Large blue chips, including some consumer-oriented companies, will have to show they can counter sluggish developed economies by leveraging growth in emerging markets and technology — if Wall Street is to maintain earnings momentum this week.
Companies like Microsoft, PepsiCo, and Coca-Cola, unloved on Wall Street, could turn out to be good buys if they can show they justify higher valuations than investors are now willing to give them.
"If you see these Cokes and Pepsis and these kinds of multinational consumer names post good results, I think it is going to give the perception that the equity market can overcome a lot of these domestic issues," said Nick Kalivas, an analyst at MF Global in Chicago.
Before the recession, the consumer and financial sectors benefited from huge credit expansion. Not so any more.
Growth is now concentrated in industrial, materials and energy stocks that benefit from strong demand in emerging markets, as well as a technology sector boosted by robust demand from businesses.
Average earnings growth across those sectors amounts to almost 33 percent in the first quarter over a year ago, according to Thomson Reuters data. That is more than double the estimated growth for the S&P 500 and towers over the 5 percent growth in a financial sector burdened by a weak housing market.
Investors will also want to see at least stable performance in developed markets as they gear up this week for a press conference by U.S. Federal Reserve Chairman Ben Bernanke. Tough questions will be asked about what monetary policy will look like after the Fed's easy money policies come to a close at the end of June.
Embracing the Unloved
Growth is scarce and it is driving up valuations in sectors where it is concentrated.
Last week, investors chased a host of relatively expensive technology names like Apple and VMware. Some valuations look extreme: Cloud computing company Saleforce.com is priced at nearly 300 times current earnings.
The trailing price-to-earnings ratio in the S&P's materials sector is more than 20 times current earnings compared with 16.3 for the whole market, according to data from Thomson Reuters' StarMine.
For investors like Whitney Tilson, a hedge fund manager at T2 Partners in New York, that is creating opportunities in unloved blue chips, where he is focusing his attention instead.
"There are a lot of big-cap blue-chip companies that are trading at moderate prices," he said.
"At a time when everyone is getting enamored with high- growth darlings and commodities, that is precisely the time when we look to play defense and own boring companies that we think have a lot of growth."
One of those less favored companies set to report next week is Microsoft. The company suffers from a reputation for slow growth and its price at nearly 11 times current earnings clearly reflects that.
Comparing Microsoft with Apple, Tilson says that the former is an inherently better business as it focuses on software with marginal incremental production costs compared with Apple's consumer hardware business.
Apple is "a fabulous business, but I'm simply pointing out that you can own a better business, albeit one that is not growing as quickly — but still growing nicely — for half the price in terms of price-to-earnings multiple," Tilson said.
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