By: Dividend Sensei
In my last article I explained why strong economic/corporate earnings fundamentals combined with market history mean that stocks might be ready to rally up to 20% from Q4 2018 through the end of 2019. That means that long-term investors should remain in the market to profit from what might be a strong rally.
But what if you are looking to maximize your returns over time and have new money to invest? Should you just put the cash in a low cost S&P 500 index ETF like the Vanguard S&P 500 ETF (VOO)? Well that’s one easy and low cost way to do it. However if you consider the reasons for the potential coming rally then history indicates there are three sectors in particular that might do exceptionally well.
The Top 3 Sectors For Our Current Economic/Interest Rate Conditions
BlackRock, the world’s largest asset manager, has done extensive research on what types of stocks do best in various economic/interest rate environments. The company concludes that during a strong economy, when interest rates are rising, but the yield curve (10 year Treasury yield minus 2 year Treasury yield) is flat or falling, technology, energy, and REITs do best.
This makes intuitive sense if you consider what interest rates are telling us right now. For example if the bond market believes that the US economy is likely to grow strongly over the long-term then rising inflation expectations will cause long-term rates (10 year yield) to rise.
However short-term rates, which are influenced by the Federal Reserve’s fed funds rate (scheduled to rise 1.75% more through 2020), also matter. That’s because financial institutions borrow at short-term rates to lend at a profit at higher long-term rates. This is why the yield curve is important. If short-term rates rise too quickly and faster than long-term rates then the yield curve (lending profitability) falls and financial companies (such as banks and credit card companies) earn less on new loans. That can result in less lending to consumers. And since consumer spending makes up 70% of the US economy, this can lead to a recession. Since 2014 the yield curve has been flattening but recently faster rising long-term rates have halted the decline. However unless the curve actually starts rising over time the flattening trend will remain in effect.
So given our current economic/interest rate environment (rising rates, falling/flat yield curve), those three sectors are the ones that are most likely to outperform the broader market, even in a strong general rally.
So what should investors do with that information? Just buy sector based ETFs? Well that’s one solution but here are my top three fast growing stocks, gleaned from my master watchlist, that are potentially set to do better than their broader sectors. Each of these stocks is undervalued, growing quickly, and benefits from one or more long-term economic megatrends that should help drive strong dividend growth and market beating returns over not just the next few years, but at least a decade. Each one is also a stock that I own already or plan to buy in the coming weeks.