Market got a bit ‘ahead of itself,’ market strategist says

Key Concepts

• Risk-On vs. Risk-Off: Market sentiment indicating investor appetite for riskier assets (risk-on) or a preference for safer assets (risk-off).
• Growth Stocks: Companies expected to grow at an above-average rate compared to other stocks.
• Value Stocks: Companies that appear to be trading for less than their intrinsic or fundamental worth.
• Price-to-Earnings (P/E) Ratio: A valuation ratio of a company's current share price compared to its per-share earnings.
• Forward P/E Ratio: A company's current share price divided by its estimated future earnings per share.
• Bear Market: A prolonged period in which investment prices fall, typically by 20% or more, from their recent highs.
• S&P 500: A stock market index representing 500 of the largest companies listed on stock exchanges in the United States.
• S&P 1500 Electric Utility Forward PE: A valuation metric specific to the electric utility sector within the S&P 1500 index.
• Multiple Expansion: An increase in the valuation multiples (like P/E ratio) applied to a company's earnings, leading to a higher stock price.
• Crack Spread: The difference between the price of crude oil and the price of refined petroleum products derived from it, indicating refining profitability.
• Analyst Recommendations: Ratings provided by financial analysts on stocks, such as "Buy," "Strong Buy," "Hold," or "Sell."

Market Sentiment and Growth Stock Valuation

The stock market's recent behavior suggests a shift from "risk-on" to "risk-off" tendencies, particularly evident in the performance of growth stocks. The Invesco S&P Growth ETF has been retreating against the Invesco S&P 500 Value ETF. This is attributed to growth stocks, especially technology companies, trading at significant premiums. Specifically, technology was trading at a 73% premium to its 20-year average forward P/E ratio, and at a greater than 40% premium overall. Investors are perceived to be signaling that "a lot of the juice out of the lemon" has been squeezed, prompting a search for opportunities elsewhere, at least in the near term.

Potential Market Pullback and Support Levels

Following the reversal on Friday, there's a concern about market vulnerability and the extent of potential declines. Sam Stovall, CFRA Chief Investment Strategist, believes that any decline experienced will not be the start of a new bear market. He notes that historical declines, excluding those during World War II, have averaged less than 9%. The most recent decline falls within the range of 14% to 23%, which is smack in the middle of historical pullbacks. A decline of less than 9% would bring the S&P 500 down to just below 6300. A further drop would reach the 200-day moving average, which was at approximately 6125 as of the previous week.

Investment Opportunities in Value Stocks

Evercore Energy

On the value side, Evercore Energy is highlighted as a company with a five-star or strong buy recommendation from analysts. It is currently trading at a 22% discount to the S&P 1500 Electric Utility forward P/E. The potential for multiple expansion in the near term is considered an opportunity. Furthermore, the company's exit from the offshore wind area and the pending sale of its water utility are expected to support a simpler, more streamlined operating model.

Pharmaceutical Distributor

Another identified opportunity is a pharmaceutical distributor, which has received buy or strong buy recommendations and favorable technical analysis. This company is not affected by tariffs and faces fewer regulatory risks compared to other areas within healthcare. The transcript notes an overall improvement in the healthcare space.

Phillips 66

Phillips 66 is also favored, with its rating recently raised to "Buy" from "Hold." This upgrade is primarily driven by an uptick in refining, signaling the early stages of a refining earnings upcycle. This is linked to the "crack spread," which represents the difference between the cost of crude oil input and the price of refined products output. The performance of Phillips 66 is not necessarily dependent on oil prices moving sideways.

Conclusion

The discussion emphasizes the utility of the stock market in discerning "risk-on" versus "risk-off" tendencies. While growth stocks have experienced a premium and subsequent retreat, value stocks present compelling opportunities. Specific recommendations include Evercore Energy, a pharmaceutical distributor, and Phillips 66, each supported by analyst ratings, valuation metrics, and favorable industry trends. The market is anticipated to experience pullbacks rather than a new bear market, with identified support levels providing potential entry points for investors.