The euphoria surrounding the new tax legislation is pushing Wall Street to new heights this year. After hitting 2,700 on the second trading session of the New Year, the S&P 500 breached another milestone of 2,800, for the first time.
Moreover, the Dow Jones also crossed the 26,000 mark, easily setting the record for the fastest 1,000-point rise in its history after topping 25,000 on Jan 4.
The massive $1.5-trillion tax cuts will create an economic surge both domestic and international, boosting job growth and earnings of corporates. Additionally, jump in oil prices, a weak dollar and rounds of upbeat economic data added to the strength. Manufacturing activity, as measured by the Institute for Supply Management, climbed to the second-highest reading in six years while construction spending hit record highs in November with broad-based gains in both private and public outlays. Meanwhile, retail sales rose for the fourth consecutive month in December, capping the strongest year of sales growth since 2014.
The market is anticipating that companies will come up with big gains in earnings and increased estimates for this year driven by tax cut savings. The Q4 earnings season is off to a strong start, with earnings of 26 S&P 500 companies that have reported results, up 13.6% from the same period last year on 9.1% higher revenues, with 73.1% beating EPS estimates and 80.8% beating revenue estimates. Overall, total earnings and revenues are projected to grow 9.2% and 7%, respectively.
However, the rally fizzled out later in yesterday’s trading session on concerns over the possible government shutdown. This represents the second drop so far this year. Congress needs to pass a spending bill by the end of Jan 19 to avoid a government shutdown. This pullback could be just a pause in the rally as traders took the chance to book some profits after a record run.
Given the bullish fundamentals, the dips might charge up investors to snap up stocks and ETFs on the cheap for outsized gains in the coming weeks.
How to Find Bargain ETFs?
Using our database, first we have selected ETFs with a Zacks Rank #1 (Strong Buy) or 2 (Buy). This is because these ranks suggest strengthening fundamentals and superior weighting methodologies that could allow them to lead higher than their cousins in a booming market. Then, we narrowed down the list to funds having lower P/E ratio than 20.57 for the broad market fund (SPY).
Here are the five ETFs that are currently undervalued and could generate solid returns in a rising stock market.
Financial Select Sector SPDR Fund (NYSEARCA:XLF) – P/E Ratio: 15.01
With AUM of $33.7 billion, this is the ultra-popular ETF targeting the broad financial segment and follows the Financial Select Sector Index. It holds 67 stocks in its basket, with double-digit allocation to the top two firms Berkshire Hathaway Inc. (NYSE:BRK.B) and JPMorgan Chase & Co. (NYSE:JPM). The ETF charges 14 bps in annual fees and has a Zacks ETF Rank #2.
SPDR S&P Homebuilders ETF (NYSEARCA:XHB) – P/E Ratio: 15.26
The most popular choice in the homebuilding space, XHB, follows the S&P Homebuilders Select Industry Index. The fund holds about 35 securities in its basket, with none accounting for more than 5% of assets. It has AUM of $1.2 billion and expense ratio of 0.35%. The fund has a Zacks ETF Rank #2.
First Trust Consumer Discretionary AlphaDEX Fund (NYSEARCA:FXD) – P/E Ratio: 15.53
This ETF offers exposure to the consumer discretionary sector, holding well-diversified 116 stocks in its basket. It follows an AlphaDEX methodology and ranks stocks in the space by various growth and value factors, eliminating the bottom-ranked 25%. The fund has amassed $544.8 million in its asset base and charges little higher 63 bps in annual fees. It has a Zacks ETF Rank #2.
SPDR S&P Biotech ETF (NYSEARCA:XBI) – P/E Ratio: 16.41
This fund provides exposure to 109 biotechnology firms by tracking the S&P Biotechnology Select Industry Index. None of the securities holds more than 1.76% share. XBI is extremely liquid and an easily traded fund with AUM of $4.8 billion and charges 35 bps in fees per year for the exposure. It has a Zacks ETF Rank #2.
PowerShares Dynamic Market Portfolio (NYSEARCA:PWC) – P/E Ratio: 17.12
This ETF follows the Dynamic Market Intellidex Index, which measures the performance of companies with superior risk-return profiles. Holding 98 stocks in its basket, it is well spread across components with none accounting for more than 3.5% of assets. It has amassed $159.7 million in its asset base and charges 60 bps in annual fees. The fund carries a Zacks ETF Rank #2.
How to Find Bargain Stocks?
For this, we have used our Zacks stock screener and have selected stocks with a Zacks Rank #1 or 2 and a VGM Style Score of B or better. A top rank suggests rising earnings estimates, which indicate an optimistic view on earnings by analysts and hence higher chances of outperformance. Then we looked for stocks having a low P/E than the S&P 500 index (20.49), a double-digit estimated earnings growth rate for this year and a solid Industry Rank in the top 40%.
Finally, we arrive at the five stocks that are cheap and have the potential to deliver higher returns with lower volatility.
Micron Technology, Inc. (NASDAQ:MU) – P/E Ratio: 4.36
Based in Boise, ID, Micron Technology is one of the leading worldwide providers of semiconductor memory solutions. The stock has an expected earnings growth rate of 98.19% for the fiscal year (ending August 2018). Micron Technology currently has a Zacks Rank #1 and a top VGM Score of A. It also boasts a solid Zacks Industry Rank in the top 1%.
Prudential Financial Inc (NYSE:PRU) – P/E Ratio: 10.35
Based on Newark, NJ, Prudential Financial provides insurance, investment management, and other financial products and services in the United States and internationally. It has an expected earnings growth of 14.33% for this year and a Zacks Industry Rank in the top 26%. The stock carries a Zacks Rank #2 and has a VGM Score of B.
Morgan Stanley (NYSE:MS) – P/E Ratio: 13.03
Based in New York, Morgan Stanley is a preeminent global financial services firm that maintains leading market positions in each of its three primary businesses: securities; asset management; and credit services. The company’s earnings are expected to grow 18.21% this year. The stock has a Zacks Rank #2 and a VGM Score of B. It flaunts a solid Industry Rank in the top 9%.
D.R. Horton Inc (NYSE:DHI) – P/E Ratio: 14.88
Based in Arlington, TX, D.R. Horton is engaged in the construction and sale of high-quality homes through its diverse brand portfolio that includes D.R. Horton, Emerald Homes, Express Homes and Freedom Homes. The stock has an expected earnings growth of 27.37% for the fiscal year (ending September 2018). It has Zacks Rank #1 and a VGM Score of A. It belongs to the Industry having a Rank in the top 6%.
Cigna Corporation (NYSE:CI) – P/E Ratio: 17.97
Based in Bloomfield, CT, Cigna is a health services organization that provides insurance and related products and services in the United States and internationally. Its earnings are expected to grow 14.85% for this year. The stock has a Zacks Rank #2 and a VGM Score of A and falls in in the Industry having a Rank in the top 26%.
Bottom Line on ETF and Stocks Sale
Amid peak stock market trading, investors are seeking to invest in lower valuation stocks, which have lots of upside potential in the coming days. The above-mentioned products look like compelling choices as these look undervalued than the overall market at the current levels and have a good brand name.
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