Which Sectors are Under Valued?

Macro Perspectives

We've talked in recent days about the opportunity in bank stocks, and in commodities stocks.

The stock’s in these sectors have been dragged down, with the broad market, for non-fundamental reasons. If we step back, for some perspective, we came into the year knowing that a rising interest rate environment would not be friendly to the high valuation tech sector.

It has been the ugly unwinding of irresponsible over-concentration in these big tech investments that has led to selling of even the most fundamentally sound stocks.

As such, we've been given an opportunity to buy good stocks at a discount;

• for the banks, rising interest rates are fueling explosive net interest income growth

• for commodities, the "clean" energy agenda and pandemic-driven supply disruptions have combined to leave us with structural deficits. That has led to higher selling prices, and widening profit margins.

With this in mind, according to a Bank of America survey this week, global profit optimism is at record lows. That sets up for positive surprises (which is good for stocks). So, how is Q2 earnings season shaping up? As of yesterday's close, 81% of companies that have reported have beat earnings estimates.

Add to this, if we look at the chart of the S&P 500, coming off of the worst first half in more than 50 years, you can see we've retraced just over a third of the gains from the pandemic lows.

If these lows hold, this would be considered a shallow retracement of the trend. Shallow retracements tend to happen in strong trending markets.

Wait, a strong bull trend?

For perspective, if we extrapolate out the long-term average annualised gain of the S&P 500 (of 8%) from the 2007 pre-Global Financial Crisis highs, the S&P 500 should be north of 5,000. It closed yesterday just south of 4,000.

So, there are reasons to believe the Fed is near the end of this rate hiking cycle (at least, nearing a pause). There are reasons to believe we've had a technical recession in the first half, from which a rebound in economic growth in the second half of the year looks promising (historically, growth tends to bounce back strong out of recession). And there are reasons to to believe that there are deeply undervalued stocks in this environment.

Disclosure: My model flipped into Risk ON for 23 July 22 - I am Long $SPY. Model performance, with draw downs, shown below.