• Fri. Sep 30th, 2022

U.S. Stocks Are Expensive. Bargain Hunters Should Look Elsewhere

This commentary was issued recently by money managers, research firms, and market newsletter writers and has been edited by Barron’s.

Strategy Report
BCA Research
Jan. 7: U.S. stocks are looking pricey. While valuations are a poor timing tool in the short run, they are an excellent forecaster of stock prices in the long run. The Shiller PE [price/earnings] ratio has reliably predicted the 10-year return on equities. Today, the Shiller PE is consistent with total real returns of close to zero over the next decade.

This commentary was issued recently by money managers, research firms, and market newsletter writers and has been edited by Barron’s.

Investors’ allocation to stocks has also predicted the direction of equity prices. According to the Federal Reserve, U.S. households held a record-high 41% of their financial assets in equities as of the third quarter of 2021. If history is any guide, this would also correspond to near-zero long-term returns on stocks.

Valuations outside the U.S. are more reasonable. Whereas U.S. stocks trade at a Shiller PE ratio of 37, non-U.S. stocks trade at 20 times their 10-year average earnings. Other valuation measures such as price-to-book, price-to-sales, and dividend yield tell a similar story.

Sunny Outlook for E&P Sector

Industry Update
Wells Fargo
Jan. 7: We believe the U.S. E&P [energy exploration and production] sector can outperform the broader market again in 2022. While 2021 was the year of the three Rs (recovery, rotation, and reflation), we think 2022 will be the year of the three Cs—capital discipline, cash margins, and countercyclical cash returns. We also see less regulatory risk for the sector compared with a year ago, while there is broader recognition of the progress made on ESG [environmental, social, and governance] efforts. The hedge burden is abating, as well, offsetting inflationary pressures on cash flows. Against this backdrop, discounted valuations vs. the market shouldn’t be sustainable, opening the door for investors to be long the sector in 2022, again.

Our top picks in the sector are


Devon Energy,


Coterra Energy,
and


PDC Energy.
We like


EOG Resources,


Diamondback Energy,
and


Marathon Oil
for oil; EQT and


Antero Resources
for gas; and


Ovintiv,


Matador Resources,
and


SM Energy
for small- and mid-cap exposure.

Gearing Up for the EV Future

THINK Economic and Financial Analysis
ING
Jan. 6: In 2021, the electrification trend gathered momentum across major geographies and industry players in the auto sector. We believe that this trend will continue to move from strength to strength in 2022. In 2021, the EU presented its target to shift to full electric vehicles by 2035, the Biden administration set its 50% EV goal for 2030, and a range of other countries pledged to make a shift before 2040.

On the corporate side, in 2021, virtually all major players either reaffirmed or announced strategic plans for a shift to electric vehicles over the coming decade or so. For example, recently the world’s largest car maker,


Toyota Motor,
also announced a significant investment program aiming to reach 3.5 million battery electric vehicle sales by the end of the decade. This was somewhat less ambitious than the targets set by


Volkswagen,
but still a significant move in guidance. Major existing car makers are significantly upping the ante in electrification to retake the initiative or fend off competition from the pure-play electric car makers like Tesla, looming new entrants like


Rivian
and


Lucid,
and Chinese brands like


BYD,


Nio,
and


XPeng.

Rate Hikes Won’t Kill Stock Rally

Market Perspective
Truist Advisory Services
Jan. 6: A shift in Federal Reserve policy often injects volatility into markets. Indeed, this is one of the key points we discussed in our 2022 outlook and is a reason behind why we are looking for more moderate market returns and more normal pullbacks.

That said, stocks have generally had positive performance during periods when the Fed is raising short-term rates because this is normally paired with a healthy economy. A growing economy supports corporate profit growth, which supports the stock market.

Notably, stocks have risen at an average annualized rate of 9% during the 12 Fed rate-hike cycles since the 1950s and showed positive returns in 11 of those instances.

Likewise, stocks have generally risen during periods of rising 10-year U.S. Treasury yields. In a study of 15 periods when intermediate rates rose by at least 1.5 percentage points since 1950, stocks averaged an annualized gain of 12%.

Even with the recent rise in 10-year yields and stocks, the equity risk premium, a metric that compares the valuation of stocks to bonds, remains at a level that has historically corresponded with stocks outperforming bonds on a 12-month basis by an average of almost 11%.

New Themes in Tech investing

UBS House View—Daily U.S.
UBS
Jan. 4: The largest stocks in the


S&P 500

index (


Apple,


Microsoft,
Alphabet,


Amazon,
and Tesla) now account for 23% of the index—a very high weight relative to history. But while this heavy weighting means these stocks will have a big impact on overall index returns, we no longer see them as the best place to look for outsize returns in the tech sector. We expect more value to come from artificial intelligence, big data, and cybersecurity—the ABCs of tech….

Our “ABCs of tech” theme is driven by powerful secular trends around automation, analytics, and security—key strategic focus areas for many businesses. We expect this theme to generate 10% revenue growth over 2020-25 on average—higher than our estimate for the broader tech sector during this period (mid- to high-single digit growth per year)—and earnings-per-share growth of 16% per year, on average.

Where to Hide in 2022

PCM Report
Peak Capital Management
Jan. 3: Where might investors seek shelter against the devastating impact of inflation and slowing growth? There are opportunities, but wise investors probably already realize that market returns in 2020 and 2021 will prove to have been borrowed from future years.

When the Fed kept the liquidity spigots open, investors preferred corporate debt to Treasuries, stocks over bonds, and speculative growth over value. These trends of the past several years are likely to reverse starting in 2022.

For fixed income, I think 2022 will reward investors who focus on credit quality instead of chasing yield. Speculative debt has worked great in the past two years, but poor fundamentals may lead to strong selling in high yield. A barbell approach with short-duration and long-duration Treasuries makes the most sense, given policy and economic uncertainty.

For equities, companies with high profit margins and sustainable pricing power should be the focus. At the top of the list is healthcare, which currently trades at a historically high discount to the S&P 500. Banks are also attractive and should be the early winners of any Fed tightening, while energy is likely to lead all sectors in 2022 as oil prices rise above $80 and valuations are very low today.

To be considered for this section, material, with the author’s name and address, should be sent to [email protected]