The majority of top stock pickers can’t maintain their superior performance over a couple of years, according to a new report.denphumi/Getty Images/iStockphoto
All year, investors have been pricing in an end to the profits recession. Now that the turning point may have been reached, relief on the earnings front may not be sufficient to move markets much further.
With three quarters now in the books, stocks globally have proven more resilient than the average forecast asserted going into the year. Through the end of September, the Morningstar Global Markets Index returned 7.6 per cent this year, despite starting the year with a global correction fueled by the crash in energy prices and fears over China's economic slowdown.
Canada's main equity benchmark, meanwhile, rose by 13.2 per cent over that time as commodity prices rebounded. And the S&P 500 index handily overcame what became the longest contraction in corporate profits since the global financial crisis to advance by 6.1 per cent year to date.
"Given that corporate earnings have been weak this year, it is somewhat surprising that equity markets have remained so buoyant," Morningstar's director of North American equity research, Elizabeth Collins, said in a report.
The profits recession has now stretched over five consecutive quarters, but a moderate year-over-year increase expected by Merrill Lynch for the third quarter would mark a return to profit growth for the first time since early 2014.
That forecast implies a 2 per cent earnings beat against consensus for the third quarter.
"We don't expect a muted beat to drive the market higher, given already stretched valuations and a heightened likelihood of a correction between now and year-end," Savita Subramanian, Merrill Lynch's head of U.S. equity and quantitative strategy, said in a note.
Ms. Subramanian, who is among the more bearish of Wall Street's most prominent strategists, has a year-end target of 2,000 for the S&P 500 index, which represents a decline of 7 per cent. The average year-end estimate among 19 strategists tracked by Bloomberg forecasts a 1-per-cent rise.
The just-ended quarter, meanwhile, saw the winners and losers of the first half of the year trade places.
"Q3 was a rotation out of what worked in the first half into what didn't work," Bespoke Investment Group said in a note.
The 100 best performing stocks in the S&P 500 index in the first two quarters were down slightly in the third quarter, on average. Meanwhile, the biggest decliners in the first six months were up substantially.
Aside from technology stocks, which soared in the third quarter, the best performing S&P 500 sector was financial services.
But while bank stocks became more expensive globally, they remain among the most undervalued in the market, Ms. Collins said. Morningstar's top picks among global financials include Affiliated Managers Group Inc., Commerzbank, and Aegon.
Resource sectors account for the most overvalued stocks, according to Morningstar, which is bearish on energy and most other commodity prices. The firm's best energy investment ideas include Marathon Petroleum Corp., HollyFrontier Corp., and RSP Permian Inc. Top materials picks are Cameco Corp., Canfor Pulp Products Inc., and Compass Minerals International Inc.
Tim Shufelt