Avoid Momentum Stocks, as Volatility Could Pick Up
Momentum stocks are those that are more likely to keep moving in the upward trajectory.
Commodity producers ExxonMobil (XOM) and Chevron (CVX) reported their worst earnings in six and twelve years, respectively.
Within the cyclical sectors, technology and financials are probably best positioned to ride out a rising rate environment.
DJTI’s price-to-earnings ratio climbed from 15.7x at the start of 2013 to 20.2x at the end of 2014. This year, transportation stocks (IYT) have taken a hit, leading to multiple contractions.
Despite headwinds, stocks appear more attractive. Currently, bonds (AGG) are yielding way below their historical averages.
Both utilities (IDU) and telecom need heavy investment in infrastructure, which means they have huge capital needs.
Utilities are defensive in nature and underperform cyclical stocks when the economy improves. Having said that, they can provide a cushion during risk-off periods.
Valuations in the utility sector are beginning to look good, but watch out! Currently, the utilities sector provides a dividend yield of ~3.8%.
Expect poor stock performance when rates rise. The strong labor report led the markets to believe that the Fed would raise rates sooner rather than later.
Investors are ready to pay a premium to own shares. Stock valuations are rich. They’re sensitive to rising interest rates. Don’t abandon them though—just be selective.
Currently, the price is running ahead of earnings. The bull market is in its seventh year. However, US equities (VTI) are beginning to not look attractive.
As we’ve suggested throughout this series, US stocks don’t have a clear growth catalyst once interest rates rise. Still, you may find value in select sectors such as financials and technology.
Rich valuations and higher rates are a lethal combination for stocks. Over the longer term, multiple expansion and tightening lead to negative returns.
Although the savings at the pump have not led to higher consumption, it could translate into spending as consumer sentiments improve.
Mature tech stocks have seen their earnings propel at a great pace. The recent growth in tech stocks has mainly been due to earnings growth, rather than multiple expansion.
In the three months following an initial rate hike, the S&P 500 has performed surprisingly better if valuations have been increasing over the past year.
Today, biotech is one of the hottest investment areas. It’s driven by the demand for effective treatments and new cures. Stocks had strong growth in recent years.
What makes the utilities unattractive is the fact that interest rates will likely be rising soon. The utilities require a huge amount of infrastructure.
With interest rates rising soon, the profitability of banks is likely to increase. Thus, the financial sector could be a good place to invest.
Tech valuations appear attractive, mainly since earnings growth remains strong.