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Which Segments to Bet On as U.S. Economy Rebounds

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As expected, the U.S. economy is on its way toward a strong recovery. Just how strong that is, is something we haven’t figured out yet. But if fourth-quarter numbers are anything to go by, it’s now abundantly clear that the recovery will be “better-than-expected.” 

Our latest Earnings Trends Report says, “For the 492 S&P 500 companies that have reported Q4 results already, total earnings are up +3.0% from the same period last year on +3.0% higher revenues, with 79.3% beating EPS estimates and 75.2% beating revenue estimates.”

Moreover, the consecutive quarters of better-than-expected results and continuously improving outlooks have taken the 2021 aggregate earnings growth estimate for this group from 11.7% on Dec 9 2020 to 18.5% on Mar 5 2021.

What’s more, the outlook for the small-cap S&P 600 is moving in the same direction, with the 551 companies that have reported so far growing their revenue and earnings 0.7% and 0.6%, respectively. 64.8% have topped EPS estimates with 75% topping revenue estimates.

Two sets of numbers, on manufacturing and employment, that were released by the government last week provides further evidence of this recovery-

The ISM manufacturing report for February shows notable expansion (PMI is at 60.8%). New orders were at 64.8%, production was at 63.2%, backlog at 64%, employment at 54.4% and inventories at 49.7%.

Since any number above 50 indicates expansion, it’s evident that strong demand is boosting manufacturing activity even as supply issues are keeping the pressure on raw material inventory, which “continues to shrink.” So while we’re getting ready to combat the coronavirus, the supply chain disruptions it caused are still a reality companies have to deal with.

The second set of numbers came from the Bureau of Labor Statistics (BLS) and these too increase confidence in the recovery. Non-farm payrolls jumped 379,000 in February with the unemployment rate of 6.2% being well above the year-ago level (pre-pandemic) although much lower than the April highs.

The lion’s share of the new job adds (355,000) were in hospitality, 80% of which were in food services and drinking places, with the balance being in accommodation, amusements, etc. Hiring in these beaten-down segments is one of the strongest indicators of a broader recovery.

That’s not to discount the still-large numbers of people that remain unemployed or under-employed because of issues at their employers. The fresh stimulus, just okayed by the Senate, should help this group get back on their feet.

Clearly, many problems remain. But we are beginning to see the silver lining and that’s reason for cheer.

As investors, it means we can look forward to making more money. And whether we’re looking for growth or value, there are opportunities we can tap into. I generally like the idea of waiting for a stock to reach a valuation I can trust before investing in it. But with growth stocks, you will sometimes have to wait forever with that kind of strategy.

That’s why we build portfolios with different kinds of stocks, some in the value category, some in growth and some yielding revenue (dividends). If you have a well-diversified portfolio, you will be able to make good any losses more easily.

Of course we don’t plan to make any losses. But we need to prepare for such a situation because there are many factors that make a market unpredictable.

Value investing involves buying a good company at a reasonable price and then holding on to it for a number of years until it appreciates (which it inevitably will).

So the first thing we need to do is find the “good” companies. These would be companies with a history of steady revenue/earnings/dividends as well as attractive forward estimates. When such companies are going cheap with respect to their peer group, industry, the S&P 500, etc, or even their own historical performance, they are worth buying.

At times, analysts can be very upbeat about companies that are relatively new, or operate in fast-growing market segments, even if they don’t have a great track record. It is their potential for growth that makes these stocks attractive. Although more risky, this is a segment where a lot of money is made.

Construction remains one of the most attractive sectors because of attractive demographics, virus-driven demand, relatively low mortgage rates and low inventories that are keeping prices high.

Inventories are particularly low at the wood companies, leading to continued strength in prices. The situation is likely to continue through 2021. UFP Industries, Inc. (UFPI - Free Report) , Boise Cascade, L.L.C. BCC and LouisianaPacific Corp. (LPX - Free Report) among others are looking good now.

Certain segments of retail like apparel and shoes are looking up, as the economy is set to re-open. However, it’s the home furnishers with their correlation to the construction sector that look the most attractive. Haverty Furniture Companies, Inc. HVT, Ethan Allen Interiors Inc. (ETH - Free Report) and Tempur Sealy International, Inc. (TPX - Free Report) are some of the best plays in the segment.

With manufacturing going strong, there are quite a few opportunities in basic materials.

Steel makers that benefit from overall growth in the economy and particularly in things like auto and construction, are therefore worth considering. Accordingly, Schnitzer Steel Industries, Inc. (SCHN - Free Report) , ArcelorMittal (MT - Free Report) and L.B. Foster Company (FSTR - Free Report) look good right now.

Data from the American Chemistry Council (ACC) indicates stronger demand (on a 3-month moving average basis) in January for chemicals due to rising activity levels in housing, auto, consumer and institutional packaging, and manufacturing segments. Diversified chemical suppliers like Arkema SA (ARKAY - Free Report) , Brenntag AG BNTGY and Cabot Corp. (CBT - Free Report) are some attractive stocks here.

And then of course there’s the technology sector. Valuation may be a concern here because the market is quick to price in all the expected growth. But digging deeper, we can find stocks that continue to hold promise.  Lenovo Group Ltd. (LNVGY - Free Report) , Universal Electronics Inc (UEIC - Free Report) and Ultra Clean Holdings, Inc. (UCTT - Free Report) are worth considering.

Conclusion

There’s no perfect formula of success in investing and it is ultimately all about opportunistic buying and selling, keeping in mind one’s own financial goals and risk appetite. Still, a better knowledge of some of the most attractive segments at any given time can provide you with a broad framework within which you may find what you’re looking for.  

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