Stock Picker’s Market

“It’s a stock picker’s market”…hearing this comment a lot on the TV from pretty much every guest that comes on the TV these days. If you watch/listen to the business news as much as I do, you get a little numb to it. Most guests are “talking their book”, which is a term that means “promoting themselves”. This time around, I tend to agree. There is undoubtedly a rotation in leadership happening in the market right now, and a lot of data points being digested. The opportunity presenting itself right now is that earnings matter again, and that is when a good stock picker has potential to shine.

The past few years have shown that just being in the index was good enough, as the larger companies did very well and because the major indexes (DJIA and S&P 500) are market weighted the movement of the biggest stocks in the index play a bigger part in the index result. What is happening now is the opposite. There are a few larger cap companies that are going through the ringer, and that will put a lot of pressure on the overall stock index. 

So let’s do a quick re-cap of how I eventually get down to the names that I choose for my client’s portfolios. We start with big picture. Referencing the current environment, high inflation, interest rate hikes etc., paves the way for companies with lower price to earnings ratios to outperform. With the massive amount of stimulus pumped into the economy, prices got elevated and now that we are withdrawing money out, a more normalized valuation can come with it. That’s divergence started with the turn around in value stock starting to outperform growth stock for the first time in many years.

The chart above only goes back 3 years, but I can tell you that the out performance of growth over value in this cycle, started at about the bottom of the financial crisis. My view is that value stocks will continue to outperform while the Fed is tightening, and that could be a while.

So now I know what size of company I want, and the style of company I want (value), now it’s time to go to the sectors. There are 11 of them in the S&P 500 and diversifying through them is critical when considering risk. Sectors tend to move together. Sure, there will be some stocks that perform better in each sector than others, however when we talk about market leadership, one of these sectors needs to take charge. For the past many years through this growth phase, technology has been the leader. It’s the biggest sector in the S&P 500, which makes sense because we are all controlled and consumed by the digital world today and will probably gather more importance as we move forward. A portfolio manager will have opinions on which sectors he wants to overweight and underweight at any particular time. So, here’s mine.

Overweight

Health Care. This is my favorite sector right now. It’s usually a good place to hide when markets are bouncing around like they are currently. This sector has one of the lowest P/E ratios around, which is what I like about it.

Financials. As the yield curve steepens, banks should technically make more money. They borrow short term and loan long term, keeping the spread. They have pulled back quite a lot, and the consumer has more money now than any time in history and most of it is in checking accounts, which banks don’t pay much if anything at all in interest. Loan growth is still accelerating, and their credit is strong.

Industrials. Although they have been moving sideways, there is interesting movement in the sub sectors of Industrials. Airlines and Rails have been hit, but defense contractors have done well. Overall, this sector is affected more by higher commodity prices, war, an appreciating dollar, but I feel like these issues will dissipate over the next 6-12 months which should be a positive for this space. Did somebody say stimulus bill? Maybe one day…

Energy. WOW. But after a dismal 5-year patch. As I often joke, I’m never wrong, just early. The conflict helped oil prices rise which in turn gives these guys more profit. With prices set to likely stay high, the valuations are low even after this run and profit is high. 

Equal Weight

Consumer Discretionary. Valuation has been high for this sector. It’s also pretty concentrated with a handful of stocks making up a huge percentage of it. There are pockets inside this sector that look intriguing, but there are some expensive areas to be wary of.

Communication Services. This is your media companies and phone providers. This sector has been killed but is looking really cheap now after some big swings. It’s a border line underweight, but recent moves have made me take notice and put it in the equal category.

Materials. Opposite story of Comm Services with the sector doing well of late and recently consolidating. The macro headwinds don’t usually help this sector and overall, I’m cautious, but there are some pockets in here with some excitement.

Real Estate. For some reason in volatile markets, this sector holds up pretty well. It’s a really diverse group from commercial and residential REITs to Storage Facilities and Phone Towers. A lot of the revenue that is created in this space has the ability to increase in inflationary times like now, because most landlords have CPI adjustments in the leases.

Technology. This sector is the biggest and provided the most upside. It’s hanging on by a thread in my equal weight category. P/Es are always high in this sector, but again there seems to be some short-term opportunities based on recent price declines.

Underweight

Consumer Staples. This sector is where you want to be if you think the market is going to take a big crap. It’s outperformed a lot of other indexes in the past few months, but I think it’s over valued in the short term. I think the overall economy is on good footing and I think we will sort out a lot of the headwinds the market is facing in the next couple of quarters. If I’m right, then you don’t want to be overweight this sector.

Utilities. I’ve had this one in my underweight category forever. It has done well recently, but it’s expensive now. I still believe investors in this space are buying for dividends, and that investment philosophy gets killed when rates rise, so I’m very wary of this space.

OK now onto Stock Selection. Just kidding, if you’ve read this far you should be rewarded not punished with another 25 pages of my gibberish. Plus–it’s a secret. 

Summing up, this volatility is normal when a market is consolidating and looking for new leadership. I think this will continue for the first half of the year, and settle out in the later half. We may not have found our bottom yet, and if we go down further from here, then I would expect to see some really good companies and really good prices. This is what it’s all about…Stay strong. 

With that here’s the buy sell.

Have a great week. Don’t hesitate to call with any questions.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Mick Graham and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions.

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The NASDAQ composite is an unmanaged index of securities traded on the NASDAQ system.

Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence.  There are additional risks associated with investing in an individual sector, including limited diversification.