Expect More Gains, But Leadership Is Shifting
Despite prospects for a modest acceleration in growth, monetary accommodation, both in and outside the United States, can probably carry markets through year's end. That said, investors need to take note of a few trends.
First, investors are growing increasingly choosy. Evidence of this can be seen in the surge in large price moves related to earnings announcements. The number of instances where a stock price moves up or down by 10% or more following an earnings announcement is much higher this quarter than in recent years.
Second, the possibility of more QE from Europe may turn out to be a mixed blessing. While QE in Europe was one catalyst for U.S. stocks' rally, the positive reaction was somewhat ironic given the recent pressure a strong dollar has put on U.S. corporate earnings.
Third, leadership among sectors is shifting. Health care, the previous leader, is now struggling. U.S. health care stocks have rebounded from their recent lows, but are now underperforming the broader market even as other defensive sectors, notably utilities and consumer staples, perform well.
Finally, investors need to take note of falling expectations for 2016 earnings. While analysts expect better than 9% earnings-per-share growth in 2016, estimates have been declining. To the extent that economic growth remains modest, U.S. companies, with already high profit margins, will struggle to grow earnings.
So heading into the end of the year, we are focused on areas where earnings growth may be easier to come by in a slow-growth world. We continue to favor technology, which is up around 6.5% year-to-date, comfortably outperforming the broader market. We believe this can continue. We also maintain our preference for European equities, which can continue to benefit from more monetary accommodation and a stabilizing economy. The only caveat, given our expectation for more QE and a soft euro: Consider strategies employing a hedge against some or all of the foreign currency exposure.