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3 Gems Defying Equity Index Acrophobia

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The Dow Jones Industrial Average recorded an all-time closing high of 16,000 on Nov 21, while fellow benchmark S&P 500 Index is also hitting newer peaks at regular intervals. However, one cannot run down investors’ apprehension about a market correction happening anytime soon.

It’s true that a superlative performance by the broader equity markets is a precursor to the overall improvement in the economy as stocks are usually the front-line indicators. Nonetheless, a 165% rally since 2009 and high valuation metrics of the S&P 500 (trading 17x reported profit – the highest valuation since May 2010) spur antagonist feelings that the rise may have been too fast and too far beyond the comfort zone.

Despite the acrophobia, or fear of heights, the market still boasts a handful of stocks that have defied the law of averages. Before we cherry-pick some outperformers, let us have a recap of the various turn of events.

The Driving Factors

The spurt in various indices is primarily attributable to the Federal Reserve’s economic stimulus that is centered on an $85 billion monthly bond repurchase program to spur growth. Although Fed initially fueled speculations of a partial withdrawal of the economic stimulus, or QE3 tapering, in September, it eventually backed off citing several macroeconomic headwinds, including high unemployment rate, low inflation, rising mortgage rates and a budgetary standoff.

Both current Fed Chairman Ben Bernanke and Chair successor Janet Yellen have vouched to continue the stimulus and near-zero interest rates until at least the economy improves to an optimal level. The latest minutes from the FOMC meeting noted that the economic data will “prove consistent with the committee’s outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pact of purchases in coming months.”

As the Fed deferred its decision of tapering, equity markets kept hitting record highs buoyed by strong quarterly earnings by majority of the S&P 500 companies. Statistics reveal that the third quarter earnings season had been probably the best so far in 2013. Total earnings for the 460 S&P 500 companies that have reported results till the morning of Nov 14 are up 4.8% compared with the year-ago period.

About 65.2% of these companies have outpaced earnings expectations with a median surprise of +2.5%. Furthermore, total reported revenue are up 3.0% as 42.2% of these companies beat revenue expectations with a median surprise of +0.1%.

About 86 companies in the S&P 500 Index have climbed over 50% or more so far this year. These include some stellar performances by diverse companies such as drug store chains CVS Caremark Corp. (CVS - Free Report) and Walgreen Co. ; grocery store chains Safeway Inc. and The Kroger Co. (KR - Free Report) ; and blue-chip Dow components like The Boeing Co. (BA - Free Report) and Nike, Inc. (NKE - Free Report) .

The stock markets also benefited from the reform push in China, the second biggest economy in the world, as it tries to steer away from an investment-led growth to a consumption-driven economy. In addition to societal changes that relaxed the one-child policy to support an aging population, China liberalized the labor market by allowing the free movement of labor and encouraging urbanization. At the same time, the communist country offered greater freedom to farmers and stepped up financial reforms to allow markets to play a decisive role in resource allocation.

The Implications

Although Dow closing above an all-time high of 16,000 is worthy to take note, it does not mean anything in isolation. Rather, it’s more of a psychological effect and entices investors into buying more equities.

As more investors park their money in the equity market, both Dow and the S&P 500 Index continue to gain traction. The benchmarks have risen 22% and 26%, respectively, so far in 2013. According to data from the Investment Company Institute, the national association of mutual funds; closed-end funds; exchange-traded funds (ETFs) and unit investment trusts (UITs), investors have put over $140 billion in 2013 into mutual funds that invest in stocks compared to a net outflow of $153 billion in 2012.

Another data from TrimTabs Investment Research, a leading independent institutional research firm focused on the supply and demand of shares of stock and money available for investment, reveal that $277 billion have been invested into stock-based mutual funds and exchange traded funds through Oct 25 – the largest inflow in a year since the tech bubble burst in 2000, when about $324 billion went into these funds.

The bullish sentiment is likely to be echoed across the globe. On Nov 18, when Dow first reached the 16,000 milestone before closing a notch lower, the MSCI Emerging Markets Index rose 2% on the news – the most in two months. The Shanghai Composite Index had climbed 2.9% while India’s benchmark index, the Sensex, advanced 2.2%. In addition, indices in diverse countries like Brazil, Indonesia, Turkey, Poland and the Czech Republic also moved up over 1% each.  

3 Top Stock Picks

Amid such chart-busting performance by the equity market across most indices in the recent times, there are certain stocks with attractive valuation metrics backed by a solid Zacks Rank. Let’s take a closer look at these companies that appear to be well positioned to benefit from the solid sector dynamics.

Netflix, Inc. (NFLX - Free Report) : Headquartered in Los Gatos, Calif., Netflix offers Internet television network services across the globe, enabling subscribers to stream TV shows and movies directly on TVs, computers, and mobile devices. This Zacks Rank #1 (Strong Buy) stock has a phenomenal year-to-date return of 278.8% and is currently trading at a forward P/E of 195.4x with a long-term earnings expectation of 21.7%. Netflix’s focus on improving user engagement has been its primary growth driver and its subscriber base had increased 10.87 million year over year to 40.28 million in the recently concluded third quarter of 2013.

Ford Motor Co. (F - Free Report) : Based in Dearborn, Mich., this automobile major manufactures vehicles, parts, and accessories worldwide. Recently, Ford became the first truck manufacturer to offer a half-ton pickup truck that is capable of running on both compressed natural gas (CNG) and liquefied petroleum gas (LPG). The Ford F-Series trucks have already surpassed the full-year 2012 sales tally of 645,316 and full-year 2013 sales is likely to be the highest since 2006.  This Zacks Rank #1 stock is trading at a forward P/E of 10.3x and has a long-term earnings expectation of 12.3% with a year-to-date return of 32.89%.

Best Buy Co., Inc. (BBY - Free Report) : Headquartered in Richfield, Minn., Best Buy operates as an e-commerce and physical retailer of consumer electronics in the U.S., Europe, Canada, and China. This Zacks Rank #2 (Buy) stock had a fairytale turnaround as it reversed its streak of loses in 2012 in this year riding on strategic investments and stringent cost-cutting measures. The year-to-date return of the stock is currently pegged at 237.1% and is trading at a forward P/E of 15.7x. The long-term earnings expectation of 9.7% also looks attractive.

Don’t Miss These Golden Geese

The equity market perhaps is currently passing through its stage of maturity and the euphoria is likely to continue in the short term. As the U.S. stocks continue their unrelenting rally of reaching new all-time highs in most major indices, this is perhaps the most opportune time to own such high-potential stocks with strong fundamentals that pledge a healthy ROI.

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