2018 is off to a nice start as the indices hit another all-time high in trading yesterday. Although early, there are several trends emerging in the market so far in the new year. Retail and Consumer Discretionary stocks have gotten off to a good start in 2018 and have been generally strong since early November. Given how beaten down the sectors had gotten, they were overdue for a bounce.
There are some other solid reasons behind the rally. Holiday sales were up more than 5% on a year-over-year basis; the highest levels in years. In addition, consumer confidence is high. Scores of companies lifting minimum wages and handing out $1,000 and $2,000 bonuses to employees thanks to tax reform. Combined with low unemployment and wage growth finally starting to accelerate, confidence levels should remain elevated.
However, I am fading this rally in these sectors which I already have limited exposure. The country remains overstored, more and more individuals are starting to value ‘experiences’ over ‘things’ and Amazon.com (AMZN) will remain the 800lb gorilla in the room.
The energy sector has also gotten out of the gate quickly in the new year. The industry has had several tailwinds recently. Natural gas prices have benefited from a colder than expected winter, while oil prices have rallied strongly on improved global demand and turmoil in Iran and Venezuela. In addition, few sectors will get a bigger lift from the slashing of the corporate tax rate by 40%. This will especially boost the domestically focused small and midcap concerns across the sector. I expect this sector to continue to outperform the market in 2018. The combination of lower tax rates, rising energy prices and more efficient use of drilling technology should do wonders for earnings growth this year.
The financial sector has moved up some 10% over the past three weeks or so. This is another part of the economy and market that will benefit significantly from the recently passed tax reform legislation. Fourth quarter earnings should be ‘lumpy’ as banks and insurers take one-time charges (which don’t affect cash flow) for impacts from the new tax legislation. However, these names will start to get a significant boost in earnings from lower tax rates starting in the first quarter. Take Synchrony Financial (SYF) which has a current all-in effective tax rate of 37% as a microcosm of the sector. The impacts of tax reform should lift its earnings by nearly a buck a share in 2018 without factoring in any growth.
In addition, rising interest rates will help banks’ net interest margins and insurers’ portfolios. Add in the positives from an accelerating economy and strong job market, and this is a sector ripe for a very nice 2018.
And that is my early view on the market in the new year, with two trends to continue to play and one to fade.
This commentary originally appeared on Real Money Pro on Jan. 12. Click here to learn about this dynamic market information service for active traders.