Value stocks and value cyclicals could be big winners regardless of what the S&P 500 does
For the next few months, the S&P 500 will trade with an embedded fiscal “option” as valuations are back to “fair” and without any fiscal policy changes from President Trump over the next few months, the market looks expensive that’s according to a new equity research note from analysts at Barclays.
At the beginning of March, Barclays’ US equity analysts estimated that the upside case for the S&P 500 is 300 points assuming a 25% corporate tax rate, no border adjustment tax and a personal tax cut. However, if Trump admits failure on tax reform the estimated downside for the S&P 500 could be as much as 280 points.
Value cyclicals – Even If Trump Fails These Value Stocks Will Outperform s&p 500
It seems the markets have already priced in a Trump fiscal stimulus, but if this fails to materialize the downside could be huge. Barclays argues that the current Wall Street estimates for cyclicals ex-energy to grow earnings per share by less than 10% in 2017 according to bottom-up analyst estimates, are accurate and as a result relative cyclical valuations to not look out of line. On the other hand, the Street’s 10% growth expectation for 2018 looks optimistic based on the current nominal GDP growth rate. Without a further acceleration in GDP growth (which would only come as a result of increased stimulus) Barclays argues it would be difficult for S&P 500 EPS growth to hit Street expectations.
However, Barclays’ analysts see some value in certain corners of the market, namely cyclical sectors. They point out that defensives, tech, and the discretionary sector now account for 70% of S&P 500 earnings, up significantly from the pre-crisis level. Energy and financials used to account for 14% and 26% of earnings in 2006-07, respectively, and their weights have fallen to 4% and 18%. It’s these unloved cyclical sectors where the analysts believe value can be found:
“Relative earnings upside potential is considerable for the “value” cyclicals. After the oil collapse, industrials recession and fall in rates, the “value” cyclicals (energy, materials, industrials, financials) have seen their earnings fall considerably, and their relative share fall ~9pp to 34% over the last 2-3 years. On the other hand, the share of earnings for “dependable growth” sectors (tech, healthcare, discretionary, staples) has increased 7pp to 57% and the share for bond proxies (utilities, telecom, real estate) has risen 2pp to 9%. We see EPS for the value cyclicals as having the potential to grow at a faster pace, as relative shares of earnings could normalize. More specifically, energy earnings in 2017 are expected to come in ~60% below 2012-13 pre-collapse levels, even though energy prices are 45% below those levels; 2018 EPS expectations are 45% below the 2012-13 levels. Accordingly, we do not see energy earnings expectations as very high given the cycle.”