Make no mistake – we are in the final few years of this bull market in U.S. stocks (and global stocks). In the last stage of most bull markets, a few sectors tend to outperform.
The S&P 500 can be split into 11 sectors:
- Information technology
- Consumer discretionary
- Consumer staples
- Real estate
- Telecommunication services
Here are the sectors that are most likely to beat the S&P 500 index in the next few years.
Over the past few years, the tech sector has been primarily driven by overvalued but fast growing tech companies like Facebook, Netflix, Tesla, Twitter, etc.
Make no mistake: most of these tech are insanely overvalued. Many of these companies IPO when their growth rates start to slow down, and even then they have P/E ratio’s of 100+! Such high P/E ratios might be justified if they have a lot of room to grow, but many such as Twitter don’t!
So yes, many tech stocks will crater in the next recession and bear market. Keep in mind that from 2000-2003, many tech companies – including solid ones such as Amazon and Yahoo – saw their stock prices fall more than 90%!
But history shows that before a bull market ends, overvalued and high flying stocks always become more overvalued first. And they rise much more than “cheap” stocks because investor euphoria pushes these high flying stocks even higher.
We’re also going to see a lot of tech IPO’s in the next ew years (Uber and Airbnb?). It’s funny how everyone can justify these very high valuations. For every one Facebook, there are 10 Groupons, Twitters, Demand Medias, Box.net’s. These are companies that ultimately failed to live up to their IPO hype. But in the meantime, investors will probably snap up these IPO stocks with glee.
Bank stocks significantly underperformed the S&P 500 from 2013 to November 2016 when Trump was elected. This was because interest rates were pushed too low by the Federal Reserve. When interest rates are low, the difference between rates that banks borrow at and rates that banks lend at shrinks to a minuscule margin. The minuscule difference is their reduced profit margin. So when rates go up, this difference increases and banks’ profits increase.
That is why financial stocks soared from the Trump election to March 2017. As U.S. interest rates went up, prospects for banks started to improve. Of course interest rates are consolidating right now, but keep in mind that interest rates will go up in the long term. This means earnings in the financial sector will improve significantly in the next few years.
In addition, there tends to be a flurry of deal making in the final few years of every bull market. Companies want to merge, raise capital, and buy up smaller firms. They turn to banks for help, and banks profit handsomely from increased underwriting fees.
But of course when interest rates get too high, banks suffer as well. Banks have a unique problem of borrowing short term and lending long term. Perhaps they’ll extend a 10 year loan at 6% while they’re borrowing money at 1.5%. But when short term interest rates rise to 8% in 5 years, they still have the loan that yields 6%! In other words, they now hold loans that yield 6% but borrow money at 8%, resulting in a 2% loss!
Energy and materials
Energy comprises of oil and natural gas companies, and the materials sector is heavily driven by gold miners.
After a huge collapse in 2014-2016, energy prices have mostly stabilized. As a result, energy prices will most likely drift upwards in the coming years. But if inflation really starts to pick up as it often does in the last stage of economic expansions, then energy prices will rise much more. The exact same thing applies to the materials sector. Gold and silver follow rising commodity and energy prices. And when inflation rises significantly, gold and silver soar.