Time to start “dialing back.”
That’s how Mary Daly, president of the San Francisco Fed, views the Federal Reserve’s stimulus measures. Daly sees less need for support, and she’s hardly alone in her view.
No fewer than eight other Fed presidents have voiced a similar assessment recently. That’s because they are confident about the ongoing economic recovery.
The first place they will start is the Federal Reserve’s massive $8.2 trillion balance sheet, which has swelled by 100% since the pandemic began.
But those views are at odds with the surge in new COVID-19 cases as the delta variant spreads.
There’s evidence that rising case counts are derailing the recovery. I wrote here about what stats you should track.
Look at how the most recent report on consumer confidence plunged (see the chart below), while airlines are warning that COVID-19 is hurting booking trends. A report on retail sales showed a much larger-than-expected drop just yesterday.
(Click here to view larger image.)
That means investors will encounter a dual threat as we head into the fall: a less supportive Fed coupled with signs that economic growth could slow meaningfully.
That doesn’t mean you have to abandon the stock market altogether. You just have to refine your search for the best stock ideas.
How to Adjust to the New Stock Market
First, identify stocks that are cheap relative to their growth potential.
Let me be very clear on this point. You can’t just say that a stock is cheap because it has a low price-to-earnings ratio. It needs to be cheap relative to its long-term prospects. This style of investing even has a name: growth at a reasonable price (GARP).
Next, you should focus on earnings volatility.
You’re probably familiar with volatility as a stock term, which measures how wide a stock price swings.
You can also apply the same concept to earnings, and how variable they are over time. Especially in times of uncertainty, you want to focus on companies with stable profits.
Using these criteria, here’s what my search uncovered.
Find Opportunities in This Sector
When I scanned S&P 500 sectors to see which fit the bill, one stood out: health care.
Using next year’s earnings estimates, the health care sector is the third cheapest behind energy and financials, as you can see below.
(Click here to view larger image.)
But here’s where the GARP characteristics emerge…
In addition to a low valuation, health care’s earnings growth is 54% ahead of the S&P 500’s projection next year.
Plus, the health care sector has experienced the second-lowest level of earnings volatility over the past decade. Only consumer staples came in slightly lower.
That combination of valuation, growth potential and earnings stability makes the health care sector a top pick. You can grab exposure with the Health Care Select Sector SPDR ETF (NYSE: XLV).
Best regards,
Clint Lee
Research Analyst, The Bauman Letter
