Company / Analytics

Analytics, 02 June 2022

Stock market sectors likely to show good growth

As central banks continue to tighten monetary policy with rate hikes, some sectors of the market will lose while others will take lead. Analysts at Goldman Sachs recently noted that financial assets will continue to underperform physical assets like commodities.

Slowing growth remains the biggest challenge for investors, especially in an environment of rising interest rates, high earnings estimates, high energy prices, and market volatility. Many investors are likely looking for the next growth frontier or sectors and industries with growth potential and high returns.

The energy sector has performed best in the S&P 500 this year, rising 58% through May 27 (excluding dividends), while the broad S&P 500 is down 13%. But other sectors also have potential and are worth considering in the current monetary policy environment.

Sectors of the stock market likely to show best earnings growth

Looking ahead into 2022, the sectors that are likely to perform according to one analyst, include energy, financials, industrials, communication services and consumer discretionary. Of these, the energy sector is the most bolded, since its weighted earnings per share are expected to decline over the next two years. On the other hand, financial, industrial, communication and consumer discretionary sectors are estimated to show double-digit increases in earnings in 2023 and 2024.

The energy sector will likely underperform going forward

The energy sector is expected to see a drop in earnings in 2023 and 2024. The sector is affected by many several (cyclical) factors, including increasing demand in China as Chinese economy reopens from recent coronavirus related lockdowns, expected rise in demand but low supply following European ban on Russian oil. The analysts noted that if we were to apply those expected rates of EPS decline to the $115.07 price for a barrel of West Texas Intermediate crude oil on May 27, the price would be down to a shade under $92 in 2024 — well above where oil prices have typically been over the past 10 years. This low P/E valuation may move closer in line with that of the S&P 500.

Investors who believe oil prices will stay above $80 for several years could invest in oil (and the energy sector, using exchange trade funds (ETFs). ETFs track many stocks, sometime over 100, while the S&P 500 includes only 21 energy companies. The low-price environment for oil before 2022 led to the removal of some companies that were formerly in the large-cap index.

Financial sector

Financial stocks have lost about 9% this year, as investors remained conflicted on the state of the sector. However, rising interest rates should help improve earning, since banks are flush with cash. Banks don’t need to pay much for deposits and their loan rates will also reset higher.

But the possibility of a recession caused by the Fed’s tightening would mean increasing loan losses which would negatively impact bank earnings. Investors confident about the financial sector may invest in individual stocks or take position in an ETF for a broader exposure to the market.

Industrials sector

The US economy is rapidly growing, even though companies and consumers are threatened by high inflation and the Federal Reserve tightening. While a recession remains possible, companies that create goods needed for economic growth (industrials) will benefit whether there is recession or not. In fact, they will benefit more in a post-recession environment.

Industrial stocks are currently trading in line with the full S&P 500 on a forward P/E basis. Investors who believe in the long-term economic growth and in companies focusing on traditional goods and services, should consider industrial stocks as they are currently favoured over technology stocks trading at much higher valuations.

Communications services

The communication sector and industry that has potential for earnings growth. While companies in the sector had previously focused on subscriber or user growth in their financial reporting, they now have to direct investors’ attention to revenue and profit. One such company Netflix is a prime example. The stock is down 68% this year and now may be an excellent time to buy the stock.

But the communication sector is broad, as it includes companies such as AT&T Inc. and Verizon Communications Inc., but also Meta Platforms Inc. and Alphabet Inc., as well as traditional media companies. The broader sector has dropped nearly 25% so far this year, and it might be a good time to take a position in the sector, example, through an ETF that tracks the sector such as the iShares U.S. Telecommunications ETF. This ETF is heavily concentrated and focused on traditional telecom and networking companies, with top five holdings - Verizon, Comcast Corp. Cisco Systems, and AT&T – making up 53% of the portfolio.

Consumer discretionary

The consumer discretionary sector includes plenty of retailers but also auto manufacturers such as Tesla, airlines, hotels, and casinos. After suffering from the pandemic, the sector has undergone recovering as economies reopened. Analysts expect earnings for the sector to rise by more than a third next year, with another 15% increase expected in 2022 alone. The sector is thus worth considering for investors.

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