Three Sectors To Stuff Your Stocking With for 2020

A Top-Down Approach To Stock Picking

With 2020 just around the corner it’s time to start looking for those last minutes investments. When it comes to investing, be it growth or income, the earnings outlook is always a good place to start. For me, a top-down approach tends to work best. Start with the best looking sectors for earnings growth and invest in them, or stocks of companies within them.

If there is one thing that 2019 did not bring to the market was earnings growth, at least not for the average S&P 500 (SPY) stock. At best, the 4th quarter will deliver 0.0% to low-single-digit earnings growth which means FY 2019 will look the same. The good news is that next year is expected to be much different. The broad S&P 500 should produce growth in the range of 9.7% and there are some sectors within the index looking at double-digit YOY gains.

Avoid Energy, Eye The Industrials

The Energy Sector (XLE) is one of note. The Energy Sector is expected to produce a consensus 21.3% earnings growth in 2020, a very robust number until you factor in what happened this year. In 2019 the Energy Sector saw EPS decline by 27.70% so next year’s growth isn’t really growth at all.

The Industrial Sector (XLI) is a much better choice. The Industrials will see a small contraction in earnings in calendar 2019 but the outlook for 2020 is much better. Next year, the Industrials are expected to post a consensus of 16.10% EPS growth to lead the S&P 500 ex-energy. Boeing is going to drag on the sector, the 737-Max scandal is far from over, but others are poised to have their EPS targets raised for 2020.

Companies like Deere (DE), Cummins (CMI), and Caterpillar (CAT) have all had EPS downgrades to both the current year and next year attributable to market weakness, tariffs, and the trade war. With the Phase One Deal seemingly in the bag international trade can begin to accelerate once more. It will take some time, perhaps more than a quarter, but sooner or later EPS estimates are going to rise as well. The risk, of course, is that the deal won’t go through but so far all signs are positive that it will.

Materials No, Consumer Discretionary Yes

The Materials Sector (XLB) is another false-promise of earnings growth. The 2020 outlook is robust at 13.70% EPS growth but undermined by -15.00% growth in 2019. A better choice for true growth is the Consumer Discretionary (XLY) sector. The Consumer Discretionary sector is having a small contraction of EPS this year, about -1.70%, but that will be made up and more in 2020. The discretionary sector is expected to post 12.40% EPS growth next year and that is likely a low estimate.

Trends in labor and retail suggest steady if not strong increases in consumer spending next year. While individual retailers and brands may not see the same success as others, the group as a whole is expected to benefit from labor-related consumer health.

A recent round of downgrades has the sector lagging the broader market but those downgrades are rear-looking and largely attributable to two things; slowing auto sales and Amazon’s increased competition. What this means for investors today is an opportunity to invest in next year’s leaders at this year’s bargain prices. The risk is in the 4th quarter reporting. The discretionary sector is looking at a -13.70% YOY decline in EPS for the quarter and that may drive prices to even bigger bargains.

Communications Services, A Clean Path To Growth

The Communications Services (XLC) sector is not going to have the strongest EPS growth next year but it does have the cleanest path to growth of any S&P 500 sector. At 12.10% Communications Services is going to be a top-five sector and that is on top of positive EPS growth in 2019. The full-year 2019 should deliver about 4.70% EPS growth with the 4th quarter running near 4.2%. That’s nothing to write home about but better than contraction and what I would call a solid foundation for the next year.

Looking forward, much of the growth in Communications Services is going to come from 5G. The 5G market is already worth close to $50 billion and expected to grow at over 50% CAGR the next five years. Stocks within the group have been on the move in recent months but the gains are not yet over. Stocks like Verizon and AT&T are both on break-out watch, a move to new-highs in either would be the signal for new entries.