For a while now, Wall Street has been hovering around record highs. Trade deal optimism, decent earnings and a volley of easy money policies have been driving markets higher.
Stocks "look to extend the market's rally amid growing optimism that, as part of phase one of trade talks, the US will suspend tariffs on $156 billion of Chinese imports scheduled to take effect on December 15 and possibly roll back the September 1 tariffs on about $110 billion in goods," wrote Sal Guatieri, senior economist at BMO, in a note to clients, as quoted on CNN.
But is the investing backdrop really robust? Ray Dalio, the founder of hedge-fund behemoth Bridgewater Associates, doesn’t think so.
Prolonged Easy Money Policy Failed to Boost Global Economy
Investors are perhaps partying on years of cheap money inflows on benign central banks’ polices. But they are overlooking the fact that even after practicing monetary easing for such a long period, the global economy has failed to find a firm footing. This holds good for the Euro zone, Japan and the United States too.
The Fed has been compelled to restart rate cuts this year after enacting some hikes last year. The Euro zone was forced to re-launch QE and cut rates further into the negative territory and the Bank of Japan has not been able to come out of this easing cycle (read: Fed Cuts Rates, Signals Pause: Trick or Treat for ETFs?).
Dalio, whose fund has about $150 billion in assets under management, said that global monetary policy is “stuck... you can’t raise rates because as a result of the stimulation companies and various entities have a lot more debt.”
Margin Pressure is Palpable
Dalio sees companies striving to increase profit margins and their cost-cutting ability is limited at the current level. Per Earnings Trends issued on Oct 31, 2019, the third-quarter 2019 earnings scorecard says that 68.2% of the S&P 500 companies have reported with 0.6% decline in earnings on 4.9% higher revenues.
About 73.9% of the companies beat on earnings while 60.1% surpassed top line estimates. While earnings growth is below what we had seen for this group of companies in other recent periods, revenue growth is in line.
Partial Trade Deal Priced-In?
Since the United States and China agreed to a "phase one" trade deal in October, Wall Street has rallied. The progress seemed to have mired a bit as it remains unclear when the duo will strike the deal. Moreover, after a recent rally, Morgan Stanley’s Garner believes that the U.S.-China partial trade deal is now priced in. Rather any disappointment in investors’ expectations related to the trade deal could derail the market momentum.
U.S. Economic Data Points Soft Despite Three Rate Cuts
The U.S. manufacturing reading for the month of October marks contraction for three months in a row. Recent data for retail sales and home sales have also been downbeat (read: Forget Manufacturing Slowdown, Bet on These Industrial ETFs).
No wonder Dalio became wary about Wall Street rally. But still there are some sectors that have been exhibiting better growth rates. Below we highlight those.
Consumer Discretionary
Half of the S&P 500 companies have reported with 11.1% earnings growth on 9.7% higher revenues. About 70.6% of companies beat earnings estimates while 47.1% surpassed on revenues. The upcoming holiday season can act as another tailwind to the fund. Consumer Discretionary Select Sector SPDR Fund (TSXV:XLY) has a Zacks Rank #2 (Buy).
Medical
About 67.9% of medical companies that have reported so far reported 7.1% growth in earnings and 8.2% increase in revenues. About 80.6% of companies beat on earnings while 86.1% surpassed on revenues. Vanguard Health Care ETF (ASX:VHT) has a Zacks Rank #2.
Construction
About 75% of the companies, that have reported so far, recorded 6.1% growth in earnings on 3.9% higher revenues. About 77.8% of companies beat on earnings while 88.9% exceeded revenue estimates. The sector is currently undervalued with a forward P/E ratio of 16.86x compared with 18.92x PE boasted by the S&P 500. Invesco Dynamic Building & Construction ETF PKB looks to be a good bet. The fund has a Zacks Rank #3 (Hold).
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Vanguard Health Care ETF (VHT): ETF Research Reports
Consumer Discretionary Select Sector SPDR Fund (XLY): ETF Research Reports
Invesco Dynamic Building & Construction ETF (PKB): ETF Research Reports
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