In my more than 30 years of investing, one thing has grown clearer each and every year: Wall Street loves to hype stocks. It doesn’t matter what’s under the hood or going on behind the scenes or if even they have real sales and earnings growth. If it’s a good story, it’s going to make headlines.
Wall Street particularly loves to hype technology stocks — and sometimes that works. Case in point, Apple Inc. (NASDAQ:AAPL) has been Wall Street’s darling for years, and it recently reported record iPhone sales, 38% annual earnings growth and 30% annual sales growth. But this is more often the exception, than the rule.
Take the recent Alibaba Group Holding Ltd (NYSE:BABA) initial public offering, for example. Wall Street couldn’t get enough of this Chinese Internet company in the weeks (even months) leading up to its IPO. And guess what? Alibaba recently missed analyst earnings estimates. No surprise here; I pointed out that Vipshop Holdings Ltd – ADR (NYSE:VIPS) was a lot better Chinese Internet investment than Alibaba.
The truth of the matter is that sales and earnings are what drive stock prices long-term. But Wall Street finds earnings and sales growth boring. So, in an environment like the one we’re currently in, where stocks with robust earnings and sales growth are stealing the limelight, Wall Street is at a complete loss.
How can you sell a stock based on just fundamental and technical data?
That is the conundrum that Wall Street is now in. So, take a closer look at why sales and earnings are so important right now and how the current earnings announcement season is revealing a massive shift in market leadership.
If you’ve been paying attention this earnings announcement season, then you know that sales growth has essentially gone “poof” and disappeared. A strong U.S. dollar is squelching the sales of large multi-international companies and squeezing their underlying earnings. And given that about half of the S&P 500‘s sales are from outside of the U.S., any sales momentum in the S&P 500 has been effectively crushed.
In fact, there are 20 stocks that lead the S&P 500 and account for approximately 30% of its total value, and too many of these leaders have missed estimates, issued cautious guidance below analysts’ estimates and/or now have negative forecasted annual sales growth. I’m talking about companies like Caterpillar Inc. (NYSE:CAT), Chevron Corporation (NYSE:CVX), The Coca-Cola Co (NYSE:KO), Goldman Sachs Group Inc (NYSE:GS), McDonald’s Corporation (NYSE:MCD), Pfizer Inc. (NYSE:PFE) and Procter & Gamble Co (NYSE:PG).
With negative sales growth, it is growing increasingly harder for many stocks in the S&P 500 to generate tremendous earnings growth. As a result, many of these companies now have negative forecasted annual earnings growth, too. Naturally, there are exceptions, namely Apple, Gilead Sciences, Inc. (NASDAQ:GILD) and Intel Corporation (NASDAQ:INTC).
But there is clearly a major problem on the sales and earnings front for many large multi-international corporations, and only 15% of the mega-cap stocks are now worth investing in.
So, there is now a “seismic shock” rumbling through the S&P 500 that will have profound consequences for the overall stock market. A massive flight to more domestic stocks with real sales and earnings growth, particularly those in the mid- to small-cap arena, is now underway.
In fact, domestic stocks are dramatically outperforming international stocks:
We saw this exact type of leadership change occur after the mega-cap bubble burst in March 2000. At that time, the tail end of the S&P 500 did much better as did many small- to mid-cap stocks, and this parade out of the previous leaders lasted several years.
In fact, the folks at McGraw Hill, who are the keepers of the S&P 500, were so frustrated by the leadership change that Standard & Poor’s implemented a major realignment called the “free float adjustment.” This significantly reduced the capitalization weighting in the S&P 500 back in 2005.
However, since then, indexing has boomed, and the S&P 500 has gotten top-heavy again. Oops! This is not going to end well.
So, the bottom line: We are now unquestionably in an increasingly narrow stock-picking market, and the “sweet spot” is moving down the capitalization ladder.
Now, there will still be large-cap stocks that buck the trend; more domestic companies with solid earnings and sales growth, as well as a strong history of dividend payments. In fact, with the stock market yielding more than a bank (more on that in a moment), yield hungry investors continue to flock to high dividend stocks.
So, the companies like Pilgrim’s Pride Corporation (NASDAQ:PPC), Tyson Foods, Inc. (NYSE:TSN), Kroger Co (NYSE:KR) and Southwest Airlines Co (NYSE:LUV) will continue to lead the way.
Louis Navellier is the editor of Blue Chip Growth.
