Climbing GNP Will Benefit Specific Market Sectors

Much has been made of President Donald J. Trump’s boastful rhetoric on the U.S. economy cresting the magical 3 percent gross domestic product mark.

But as baseball legend Dizzy Dean once said, “It ain’t bragging if you can do it.”

That’s because the U.S. economy has, in fact, reached that number two quarters in a row. Both the second-quarter and third-quarter GDP numbers have been revised upward, to 3.1 and 3.3 percent, respectively.

Fourth-quarter GDP growth is expected to be even more robust.

The Atlanta Federal Reserve now forecasts real fourth-quarter gross domestic product of 3.4 percent, while the New York Federal Reserve’s analysts project 3.8 percent growth, said Jason D. Pride, director of investment research at Glenmede.

Other Wall Street analysts agree, adding that 2018 bodes well for U.S. investors.

“Earnings momentum is strong,” said Richard Turnill, global chief investment strategist at the Blackrock Investment Institute. “Proposed U.S. corporate tax cuts could provide an extra leg up for earnings going forward. We like value, momentum, financials, technology and dividend growers.”

All that is good news for stock market investors, if they exercise some good judgement.

"It is true that U.S. GDP has been growing at a higher pace during the past couple of quarters, however, U.S. equities have also been rallying at the historical levels,” said Chris Kim, chief investment officer at Tompkins Financial Advisors in Ithaca, N.Y. “While the economic backdrop presents a benign environment for equity markets in general, valuations are uncomfortably tight and I recommend being selective in asset allocations.”

Downside Risks Remain

U.S. equities are trading at a price-to-earnings multiple higher than 81 percent of history since 1990 and continue to grind higher. But downside risks are plentiful – from politics to central banks to various geopolitical concerns, Kim said.

“In my view, maintaining a defensive stance is still the appropriate course of action,” he said. “I recommend focusing on opportunities in undervalued sectors, companies with less cyclicality and limited volatility of cash flows.”

Relative valuations between asset classes are an important basis for investing at this market valuation level, Kim noted.

“The financial sector appears to be inexpensive at current levels and would benefit from potentially higher long-term interest rates,” he said. “Other undervalued sectors that have stable cash flows, less cyclicality, and would benefit from a strengthening economy include telecoms and healthcare.”

Globally, emerging markets are attractive compared to U.S. equities due to lower valuations, a synchronized pick-up in global growth, a weakening U.S. dollar and an under-allocation by global investors to the asset class, Kim added.

Others agree with Kim’s bullish assessment of the financial sector, heading into a stronger economy.

Joel S. Salomon, author of the book “Mindful Money Management: Memoirs of a Hedge Fund Manager”, and a prosperity coach at New York City-based SaLaurMor Management, also likes financials, and owns the following sector stocks in his portfolio:

• AEL (American Equity Life Investors Holding) -- AEL is an equity indexed annuity insurance company that benefits from higher interest rates as it earns money on the spread between its portfolio rate and the rate it credits its policyholders, Salomon said. “It is the most levered (assets/equity) of the life insurers and thus makes the most money from higher interest rates versus its peers.”
• DFS (Discover Financial Services) -- “All credit card companies will benefit from higher long term rates as they will charge their credit card holders more while not crediting much more to their depositors - much like traditional banks,” Salomon said.
• FHN (First Horizon): -- FHN is one of the most asset-sensitive regional banks. “They will make more money as the yield curve steepens,” Salomon added.
• HTH (Hilltop Holdings) -- Hilltop is one of the most asset-sensitive regional banks.

Housing Industry has 'Rapidly Grown'

Another area ripe for growth is the U.S. housing sector, which should really pop in 2018, according to Brad Hunter, chief economist at HomeAdvisor. A subsector with legitimate growth prospects is in home improvement.

“The home improvement industry has rapidly grown since the bottom of the housing cycle – and the results of the most recent HomeAdvisor Farnwsorth Index indicates that it’s set to rise even faster over the next twelve months than during the last year,” Hunter said.

In a survey, nearly nine of 10 home-related business owners were bullish about their company’s prospects for new business in the next six months, Hunter said.

And that was before hurricanes Harvey and Irma sent demand through the roof, he added. Recent storms contributed to an additional $282 million in sales for Home Depot, while Lowe’s reported a revenue impact of $200 million.

The surge in homeowner equity has empowered homeowners to tackle bigger projects, catch up on remodels they may have put off, and indulge in improvements that are just nice to have, Hunter said.

“Additionally, higher levels of homeowner equity have made it easier for people to get access to home equity loans and lines of credit,” he added.

Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms. Brian may be contacted at [email protected]