Trading Desk: Avoid Remaining Post-COVID Bubbles

It’s been a crazy three years for the market, which leaves a lot of investors a little estranged from normal expectations about which stocks are fairly valued for a post-COVID world and which ones are still swollen with pandemic money . . . bubbles waiting to burst.

Year-over-year comparisons are meaningless. That’s why I prefer taking a longer view that averages out the 2020-1 bubble against the 2021-2 bust to provide a better sense of which stocks deserve to be rewarded for emerging from the pandemic in a better tangible position.

Those are the ones worth owning. And even then, some of these stocks are priced for the pandemic world. They’re just too expensive for the world the Fed is engineering with every rate hike.

We’ve all learned a lot about this earnings season where Corporate America is still raising the bottom line and where expansion has effectively stalled. On the whole, the traditional” growth” sectors just aren’t doing much better than more “mature” areas of the economy right now.

On the whole, earnings have hit a plateau. We’re looking for profit across the S&P 500 to inch up about 5% in 2022 as a whole and then another 5-6% next year. That’s not so bad as an absolute number. It’s definitely better than an outright earnings recession, which naturally robs stocks of their power to move in any direction but down.

But that’s exactly the growth rate the normally “sluggish” utilities are tracking. I’d rather own the utilities if I’m concerned with valuation or growth. After all, there’s a surprising lack of easy COVID money sloshing around the utilities.

Earnings across the utilities sector are on track to end 2023 about 21% above where they were at the end of 2020. That’s slow but steady progress, about what we expect from a slow but steady sector.

And yet utility stocks are down 3% from their pre-COVID peak. These stocks have gotten cheaper in absolute terms over the past three wild years. The S&P 500, meanwhile, has seen earnings climb twice as fast and the stocks are up 18% from their pre-COVID peak . . . even after the recent selloff.

Keep that comparison in mind when reviewing your expectations. If you’re looking for value, the utilities are cheap. If you’re looking for growth, the S&P 500 as a whole is a pretty good benchmark.

Only the consumer discretionary sector, materials stocks and energy have boosted their earnings faster than the S&P 500 over the COVID era. That’s where the growth pockets are. In the consumer group in particular, we’re really talking about Tesla (TSLA). The commodity names are more obvious: this is about inflation.

Energy stocks have had a great run this year. The group is 72% up from where it was before the pandemic. In my view, what’s left of the pandemic bubble has rotated into the apparent safety of Big Oil. Is that a trap? Ask me again when winter is over and the year-over-year impact of the Ukraine war rolls off the comparisons.

But I’m looking at the materials stocks to enter an earnings recession next year almost as deep as what Big Oil is probably confronting. Both sectors are probably going to struggle to keep their profits at record levels. I think neither one will succeed by the time the year is over.

The near future doesn’t look good for either sector. The COVID era in its entirety has been a windfall . . . but the windfall era is ending fast. If I were forced to buy either group, I’d buy the materials stocks. They’ve only climbed half as far as energy in the last three years, so there’s less easy money sloshing around there.

And as for the consumer stocks, just buy TSLA if you think its growth profile remains intact. I’m not convinced. However, there’s a better case for TSLA than Big Tech proper, which is staring at a growth profile on a level with Big Food and Big Retail in the coming year.

That should shock every fan of the former FANG. Big Tech isn’t where you find Big Growth any more. The ’90s are over. These companies grew to trillion-dollar scale and the math gets a lot harder from here.

At best, the technology sector might have another 4-5% in earnings growth ahead of it in the coming year. That brings their profit growth in the 2019-23 timeline to 21% . . . exactly what the “sluggish” utilities and Big Retail have delivered.

Don’t come to Big Tech for growth any more. The only reason to buy those stocks is for value: when they’re cheap. After a dip. Since tech stocks are still 31% above their pre-COVID peak, there’s still a little fat left here to cut before they present us with tangible value.

To put it simply, these stocks aren’t attractive until they fall at least another 10-15%. Otherwise, I’d rather just buy the S&P 500 and get the exposure to the economy’s real hot spots these days.

There’s no oil in Apple (AAPL) and no mining in Microsoft (MSFT). Energy and materials stocks have soared lately, but their growth rate earns them a premium price. Tech stocks still command a vestigial premium, but their growth rate doesn’t support it.

They deserve to fall. If you’re looking for growth in the new year, consider the banks. Consider the manufacturers. Consider telecom and the cable companies.

And if you’re looking for value, consider real estate, where stocks are now trading below their pre-COVID peak despite real earnings progress over the intervening three years. The REITs are cheaper than they were three years ago. There’s no easy money sloshing here.

Consider telecom and cable. They’re the solid framework of the communications sector, driven down by the outcry around Meta (META) and Alphabet (GOOG) and now Disney (DIS).

At all times, know why you’re buying a particular stock. If you’re here for growth, get a good price. If you’re here for value, make sure the underlying company can at least support its current business.

Buying a dynamic company at too high a price means buying a bubble. You’ll be disappointed. Buying a deteriorating company at a bargain price means buying into a sinking ship. You’ll probably need patience while waiting for the turnaround.

The market as a whole looks pretty good. Use that as your benchmark. As a whole, we’ve made real progress through the COVID era. The upside has been extreme. The downside has been tragic. Average it all out and investors shouldn’t feel too unsteady. The net gain is warranted.