It’s hard to fault investors who are nervous about the near-term future of the stock market.
After all, they just experienced the worst year for equities since the financial crisis. And the scapegoats for the meltdown — which range from slowing earnings growth to trade disputes — are still very present.
Wall Street’s fear is showing up in numerous ways beyond the beaten-down price of stocks. Over in the rates market, for example, traders don’t expect the Federal Reserve to find the justification for interest-rate hikes throughout 2019, according to probability data compiled by Bloomberg.
UBS has identified another manifestation of investors’ anxiety, found in the premium that they’re paying for the most undisturbed stocks. According to Keith Parker, the firm’s head of US equity strategy, there’s a record 45% premium for stocks with low volatility versus high-volatility names. This factoid is derived from a comparison of the relative price-to-earnings ratios of the two groups of stocks.
Despite all you might have heard about a looming recession, Parker says it’s still too soon in the cycle for investors to be forking out such a premium for the safest stocks.
His study of previous cycles drives his conviction that the ongoing expansion could continue well into 2020. On average, he said, the Institute of Supply Management’s manufacturing index bottoms 26 months after it tops. It’s only been five months since the index’s most recent peak.
“We position to capitalize on underappreciated later cycle upside and leadership/momentum that we think is still relatively cheap while still accounting for the key risks as it relates to tariffs, decelerating growth, rising wages, and margin sustainability,” Parker said in a recent client note.
This alternative strategy involves staying overweight the healthcare and technology/software sectors instead of their defensive counterparts like consumer staples and utilities.
His recommendation may sound familiar because it’s precisely what has worked well for most of the nearly 10-year-long bull market. An investor who chased the momentum of major technology stocks and shunned concerns about their high valuations enjoyed sizable returns. This strategy came under pressure last year, however, as investors became concerned that tech giants were incapable of sustaining their rates of earnings growth.
While advocating that investors reconsider growth stocks, Parker is well aware of the risks to the market. In fact, he cut his year-end S&P 500 target to 2,950 from 3,200 in light of the painful fourth quarter.
He further advocated that investors suss out high-quality companies and buy stocks that can grow their dividends well above the market average.