On the surface, it hasn’t been a terrible earnings season. Most companies are beating their targets and the market as a whole is actually moving the bottom line up a little from last year’s level, revealing once again that business is holding up better than the gloom around inflation, the economy and the Fed would suggest.
But here’s a shocking statistic: take energy stocks out of the calculations and earnings across the remainder of the S&P 500 are now tracking DOWN 5% from last year. And since energy only accounts for 5% of the market (and 23 names on the S&P 500), that means most companies are indeed struggling to do much more than keep up.
They’re running as fast as they can against inflation and the Fed . . . and still falling behind. As far as the earnings environment goes, the recession is already here.
However, as the energy stocks demonstrate, it isn’t evenly distributed. There are always going to be hot spots: business models that are making progress through the economic chill. Investors want to be in position to capture that heat when it flares.
So in a season where you can either stay warm huddled around the energy sector or risk freezing, where do you go? I always follow the numbers.
Strength In The Niches
Earnings growth is the surest way of gauging a company or sector’s ability to do more than survive unfavorable conditions. A really attractive long-term investment opportunity is all about thriving . . . expanding into new markets, disrupting the status quo and generating wealth in the process.
I favor a disruptor, an innovator with fresh ideas. But after the multi-year era of pandemic disruption, simply reverting to the old status quo can have a very similar impact. Companies that languished in the lockdowns are now coming to life again. They’re getting back to work.
This year, that narrative obviously applies to the energy sector. Oil prices crashed in 2020 and were barely recovering last winter before the Ukraine invasion shocked the global supply dynamics.
In a few months, we’ll be a year into the Ukraine war and the disruptions will be baked into the year-over-year comparisons. For now, however, it looks like a boom . . . and in real ways, it is one.
That’s why energy earnings are going through the roof. These stocks were left for dead two years ago. Now they’re holding the market as a whole together.
Likewise, old-fashioned real estate is bouncing back from the COVID crash. Evidently a lot of people never abandoned their office leases. They like coming into work and then leaving again at the end of the day. REIT earnings are up 18% from last year.
And the airlines are lifting the entire industrial sector out of the doldrums. That’s the hot spot here. It’s been an icy couple of years, but cash is finally flowing again . . . and rewarding shareholders.
Add Tesla (TSLA) to the pack as the only consumer name that’s really growing right now, and you’ve got all the appreciable hot spots. Notice what’s missing: the rest of the Big Tech club, as well as the banks, commodity producers and even defensive groups like healthcare and the utilities.
They’re all taking a big step back on the bottom line. It’s no wonder the stocks are vulnerable as well . . . after all, when earnings are going down, it’s hard to justify paying a premium for shares in what amounts to a depreciating asset.
I see the trend continuing into the current quarter. Buy real estate for the dividends . . . and buy the energy stocks as well. Own TSLA if you feel comfortable with the price. Hold onto the airlines.
It’s a small collection of hot spots. But it’s enough to help you stay warm while the rest of Wall Street worries about winter.
The Year Ahead
But maybe you’re the kind of investor who looks farther out. You’re buying cold stocks today because sooner or later everything turns around and they’ll heat up . . . much like people who bought energy and airlines in 2020 are being rewarded today.
Energy will run out of steam sooner rather than later. Gas prices might not actively go down, but they’re unlikely to spike like they did early this year. Growth here has hit a wall . . . and when it does, the stocks usually do as well.
Real estate and airlines will calm down, reverting to their more normal low-growth trajectories. That’s what we expect from these stocks. They’re rarely an exciting ride.
The excitement comes from the banks, which will come out of the Fed’s tightening cycle with new clarity on just how bad things will get for consumer credit. And they’re already reaping the rewards of the highest interest rates in well over a decade.
I’ve been waiting for the banks to become a thrill for years now. Finally, the moment is coming. The stocks might go down before they go up a lot from here . . . again, we need to see just how bad credit quality gets before the relief kicks in . . . but they will go up.
And Wall Street is really banking on Amazon (AMZN) to recover profitability. I’m not really convinced on this one. But that’s the story a bullish 2023 revolves around now.
If you want growth in the future, these are the stocks you want. Add selected communications names like Disney (DIS) and the telephone carriers for added diversification . . . but once again, it’s a limited list.
The secret to long-term success on Wall Street isn’t necessarily buying the market and letting the random walk take you on an upward rollercoaster journey. It’s about avoiding obvious weakness and doubling down on strength.