BMY Bristol Myers Squibb Co

By Akane Otani 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (November 19, 2018).

Many on Wall Street are weathering the autumn technology rout by buying the shares of firms with slower, steadier earnings growth, the latest sign that investors largely remain sanguine about U.S. stocks despite recent reversals.

Trading has turned rocky since the S&P 500 finished the third quarter with its biggest gain since 2013. The broad index is down 6.1% since the end of September, while once-favored shares like Netflix Inc. and Amazon.com Inc. have shed more than 20% apiece.

Nine years into the U.S. stock rally, investors are grappling with two forces. Many feel the best days of this economic cycle are past, especially with windfalls from 2017's tax overhaul set to fade. Though few economists foresee a recession soon, analysts and portfolio managers say the fall pullback offers a reminder of the ever-present risk that markets will fall sharply as rising interest rates and slowing growth hit corporate profits.

But a hefty contingent contends there are still significant gains to be had, thanks to the robustness of companies' bottom lines. Third-quarter earnings at S&P 500 companies have surged 26% from the year-earlier period, according to FactSet, on track for the largest gain since 2010.

While few traders and portfolio managers expect profit growth to continue at anything approaching that clip, many say that buying the shares of firms that are producing solid sales and earnings growth will remain a winning strategy until profits actually begin falling.

"You can't just buy willy-nilly anymore," said Michael Farr, president of investment management firm Farr, Miller & Washington in Washington, D.C. Rather than make bets on U.S. stocks as a whole, Mr. Farr and his team have been scooping up shares of companies whose potential to generate growth looks promising, like Starbucks Corp. and Bristol-Myers Squibb Co., while trimming their holdings of United Parcel Service Inc.

Starbucks delivered double the U.S. sales growth that analysts had expected in the most recent quarter, while Bristol-Myers raised its 2018 profit forecast after getting a boost from sales of drugs like its cancer treatment Opdivo.

Mr. Farr isn't alone. In the third quarter, many hedge funds retreated from shares of social-media firms that rallied sharply over the past year, while picking up shares of businesses including consumer staples firms, coffee chains and established software developers.

Jana Partners LLC bought shares of packaged-food company Conagra Brands Inc. while dumping all of its Facebook Inc. shares, according to its most recent 13F filing. Activist investor Bill Ackman disclosed a long position in Starbucks in October, while Stanley Druckenmiller's Duquesne Family Office LLC dumped nearly a quarter of its Amazon shares and picked up Microsoft Corp. shares.

The jockeying reflects widespread expectations that economic momentum will slow as factors like wage growth, rising interest rates and a stronger dollar take more of a toll on profits, analysts and investors say.

Earnings growth is expected to slow to 14% in the fourth quarter before tapering off in the single-digit range in 2019. And although more than three quarters of S&P 500 companies have posted stronger-than-expected earnings, sales results have been less impressive, with just 59% of firms beating analysts' estimates, according to RBC Capital Markets.

That puts a premium on firms whose earnings are perceived to be likely to hold up better as the economy slows. Oil giants Exxon Mobil Corp. and Chevron Corp. each reported their best third-quarter earnings in four years, thanks to a recovery in crude prices earlier in 2018.

When Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, traveled around the U.S. to meet with clients, she heard the phrase "late cycle" in many of her conversations. It is a sign, she said, many investors can't help but feel the end of the economic expansion is drawing closer, even in the face of solid economic data.

The firm lowered its year-end target for the S&P 500 to 2890 from 3000 in April and cut its rating for technology stocks to "underweight."

There is a silver lining. The S&P 500 has historically struggled in the short term after a peak in earnings growth. But the stock market has managed to produce double-digit percentage gains over the following three years when profit growth peaked and then decelerated -- rather than outright contracting, according to RBC Capital Markets.

"Equity markets are saying to companies that the easy money has already been made," said Nicholas Colas, co-founder of DataTrek Research. "In 2019, they'll have to work for it."

Write to Akane Otani at akane.otani@wsj.com

(END) Dow Jones Newswires

November 19, 2018 02:47 ET (07:47 GMT)

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