Market Strategist: Invest in Tech, Financials in 2018

Samantha Azzarello is a global market strategist at J.P. Morgan Asset Management. Here's an excerpt from our interview:

KIPLINGER’S: Where do you see the U.S. stock market headed in 2018?

AZZARELLO: We see a continuation of the bull market. The backdrop for that is economic growth that remains on the path it’s on, corporate earnings growth that continues and revenue growth that maintains a positive trend. If all that stays the same, we think the chances of a bear market in 2018 are close to zero. That said, we are in the later stages of the economic expansion in the U.S., so being more selective and taking some risk out of your portfolio is a good idea.

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What’s your forecast for economic growth? It’s more of the same. We think the trend is for about 2.5% growth in gross domestic product for 2018. That’s not fireworks-worthy. But one of the silver linings to growing slower is that we can grow for so much longer. U.S. companies also benefit from global growth picking up—I don’t think that’s emphasized enough. And the fundamentals for stocks are supportive.

Such as? When I think of equity fundamentals, I think of two questions: One, are companies more profitable than they were the year before or the quarter before? And two, are stocks cheap? Earnings growth is there, and it’s real. It’s not just cost-cutting to prop up earnings, it’s real revenue growth that’s coming in positive—and you can’t fudge that. We’re expecting revenue growth of about 5% for Standard & Poor’s 500-stock index and earnings growth in the high single digits. Corporate profit margins are high now, but we think they can be sustained. If you keep profit margins high, then any bump to revenues supercharges earnings.

But stocks aren’t cheap. What about valuations? Stock valuations are more art than science. There’s no clear price-earnings ratio that’s going to tell you when to get out of the market. Think of a traffic light. There’s nothing about valuations now that screams green light. But at the same time, there’s no red light, either. We’re somewhere in the middle—a yellow light. That’s harder to navigate, which is why you need to be more selective, why you need to be picky, when it comes to investment styles, themes and sectors—that’s what’s going to matter to your return over the next few years, because valuations are so elevated.

Where should investors put their money now? We still like stocks of large companies with faster-than-average earnings growth. They’ve worked well in this environment, and we think they’re here to stay for a while longer. We don’t like relying on something coming from Washington for tax reform or deregulation to rally behind small-cap stocks. We could get behind small caps in 2018, but it depends on things that really are outside anybody’s control. Within sectors, we like technology, and not just the sexy, social media story. We like tech across the board. There are a lot of interesting things going on in tech, and it’s all underpinned by long-term growth in the industry. We also like financials. People think financials are a rising-rate story. That’s part of it; they’ll benefit as rates rise. But at the heart of why we like financials is that we think they’re undervalued. And we think they’re the next yield play. People need dividends, and financials are going to start returning a lot more cash to investors. That’s going to be a long-term trend for that sector.

Are there other themes you’d emphasize? Something we’re talking about with clients is that we are late in the bull-market cycle. No one can call the end. But we’re looking for overheating or significant imbalances and watching GDP growth, inflation and corporate debt levels. Risk-averse investors should make sure there’s a quality bias to the stocks they’re buying. By high-quality, I mean strong balance sheets, strong management, and the ability to pay out dividends and to produce long-run sustainable returns. And you still need good, high-quality fixed income in your portfolio, such as Treasuries or high-quality corporates. They’re the counterbalance to stocks. They’re like an umbrella—you need them in a storm. The problem is that you can’t buy the umbrella once the storm hits.