle if historically low rates persist. Conversely, he thinks housing-related companies, such as realtors and title companies, could benefit, as borrowing costs for home buyers remain low, while REITs (real estate investment trusts) could continue to gain, as investors look for yield. It’s worth noting that real estate will be carved out of the financials sector in August and will be newly classified as its own sector.

2. Telecom dialed up a winning combination.

Let’s move from one of the worst sectors this year (financials) to one of the best: Telecom is up nearly 10% year to date (as of April 19, 2016), as investors have flocked to the relative stability of this sector, along with its above-market-average dividend yields. The telecom sector has called up some notably strong fundamentals over the past year, generating the highest last-12-month earnings growth, nearly 10%, and last-12-month free-cash-flow margin among all the sectors.

Indeed, according to Fidelity’s 2016 second-quarter sector scorecard, telecom ranks as the most attractive sector right now, based on its fundamentals, relative valuation, momentum, and relative strength.

3. Tech still shows strength.

Another group of stocks that Fidelity’s sector scorecard continues to rank highly is technology. Year to date (as of April 19, 2016), tech stocks, up nearly 4%, have moderately outpaced the S&P 500® Index, up nearly 3%. The largest sector of the stock market has generated the highest last-12-month free-cash-flow margin (nearly 20%) of all the 10 sectors, helping it remain relatively attractive from a free-cash-flow yield and earnings-yield perspective.

While this quarter’s scorecard does not rank technology as strongly as it did in the previous quarter, tech still registers high marks for fundamentals, valuation, and stage of the business cycle. However, if the business cycle were to transition to the late cycle, tech investors may be on notice, as this sector has historically not performed well during this phase.

4. The energy sector bounced back.

Despite an adverse climate for the energy sector, including relatively low oil prices (even considering this year’s gains) and declining profit margins, this group of stocks is up roughly 9% year to date (as of April 19, 2016). The energy sector has been bolstered primarily by rebounding crude oil prices, up nearly 15% through mid-April.

In Fidelity’s second-quarter market update, our research shows that oil prices are at levels that could lead to a decline in non-OPEC (primarily U.S.) production in 2016, which could result in higher prices—a positive for energy stocks.

5. Gold shines.

Gold was mired in a four-year slump as 2015 came to a close. However, the volatility of the first quarter of 2016, and global monetary policy easing, sent many investors rushing into gold in a flight to safety. As a result, gold surged 17% last quarter. Of course, gold prices are also driven by macro and supply-and-demand factors.

The analysis in our latest quarterly market update shows that real interest rates below 3% have historically been supportive of gold prices, and real interest rates in many countries are well below 3%. More broadly, the recent steep downturn in commodity prices may be ending, as the “base effect” takes hold. After steep plunges in commodity prices and inflation in recent years, a lower base may have been established. If global activity continues to stabilize, this base effect could push up global inflation, with one consequence potentially being higher gold prices.

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Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments.

Because of its narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies. Sector investing is also subject to the additional risks associated with its particular industry.

Changes in real estate values or economic downturns can have a significant negative effect on issuers in the real estate industry.

The telecom services industries are subject to government regulation of rates of return and services that may be offered, and can be significantly affected by intense competition.

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