S&P Economics says a recession is more than 60% likely. Here are ways investors can protect their money in that event
From Standard & Poor's Equity ResearchS&P Equity Research believes 2008 is likely to be a tale of four quarters, with poor economic and earnings outlooks limiting P/E expansion early and late in the year. If economic growth accelerates in the second and third quarters, as we expect, we see performance improving.
Specifically, we think early 2008 U.S. equity performance is likely to be mediocre due to weakness in the residential housing market, tighter lending standards, high oil prices, and worries about the Federal Reserve's ability to stimulate the U.S. economy. But attractive valuations should help improve performances in the second and third quarters, in our view.
The S&P 500 index recently traded at about 13.4 times our estimated 2008 earnings, which is below its long-term average. With S&P analysts expecting continued positive S&P 500 earnings growth in 2008, we think further P/E contraction is unlikely.
At the sector level, we recommend a defensive stance with overweights for consumer staples, health care, and utilities, where we believe negative earnings revisions are least likely. Conversely, we recommend underweighting economically sensitive areas with poor earnings growth prospects like financials. We are also negative on the consumer discretionary sector, since its profits are most vulnerable to housing weakness, high energy prices, and tightening credit conditions. Lastly, we recommend underweighting industrials and information technology, as slowing international growth exacerbates weakness in the U.S. economy. The P/E and Price/Earnings-to-Growth (PEG) ratios listed below are as of January 24.
We have a negative outlook on the restaurants, homebuilders, and home furnishings industries, but we are positive on apparel, accessories, and luxury goods.
The sector’s P/E of 14.6 times estimated 2008 earnings is above the market’s P/E of 13.4. We estimate earnings growth of about 22% in 2008 vs. a 16% gain for the broader market. The sector’s PEG of 1.1 is in line with the broader market’s average. The sector’s marketweighted STARS average of 3.6 (out of 5.0) is below the average of 3.7 for the S&P 500.
A favorable outlook for international business opportunities, defensive/lower-risk characteristics, and an above-average yield are likely to be offset by raw material costs and a premium valuation.
The sector is trading at a P/E on estimated 2008 earnings of 16.2, and it has a PEG of 1.5. Consumer staples carry the second-highest S&P STARS average of 4.1.
We have neutral outlooks on integrated oil & gas, E&P, and refining & marketing, but a positive fundamental outlook on drillers and equipment & services. S&P analysts forecast a 5% increase in the sector’s earnings in 2008. The sector’s P/E on estimated 2008 earnings of 11.2 is the second lowest, and it has a PEG of 0.9. This sector’s S&P STARS average is 3.5.
We believe the Fed’s aggressive rate cuts and the sector’s recent poor performance have already largely discounted deteriorating credit quality. The sector now trades at a low P/E on estimated 2008 earnings of 10.7. An above-average dividend yield of 3.3% should also help support the sector. Financials trade at a PEG ratio of 1.1. The sector’s S&P STARS average is 3.5.
Specifically, our outlook for the influential pharmaceuticals industry is neutral, based, in part, on uncertainty regarding the impact of next November’s elections. We have positive outlooks on the equipment, supplies, life sciences, and managed care groups. S&P analysts forecast 14% earnings growth in 2008. The sector trades at a P/E of 14.1 and a PEG of 1.2. This sector’s S&P STARS average is 3.7.
A slowing U.S. economy will likely make significant expansion in the multiple difficult, and we believe earnings growth will underperform expectations for the S&P 500. While we have positive fundamental outlooks on aerospace & defense, construction & engineering, and construction & farm machinery, we have neutral outlooks on the industrial conglomerate, industrial machinery, and railroad industries. The sector trades at 14.1 times projected earnings and 1.1 on PEG basis. The sector’s S&P STARS average is 3.8.
S&P equity analysts lowered their fundamental outlook on the information technology sector to neutral from positive on increasing evidence of a U.S. economic slowdown and the rising risk of a recession. We think 2008 enterprise spending growth will decelerate, but not significantly, owing to relatively lean budgets and potential productivity benefits. We are recommending large caps that we view as having notable non-U.S. exposure, strong balance sheets, and attractive valuations. The sector index is projected to post a 22% increase in 2008 operating earnings. It trades at a P/E of 16.7 and a PEG of 1. The sector’s S&P STARS average is 3.9.
We are neutral on diversified chemicals and negative on aluminum. These two industries comprise a significant percentage of the sector. While commodity petrochemicals and plastics prices finally gained traction late in the first quarter of 2007, feedstock costs remain high and have crimped margins. As for aluminum, a combination of slower economic growth and less demand from key end markets should result in lower volume and declining spot prices, both of which will negatively impact sales and earnings. S&P analysts expect only 1% earnings growth vs. the 8% expected for 2007. The sector trades at a P/E of 13.8, and has a PEG ratio of 0.8. This sector’s S&P STARS average is 3.1.
S&P analysts have a positive outlook for the integrated telecommunications services industry. We see the carriers generating free cash flow in 2008 from broadband growth and cost savings should support dividends and share repurchases. Although we expect telecom companies to face challenges in a slowing economy, we think their voice and broadband phone services have become staples for consumers, particularly when bundled with video offerings. The sector trades at a P/E of 12.3, and has a PEG ratio of 1.4. It has a STARS average of 4.2.
S&P analysts have a neutral outlook on electric utilities. We believe rate increases and the strength of wholesale power markets are already largely reflected in current valuations. In addition, slowing mergers & acquisitions activity also temper the fundamental outlook. S&P analysts expect earnings growth of 11% in 2008 vs. 2% estimated for 2007. The sector trades at a P/E of 14.8, and has a PEG ratio of 1.5. Its average STARS ranking is 3.5.