Post-Thanksgiving investment decisions present a choice between this year's winners and losers

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Every year around the holidays, I run into the same challenge: what to buy, when to buy, how much to buy and who’s offering the best deal. Not about food or gifts, but stocks.

Year-end might be an arbitrary goal post, but it’s all we’ve got. Therefore, we think hard about where the market and its components might move in the coming year. Since, at our firm, we own only thirty five positions, each slice of the portfolio is valuation real estate, and wasting it can be tragic.

As investors, we fall into patterns and preferences in every type of market, which result in paying a premium for certain groups – software as a service, or  SaaS, right now, for example – because we believe future earnings growth here justifies the prices. As much as the market likes some categories, it discounts others, such as oil and gas and many traditional retailers, because it believes in a bleak future for these industries.

Right now, we’re trying to imagine where the market will place its premium and discount bets next year. I am no trained technician, although I’d like to play one on TV, but I believe that stocks often fall into trends which can carry them for two to three years. With that thought in mind, I began examining data from the past three years on the best-performing equities, sectors and subsectors, in a pattern-seeking quest.

When looking over sector data for the past three years, what stands out immediately is that technology has been the strongest and energy has been the weakest. As the chart below illustrates, the gap is so large it’s hard to believe these groups co-exist under the umbrella of the same index.

The dilemma for investors is whether to stay with powerhouse names, such as Apple (up 72% through Nov 30 year-to-date), or to move elsewhere. After a year when tech is up nearly 45% year-to-date, you need to believe in these companies’ earnings growth or multiple expansion to keep overweighting them.

In technology’s favor is the fact that most innovative products and new companies end up in the tech or communications services sector for which the market typically pays a premium. Our concern relates to the extent of that premium. Despite hating labels, I think the best approach to this tech stock environment is one grounded by growth at a reasonable price (GAARP). When I have this conversation with myself, I often say, “Remember 2000.” Some of you might have been blowing bubbles back then, but, trust me, the rest of us should have been thinking more about bubbles.

Working against energy is the perfect storm of excess supply, alternatives and efficient technology eating into demand, and the continued push by investors to divest fossil fuel stocks. The sector is so beaten up that placing some funds there seems reasonable unless the companies have such debt that higher rates and a continuing poor environment might force them to miss interest or dividend payments. A disparity this wide must offer some great opportunities.

One concept to identify next year’s leaders is to identify top performers this year whose earnings growth will accelerate next year, since this has, at various times in the past, been predictive. However, intuition is never valid without facts, and the data show very little persistence in recent years.

Of the 50 top S&P 500 performers in 2018, only three were on the same list for 2017, and only four have remained on the 2019 top winners’ list to date since their appearance last year. Earnings growth for those firms was inconsistent. Also, there were just as many stocks from the worst decile of 2017 and 2018 that ascended to the top fifty in the following year as those remaining in the first tier.

So that leaves me no choice but to consider how the market might view certain groups differently in 2020 than in 2019. Healthcare has suffered from the impending doom of both drug price control and health insurance upheaval. While the group has rallied lately, up 17% this year, it is well below the S&P’s 28%. Recently, biotechnology, a subsector that was down nearly 3% in the first three quarters of 2019, has rallied almost 20% since early October. If no pricing regulations are passed on newly approved drugs, which we believe is the likely outcome regardless of the presidential election, these stocks could continue to rally into next year, closing some of the gap with other growth stocks. Selectively, across healthcare, there are other areas that will benefit from a dimming aura of government intervention.

Finally, the market has spent months of 2019 worried about the direction of interest rates. The prevailing fear has been of falling rates forecasting a recession. If rates hold up, or rise over the next twelve months, that bodes well for rate-sensitive stocks, such as banks with large cash balances and tech giants, such as Apple, Google, and Microsoft, whose tens of billions now earn them very meager returns.

Karen Firestone is chairman, CEO, and co-founder of Aureus Asset Management, an investment firm dedicated to providing contemporary asset management to families, individuals and institutions.

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