Investors are still shell-shocked from the worst October since 2008 and the pain may be far from over.
Economists are lowering estimates for next year and corporate earnings are expected to grow just 9% in 2019 against a breakneck 20% growth this year, according to FactSet Research.
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Take any analogy you like -- that the ballgame is in the 7th inning or the punch bowl may soon be taken from the party -- the fact is that investors need to start thinking about the next downturn.
Even if a recession doesn’t end the historic bull market, next year and into 2020 is likely to be marked by declining economic growth and disappointing earnings. In this kind of environment, investors should consider innovative companies that can grow irrespective of the broader economy.
The Bull Is Being Put Out To Pasture
Bull markets don’t die of old age but they can certainly slow from the raging days of double-digit gains.
Members of the Federal Reserve have recently signaled a more dovish call on rates but are still expected to raise the benchmark rate in December and at least twice next year. That would mark 11 rate increases since tightening began in 2015 and could put Fed Funds above the neutral rate at which it starts weighing on growth.
Even if the Fed slows its hikes here in the U.S., central bankers in Europe and Japan have signaled an end to accommodative policies. Higher rates will mean that debt, fueled corporate share buybacks, will become more expensive and those heavy debt loads could start limiting earnings growth. Corporate earnings also won’t be seeing the boost from tax reform over the next year and beyond.
As if higher rates and a general global slowdown were not enough, there’s also the trade war to worry about.
If the U.S. and China are able to find some kind of détente ahead of the January escalation, there could still be lingering fears and effects of prior moves. Chinese buyers of U.S. agricultural products have shifted to other markets, notably Brazil, and it might take a while for them to come back to U.S. producers.
Taken together, it isn’t difficult to see why most analysts are expecting a sharp decline in corporate earnings growth next year. While it’s come down a little, the S&P 500 still trades for a lofty 21 times trailing earnings on investor sentiment that could be disappointed in 2019 growth.
Look To Booming Industries For Stocks That Can Keep Growing
In this kind of environment, investors need to look to industries benefiting from longer-term secular growth that won’t fall in a cyclical slowdown. Healthcare and Digital Security are two potential candidates enjoying tailwinds from demographics and the rise of the digital economy.
Positioning in innovative companies within these industries can help protect and grow your portfolio even if a recession hits in the next few years.
Palo Alto Networks (NYSE: PANW) reported a 27% year-over-year increase in customers to 54,000 in fiscal 2018 and a 29% increase in total revenue. Subscription and support services make up 62% of revenue and grew at 48% from the prior year.
A fraction of the size of the larger competitors in cybersecurity, Palo Alto Networks has carved itself out a niche leadership in the network security and equipment space. The company controls a 16% share of the enterprise firewall market, according to Garner, and should continue to benefit on solid industry growth.
The company is expanding into application framework security which could add another $5 billion to its total addressable market by 2020. That’s in addition to organic growth of 8% annually in its existing markets to $24 billion.
Shares trade for a pricey 39 times trailing earnings though EPS is expected to climb 21% over the next four quarters on similar revenue growth.
BioMarin Pharmaceuticals (Nasdaq: BMRN) is an innovator in the orphan drug space for rare life-threatening diseases which gives it extended patent protection on products. Further, the cost of development for these drugs is much higher than others which means competition is fairly low even after patent protection is lost.
The company’s first blockbuster drug, Naglazyme, released in 2005, still has three years on patent protection and has been followed by two other products booking $450 million a year each. Total sales have tripled over the last five years and the company has three products in late-stage development.
High R&D spending and marketing on newer drugs has kept the company in the red with a loss of $0.70 per share over the last four quarters. The loss is expected to more than halve over the next year to $0.32 per share and the company could be profitable by the third quarter 2019.
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IQVIA Holdings (NYSE: IQV) is a leader in healthcare data & analytics and late-stage drug research. The data & analytics business compiles from more than 100,000 sources with access to half a million patient records. This gives it a competitive advantage in its contract R&D division which more than doubles the annual sales of the next largest competitor.
The company reported 9% year-over-year revenue growth in its fiscal second quarter with 14% growth in the Technology & Analytics segment. A contract backlog of $15.7 billion for R&D Solutions alone is worth more than 150% annual revenue for the entire company.
Shares trade for 22.7 times earnings, which are expected to grow 10% over the next year on 7% sales growth.
Risks To Consider: Weaker economic growth and corporate earnings will weigh on broader sentiment and could limit the upside even on high-growth companies.
Action To Take: Position in companies that can grow even in a low-growth economic environment as the U.S. sees economic headwinds over the next year.