A note of caution as SPY reverse RSI flashes a sell signal
On January 2, I predicted that the SPY would rip higher because of extremely strong earnings and revenue growth forecasts for 2020. It's still true that analyst projections are high: Q1 earnings growth of 5.0% and revenue growth of 4.4%, and Q2 earnings growth of 6.6% and revenue growth of 4.9%. That compares to just 0.3% earnings growth for the entire year in 2019.
However, I'd like to sound a note of caution as the SPY struggles at a resistance level: namely, that it's pretty overvalued right now. According to FactSet, "The forward 12-month P/E ratio is 18.3. This P/E ratio is above the 5-year average of 16.7 and above the 10-year average of 14.9. It is also above the forward 12-month P/E ratio of 16.8 recorded at the end of the third quarter (September 30). Since the end of the third quarter (September 30), the price of the index has increased by 9.4%, while the forward 12-month EPS estimate has increased by 0.2%."
The high P/E multiple isn't necessarily a dealbreaker, because securities tend to trade at a high P/E when earnings expectations are strong. However, the risk here is that the index could quickly come down from this high P/E multiple if expectations weaken or if a lot of companies start to miss the analysts' raised expectations.
In my opinion, it's risky to buy the S&P 500 at this valuation. Now is a good time for value investing-- finding solid, undervalued, dividend-paying stocks and ETFs the market has ignored.
Sectors worth looking at:
Analysts see the most upside for 2020 in the energy sector, with 66% of companies in this sector having a buy rating.
Utilities posted absurdly strong earnings last quarter, especially in the clean and renewable energy segment. This segment looks pricey, but it should continue to perform if oil and natural gas prices stay high this quarter. The utilities sector has strong execution, improving profit margins more than any other sector.
Communications services companies also posted strong performance last quarter that should continue moving forward. The entertainment segment has been especially strong. Watch the monthly jobs reports to see if "leisure and hospitality" continues to be the strongest segment of the labor market. Telecommunications companies also should benefit from the 5g revolution.
The financials sector is cheap right now even as it experiences an earnings boom. The low valuation reflects the recession risk to banks and the political risk to insurance companies, so buyer beware. The sector is still projected to post gains, and it might be worth buying for the dividends.
The sector most likely to beat analyst expectations is consumer staples. This sector has the lowest percentage of buy ratings (39%), but it had the highest percentage of positive earnings surprises (88%) last quarter.
Sectors to stay away from:
The most overvalued sectors are consumer discretionary and information technology, both with forward P/E multiples over 22, so beware those sectors. Consumer discretionary is especially dangerous, with many companies having issued negative guidance last quarter. However, isolated companies in the sector are worth buying, including Foot Locker and Zumiez. Macy's may also be a buy, having nuked analyst expectations last year, and currently trading at 6.28 forward P/E.
Healthcare, industrials, and materials companies also issued disproportionately negative guidance last quarter. If we get a really strong trade deal with China, however, the outlook for industrials and materials could turn positive very quickly.
However, I'd like to sound a note of caution as the SPY struggles at a resistance level: namely, that it's pretty overvalued right now. According to FactSet, "The forward 12-month P/E ratio is 18.3. This P/E ratio is above the 5-year average of 16.7 and above the 10-year average of 14.9. It is also above the forward 12-month P/E ratio of 16.8 recorded at the end of the third quarter (September 30). Since the end of the third quarter (September 30), the price of the index has increased by 9.4%, while the forward 12-month EPS estimate has increased by 0.2%."
The high P/E multiple isn't necessarily a dealbreaker, because securities tend to trade at a high P/E when earnings expectations are strong. However, the risk here is that the index could quickly come down from this high P/E multiple if expectations weaken or if a lot of companies start to miss the analysts' raised expectations.
In my opinion, it's risky to buy the S&P 500 at this valuation. Now is a good time for value investing-- finding solid, undervalued, dividend-paying stocks and ETFs the market has ignored.
Sectors worth looking at:
Analysts see the most upside for 2020 in the energy sector, with 66% of companies in this sector having a buy rating.
Utilities posted absurdly strong earnings last quarter, especially in the clean and renewable energy segment. This segment looks pricey, but it should continue to perform if oil and natural gas prices stay high this quarter. The utilities sector has strong execution, improving profit margins more than any other sector.
Communications services companies also posted strong performance last quarter that should continue moving forward. The entertainment segment has been especially strong. Watch the monthly jobs reports to see if "leisure and hospitality" continues to be the strongest segment of the labor market. Telecommunications companies also should benefit from the 5g revolution.
The financials sector is cheap right now even as it experiences an earnings boom. The low valuation reflects the recession risk to banks and the political risk to insurance companies, so buyer beware. The sector is still projected to post gains, and it might be worth buying for the dividends.
The sector most likely to beat analyst expectations is consumer staples. This sector has the lowest percentage of buy ratings (39%), but it had the highest percentage of positive earnings surprises (88%) last quarter.
Sectors to stay away from:
The most overvalued sectors are consumer discretionary and information technology, both with forward P/E multiples over 22, so beware those sectors. Consumer discretionary is especially dangerous, with many companies having issued negative guidance last quarter. However, isolated companies in the sector are worth buying, including Foot Locker and Zumiez. Macy's may also be a buy, having nuked analyst expectations last year, and currently trading at 6.28 forward P/E.
Healthcare, industrials, and materials companies also issued disproportionately negative guidance last quarter. If we get a really strong trade deal with China, however, the outlook for industrials and materials could turn positive very quickly.
Comment:
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