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Markets Face Key Test Ahead of Fed Decision: Stocks to Watch

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The major U.S. market indexes remain in the midst of a summer pullback, as stocks now turn their focus to the month of August. This week is a very busy one in terms of corporate earnings, particularly on the tech front with four of the “Mag 7” members reporting earnings results.

Investors are taking notice of a broader market that has altered its course in recent weeks. Tech is taking a backseat lately, pulling the major averages lower while other pockets of the market flourish amid a stronger-than-expected economic backdrop.

Late last week, we received an advance estimate of Q2 GDP which showed the U.S. economy grew at an annualized pace of 2.8%, well above the 2% growth expected by economists. A second reading is scheduled for late August.

Eyes are now shifting to Wednesday’s interest rate decision from the Fed. And as the central bank nears its first interest rate cut of the cycle, rate-sensitive areas of the market are showing renewed strength.

Cooling Inflation Trend Continues

Last Friday’s release of the Personal Consumption Expenditures (PCE) index from June showed prices rose 2.5% year-over-year, matching economists’ projections. The index climbed 0.1% on the month, also in line with estimates.

The “core” PCE, which is the Fed’s preferred inflation gauge and strips out the costs of food and energy, rose 2.6% over the prior year. While the figure came in slightly above the median estimate of 2.5%, the print still marked the slowest annual increase in more than three years. The ongoing disinflation adds credence to the notion of upcoming interest rate cuts.

Fed Chair Jerome Powell has switched his tune in recent weeks, hinting that the central bank is likely to cut rates in the near future. In remarks made as part of a discussion at the Economic Club of Washington, D.C., Powell said that while he is waiting for more confirmation that inflation will reach the Fed’s 2% target, he won’t delay cuts for that specific level.

“If you wait until inflation gets all the way down to 2%, you’ve probably waited too long, because the tightening that you’re doing – or the level of tightness that you have – is still having effects which will probably drive inflation below 2%,” Powell stated.

The Federal Open Market Committee (FOMC) will announce its rate decision tomorrow afternoon following the culmination of its two-day policy meeting. Market participants are currently pricing in just a 5% chance of a cut on Wednesday. However, odds of a rate cut have jumped to 100% at the September meeting.

D.R. Horton, PulteGroup Lead Homebuilder Breakout

Interest-rate sensitive homebuilders surged in July amid low existing housing inventory and a declining rate outlook. The Zacks Building Products – Homebuilder industry is up over 20% during the past month, widely outperforming the broader market:

Zacks Investment Research
Image Source: Zacks Investment Research

This industry is currently ranked in the top 14% out of approximately 250 industry groups. Because it is ranked in the top half of all Zacks Ranked Industries, we expect this group to outperform over the next 3 to 6 months.

Quantitative research studies suggest about half of a stock’s future price appreciation is due to its industry grouping. In fact, the top 50% of Zacks Ranked Industries outperforms the bottom 50% by a factor of more than 2 to 1. By targeting stocks contained within leading industry groups, we can dramatically improve our odds of success.

A deeper analysis of the Zacks Building Products – Homebuilder industry shows that despite their impressive move, stocks in this group remain relatively undervalued amid favorable earnings trends:

Zacks Investment Research
Image Source: Zacks Investment Research

A stock included in this group and one of the nation’s leading homebuilders, D.R. Horton (DHI - Free Report) has led the charge during the recent rally. The stock is currently a Zacks Rank #2 (Buy) and has broken out to a new all-time high on the heels of its latest earnings results.

Earlier in July, D.R. Horton reported fiscal third-quarter earnings of $4.10/share, marking a 7.9% surprise and a 5% jump versus the year-ago figure. Total revenues for the quarter came in at $10 billion, a 2% increase from the prior year.

DHI shares have rewarded investors this year with a nearly 18% return:

StockCharts
Image Source: StockCharts

Another established homebuilder that has demonstrated an ability to outperform is PulteGroup (PHM - Free Report) . Offering a variety of home designs including single-family detached, townhouses, condominiums, and duplexes, PulteGroup is also a Zacks Rank #2 (Buy) stock.

Just last week, the homebuilder reported second-quarter earnings of $3.58/share, reflecting an 11.5% surprise over consensus estimates and a 19.3% surge relative to the same quarter last year. Total revenues of $4.6 billion improved 9.8% from the year-ago period. 

PHM stock has risen nearly 30% year-to-date:

StockCharts
Image Source: StockCharts

Final Thoughts 

In terms of new portfolio additions, investors remain selective in this environment. It’s a good idea to target stocks that are just breaking out of proper bases while diversifying into a variety of leading industries.

Other pockets of the market outside of tech are showing strength as the rally broadens out. Make sure you’re taking advantage of all that Zacks has to offer to uncover leading stocks like the aforementioned homebuilders.


See More Zacks Research for These Tickers


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PulteGroup, Inc. (PHM) - free report >>

D.R. Horton, Inc. (DHI) - free report >>

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