After small-caps took charge of the bull run through February to May, mega caps returned to the forefront in June. This is especially true as the blue-chip Dow Jones index climbed 3.7% to start June, outpacing the gains of 2.7% for the S&P 500 and 2.4% for the Russell 2000. Notably, the Dow Jones surged 2.8% last week, its biggest weekly gain since March.
Improving domestic and international fundamentals, a firming dollar and compelling valuation led to the outperformance.
The recent raft of economic data points indicates robust growth after the first-quarter slowdown. American manufacturing is enjoying a 21-month winning streak, average hourly wages have been rising with 2.7% year-over-year growth, and unemployment has dropped to 3.8%, which is the lowest level since 2000. Consumer spending, which accounts for more than two-thirds of U.S. economic activity, surged the most in five months by 0.6% in April, while consumer confidence rebounded near the 18-year high in May.
Most importantly, the U.S. trade deficit, which has been the key reason for the ongoing tariff threats and trade war concerns, dropped for the second consecutive month in April by 2.1%, marking the lowest level since September. The shrinking trade gap will definitely benefit exporters, leading to a surge in mega-cap stocks. In the first four months of 2018, exports to Mexico, Canada and the European Union have recorded double-digit growth. This underscores that United States is expanding strongly in these markets despite the fact that Trump is going fierce with his anti-trade policies against China and its key trading allies, which could hurt exports.
After strong acceleration in May, the U.S. dollar against the basket of currencies has started to weaken with the start of June. A weak dollar bodes well for blue-chip companies, which derive most of their revenues from international markets. This is because a weak dollar has made dollar-denominated assets cheap for foreign investors, making U.S. multinationals more competitive thereby leading to increased profits. As such, companies having a higher percentage of international sales will likely outperform.
Added to the strength is the compelling valuation. The four months of underperformance of the blue-chip index has compelled investors to look for bargain stocks. The Dow Jones has P/E ratio to forward 12 months of 16.57 compared to that of 17.29 for the S&P 500 and 26.75 for the Russell 2000.
Given the encouraging mega-cap trends, investors should stuff stocks on the cheap for outsized gains in the coming weeks. For this, we have used a Zacks Stock Screener to select stocks with a market cap of more than $100 billion, a Zacks Rank #1 or 2, and lower P/E than the Dow Jones. A top rank suggests rising earnings estimates, which indicate an optimistic view on earnings by analysts and hence higher chances of outperformance.
Finally, we arrived at three mega-cap stocks that are cheap and have the potential to deliver higher returns.
Toyota Motor Corporation (TM - Free Report) - P/E Ratio: 9.35
This Zacks Rank #2 company produces, sells, leases and repairs passenger cars, trucks, buses, boats, airplanes and other products in Japan and most foreign countries. Although its earnings estimate has gone up by 92 cents for the fiscal year (ending March 2019) in a month, earnings are expected to decline 3.13%. Toyota Motor flaunts a top VGM Score of A and a market cap of $200.1 billion.
China Petroleum & Chemical Corporation (SNP - Free Report) - P/E Ratio: 10.53
This Zacks Rank #1 joint-stock company is focused on its core business of petroleum and petrochemicals with integrated upstream, mid-stream and downstream operations and a complete marketing network. The stock has seen solid earnings estimate revision of $1.22 for this year over the past 30 days and an expected growth rate of 62.84%. It has a market cap of $115.6 billion and a VGM Score of B. You can see the complete list of today’s Zacks #1 Rank stocks here.
Merck & Co., Inc. (MRK - Free Report) - P/E Ratio: 14.82
This Zacks Rank #2 global biopharmaceutical company provides healthcare solutions worldwide. With a market cap of $168.73 million, the stock saw no earnings estimate revision for this year in a month and has an expected earnings growth rate of 6.03%. It has a VGM Score of D.
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