Stocks have seen impressive gains of late and they may be running low on gas. But there are pockets of opportunity.
Since Sept. 23, when investors resumed buying up assets most tethered to the direction of the economy, the
has risen 22%. Investors expect a sharp economic rebound, as Covid-19 vaccine doses have been administered quickly and trillions of dollars of fiscal stimulus has shored up demand. Much of that is now priced in, and valuations are fairly rich, leaving some to wonder if the market has seen the best of its gains for the near term.
That anxiety is evident in a
(ticker: C) survey of institutional investors. A “plurality” of those surveyed, according to the bank’s strategists, expect the S&P 500 to move past 4,100 by the end of the year. That implies less than a 4% gain from the index’s current level. The average call for the S&P 500, though, was for a gain just under 1%.
Bettter opportunities may lie within the broader market. Financials is the cheapest large-capitalization sector in the country, with S&P 500 financials trading at a forward-earnings multiple 32% lower than the average on the broader index. Earnings growth for the sector is set to explode in the next few quarters—especially for banks—as long-dated interest rates have risen and have more room to rise. At such low valuations, earnings may not be priced into the stocks. As rates rise and lending activity remains strong, earnings can post low-double-digit growth though 2022, according to FactSet consensus estimates. Citi’s survey respondents are enthusiastic, as fund managers have the highest expectations for financials out of any other sector.
But maybe large-cap land isn’t even the best spot at this juncture. Small-cap value looks set for gains from here. Small caps are often more volatile than large caps. Smaller companies lack the ballast of steady sales and earnings, and changes in the economy create choppy conditions for them. Plus, the hit to earnings is more of a threat to smaller companies, which often have less access to capital; when they emerge from a recession, their shares emerge robustly. Smaller value names might be best to capture the upswing—value-oriented companies are mature in their life cycles, and their performance is more tied to economic growth, whereas revenue for companies still growing is dependent on longer-term industry changes.
Value stocks in the
Russell 2000 Index
trade at tolerable levels, clearing the way for earnings momentum to carry these stocks higher. The forward-earnings multiple there is almost 35% below that of growth stocks on the index. Growth stocks often trade at between a 15% to 20% valuation premium to value, according to Yardeni Research. The
iShares Russell 2000 Value ETF
(IWN) is expected to see earnings per share double this year, and to rise another rise another 25% in 2022.
Simply riding the S&P 500 may no longer be a top strategy.
Write to Jacob Sonenshine at firstname.lastname@example.org