Looking Past the Politics: What Does the Market Need to Grow?

As the tone of the debt ceiling negotiations in Washington wavered over the past several days, equity markets rose and fell in kind. While lawmakers were able to come to a last-minute agreement to raise the debt ceiling and end the 16-day federal government shutdown, the key to putting the markets on a solid foundation for the longer term is for corporations to generate earnings growth through increased revenues.

Since 2008, the market has relied on corporations cutting costs to improve profit margins and generate earnings improvement in the absence of top-line revenue growth. Meantime, the US Federal Reserve has tried to support the economy through a series of quantitative easing (QE) programs. Today, there’s no more room for businesses to cut costs, and the marginal utility of continued QE by the Fed is starting to decline.

I’m more bullish than that, however. I think we’re in the ninth inning of this period of earnings mediocrity, and that we may see an inflection point in earnings growth beginning late in the fourth quarter. Corporations know that the margin game has played itself out, and businesses that have spent the last few years ratcheting down their expenses are in a unique position now to move in the opposite direction and reinvest in themselves through capital expenditures (capex). I see early evidence within three key areas that the tide may possibly be turning: the monthly reports on durable goods, factory orders and industrial production all indicate that we are building significant backlogs in unfulfilled orders.

Of course, when you have a market that’s trying to make such a major transition — away from margin-driven earnings and toward capex-driven earnings — and you layer on top of that this contentious political situation, things have the potential to get messy for a while. But, that could also create opportunity, and we want to be ready for that.

So, we remain focused on businesses and sectors of the economy that have pricing power, are focused on top-line revenue growth, and yet are also reasonably valued. We have an eye on companies that are investing in research and development, with new product opportunities that can generate future sales growth. And, we’re looking for merger and acquisition activity to spur business opportunities.

Three sectors where we’re finding opportunities are industrials, technology and energy, which we believe will benefit from increased capex spending by introducing new products and having the ability to attract the right price for them. On the other hand, we continue to be underweight in consumer discretionary stocks — valuations in this sector have gone up dramatically in the past few years, but at the same time, consumers remain reluctant to spend money on discretionary purchases. We do not believe this combination bodes well for the future performance of this sector.

The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.




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