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There are plenty of reasons to be cautious about the stock market in 2020, but companies like these are likely to pay off.
American stock markets keep hitting heady new highs. So why are investors acting as though the sky’s about to fall? Yes, the S&P 500 has eclipsed the vaunted 3,000-point barrier several times over the past year. The same applies to the Dow Jones industrial average, which has regularly breached the 27,000-point level. Those high-water marks have instilled some observers with confidence that the current bull market has a room yet to run. Yet the myriad ups and downs between those highs tell a different story. As of mid-November, the market was up only slightly from peaks it reached way back in January 2018. And volatility has become the new status quo. Through October, there were 37 days this year on which the S&P 500 moved either up or down 1% or more, compared with only eight such days in all of 2017—a sign that many shareholders are antsy to punch their “sell” buttons. This dynamic is fueled by macroeconomic headwinds, including the ongoing trade wars between the world’s two largest economies and signs of a slowdown in global growth. All it takes is a White House Twitter update or an off-the-cuff remark by a Fed governor to send major indexes soaring or sinking. It’s been enough to make some investors retreat from equity markets altogether; in September, AllianceBernstein reported that investors had pulled a record $1.1 trillion out of stocks in the previous 12 months, moving most of that money into bonds and money-market funds. “Broadly speaking, the market has traded flat to modestly up” for almost two years, “and the level of optimism has declined dramatically,” says Andrew Slimmon, managing director and senior portfolio manager at Morgan Stanley Investment Management.
Going into 2020, further uncertainty abounds. A U.S. election of enormous consequence could remake U.S.-China trade relations, the regulatory climate for financial services and health care, and much more of the economic landscape. And it remains to be seen whether the Federal Reserve’s multiple rate cuts in the latter half of 2019 (along with similar accommodation by other central banks) will help sustain the longest economic expansion on record. “Will that be enough to turn around the slowing growth?” asks Saira Malik, head of global equities at Nuveen. “Or are we entering this period where that slow decline will continue until it eventually becomes recessionary?” Faced with that question, most investing pros shy away from the “R” word. None of the two dozen sources who spoke to Fortune for this feature forecast a full-blown economic downturn or recession in the next 12 months. And none said they were seeing the kinds of asset bubbles that preceded the 2007 and 2001 market crashes. Consumer spending—which represents 70% of the nation’s GDP—shows no signs of letting up, especially with unemployment at 50-year lows. Most forecasts have the American economy chugging along at around 2% growth next year. Still, even that modest forecast may be optimistic. There’s growing concern that the current administration’s erratic trade policy and hostility to immigration, combined with a rapidly climbing federal debt load, may constrain growth even further. (For more, see Geoff Colvin’s feature in the December issue.) Combine that with historically high stock valuations and slowing corporate profits, and it’s clear to see why our sources included few stampeding bulls. “Fundamentally, I think people need to expect lower returns going forward,” says Ron Temple, managing director and head of U.S. equities at Lazard Asset Management. “Heading into year 11 of an expansion, earnings growth is more limited.” Others make the case that concern about slowing long-term growth could, ironically, spark faster short-term growth—especially with someone’s reelection campaign underway. Morgan Stanley’s Slimmon says the market could “break to the upside” if, for example, the President were to fast-track a China trade deal. Still, even if investors can’t expect anything much better than so-so from stocks, there will be plenty of opportunities to make money. Some are in sectors that are less vulnerable to a broader slowdown—think tech and consumer goods. Others are in the financial and health care sectors, where investors’ recent skittishness has left many stocks unfairly undervalued. With all that in mind, here are 27 stocks and two ETFs that show signs of promise. Most are poised to do well even if the economy stays sluggish. A few are “bold bets” for those who are feeling more optimistic about the market or the economy—folks ready to put the “brave” in a brave new decade.
Shares of the biggest Big Tech companies—Google, Amazon, Apple, Facebook, and Microsoft—have been on a powerful run over the past decade. But 2019 may be the year they lost their aura of indestructibility. These top performers face growing regulatory scrutiny over privacy concerns, both in the U.S. and Europe, alongside populist calls for breakups from across the political spectrum. “There could be some significant impacts on technology depending on how the election goes or who wins the [Democratic] nomination,” notes Nuveen’s Malik. And trade tensions have threatened some companies’ customer bases and supply chains.
The upshot is that picking winners in this always-potent sector is getting trickier. Case in point: semiconductors. That very cyclical industry is poised for an upswing, with demand boosted by continual innovations in smartphones and the impending rollout of 5G wireless networks. But the geopolitics of U.S.-China relations are making life volatile for some chipmakers. One safer play: Synopsys, whose electronic data automation software is used by semiconductors to design chips—and which doesn’t face tariff challenges. The company maintains customer loyalty with three-year, non-cancelable subscription contracts that help insulate its sales from downturns. And its technology comes with a steep learning curve for engineers, which boosts Synopsys’s renewal rate. That “translate[s] from a financial perspective,” says Lori Keith, who manages the $4.2 billion Parnassus Mid Cap Fund. Synopsys’s next avenue for big growth, says Keith: the increasing chip- and software-dependent automotive sector.
Another promising play: ASML, a Dutch company that produces components for semiconductor makers. James Gautrey, a portfolio manager at $565.5 billion asset management company Schroders, thinks trade jitters will be irrelevant in the long term for the sector in general and for ASML in particular, which he deems a “classic 10-year-plus hold.” ASML is projected to grow revenues by 13% in fiscal 2020, and Gautrey sees much more upside.
The telecommunications and hardware behemoth Cisco has slumped in the market recently, trading at 15 times estimated fiscal 2020 earnings. (The sector average is over 20.) But Cisco’s huge portfolio of products and patents in networking equipment is well-positioned to benefit from the rise of 5G and growing enthusiasm for the Internet of things.
Money managers certainly aren’t abandoning the biggest tech names. Matt Benkendorf, CIO of asset manager Vontobel Quality Growth, says turmoil over data privacy shouldn’t chase investors away from Alphabet, whose regulatory issues, he says, “aren’t nearly as complicated as Facebook’s.” Benkendorf believes the company has been ahead of the field in adapting its business model to give consumers more control over their data, an evolution that should help Alphabet protect its incredibly profitable ad business from regulators. Other investors are excited about the Alphabet’s portfolio of R&D-driven businesses. Gary Robinson, the joint manager of Baillie Gifford’s U.S. Equity Growth Fund, sees autonomous driving as one of “the most impactful” trends in tech; he thinks Alphabet’s exposure to that business through the Waymo self-driving car project is an increasingly compelling reason to own the stock.
With its stock up more than 40% this year, nobody would call Microsoft a hidden gem. (Its leadership tops Fortune’s Businessperson of the Year list.) But analysts still see enormous upside in Microsoft’s Azure cloud platform. James Tierney, CIO of concentrated U.S. growth at AllianceBernstein, believes Azure could grow 40% annually over the next five years. And with returns on Treasury bills expected to stay low, some shareholders, including Randy Watts, chief investment strategist at William O’Neil, an equity research firm, like Microsoft for its dividend, currently 1.4%. “A big liquid stock like that—that can grow its earnings and grow its dividend—we think is very competitive,” says Watts.
Yes, Elon Musk generates an enormous amount of dismaying headline noise. But for investors who can look past it, Catherine Wood, CEO of ARK Invest, a tech-focused investment manager, is betting on “completely misunderstood” Tesla, the darling of short-sellers the world over. Wood believes Tesla’s low battery costs, self-designed A.I. chips, and the data it has collected from 10 billion to 12 billion miles of real-world driving by its customers put the company at a competitive advantage in electric vehicles—which Wood predicts will account for 30% of new car sales by 2023.
Synopsys (SNPS)
ASML (ASML)
Cisco (CSCO)
Alphabet (GOOGL)
Microsoft (MSFT)
Tesla (TSLA)
Toiling as they do in a heavily regulated, slower-growing industry, financial stocks usually trade at a discount to the broader market. These days, that gap looks like a yawning gulf. Financial stocks on the S&P 500 were trading at 12.8 times estimated 2020 earnings at the start of November, compared with an average of 18 for the index as a whole.
Such underwhelming metrics make sense in many respects. Indeed, analysts expect the sector’s earnings to decline next year. The Fed’s pivot back to low-rate mode hinders banks’ ability to earn net interest income—the difference between what they pay for deposits and what they earn through lending. Investment-banking-focused firms like Goldman Sachs and Morgan Stanley have taken hits to their bottom lines, as tech-driven innovations have eroded their profit margins in capital markets and trading. (See our feature about Goldman Sachs from the December issue.) And the whole sector tends to fare worse in the event of a downturn. “Banks look really cheap, but they have more headwinds,” says Olivia Engel, CIO of active quantitative equity at State Street Global Advisors.
To which some investors say: Sail into the headwinds. “The markets are discounting [banks] too much around the risk of a recession,” says Nathan Thooft, head of global asset allocation at Manulife Investment Management. “As long as the economy isn’t going into a recession and you have decent credit growth, banks will have benefits.”
Right now, those benefits seem more likely to flow from consumer-facing companies than from Wall Street dealmakers. Bank of America has delivered solid earnings growth under longtime CEO Brian Moynihan, who has grown revenues while keeping expenses in check. BofA has spent tens of billions of dollars to develop and update its technological infrastructure while simultaneously setting out to upgrade thousands of branches and open hundreds of new physical locations.
Other investors have spotted value in regional banks, where differences among local markets mean the top performers’ stocks tend to shine. “You can find a lot more daylight between the best and the worst of the regionals,” says Don Townswick, director of equity strategies at Conning, an asset manager serving the insurance industry. Citizens Financial Group, based in Providence, operates thousands of branches and ATMs in 11 states, mostly in the Northeast, where a strong economy is expected to fuel steady growth. But its shares trade at less than 10 times estimated earnings for fiscal 2020.
More tricky is the realm of investment management, where intense competition has triggered a race to the bottom as providers slash fees and commissions. Charles Schwab shareholders have ridden a roller coaster in 2019—its shares are down nearly 11% in the past 12 months, even though Schwab has delivered double-digit growth in revenue and earnings. AllianceBernstein’s Tierney thinks that’s a buying opportunity. “We view them as the Amazon of the financial world,” he says. “Their cost of service to clients is lower than anyone out there.” That should enable Schwab to digest its move to commission-free equity trades more easily than many of its competitors.
With enterprises of all kinds grappling with the rapidly evolving realm of digital payments, no company is better equipped to serve them than PayPal. PayPal is accepted by more than three-fourths of the top 500 U.S. Internet retailers and has an enviable position in mobile money transfers via its Venmo platform. The company trades like a tech stock, at 29 times estimated earnings for fiscal 2020. But analysts project that PayPal’s revenue will grow 17% next year, justifying that valuation.
Times have been tough for San Francisco–based banking giant Wells Fargo as it struggles to heal from the self-inflicted wounds of a fake-accounts scandal and aggressive sales tactics. Still, the bank is profiting from a sprawling portfolio of consumer-facing services, including mortgages, auto loans, and credit cards. And with the well-regarded Charles Scharf, the former CEO of BNY Mellon, recently installed as chief executive, investors think Wells Fargo could finally turn the page on its past. While its shares are trading near a 52-week high, they’re still priced below the average for the sector.
Bank of America (BAC)
Citizens Financial Group (CFG)
Charles Schwab (SCHW)
PayPal (PYPL)
Wells Fargo (WFC)
Matt Benkendorf of Vontobel has a message for investors: “This isn’t rocket science—the health care space will be in the spotlight” for the 2020 election. Concerns over policy (is Medicare for All to be or not to be?) and drug prices (candidates as far apart as Bernie Sanders and Donald Trump promise to curb them) loom large in investors’ minds. The rhetorical heat helps explain why the S&P health care sector has risen only about 9% in the past 12 months, lagging far behind the broader market.
But it doesn’t take a brain surgeon to recognize other factors in the sector’s favor. Aging populations in the developed world and growing affluence in emerging markets are generating enormous demand that’s insulated from political winds. (One member of Fortune’s Investor Roundtable called health care stocks “the fattest pitch that exists” right now; see this feature for more.) The upshot is that the sector is full of companies that are reasonably priced and unlikely to suffer at the hands of any President.
Eric Schoenstein, a managing director, and portfolio manager at Jensen Investment Management, likes Becton Dickinson, a medical device company that makes low-cost but essential products like needles and syringes. Parnassus’s Keith sees huge potential in med-tech play Hologic for its 3D mammography devices and other preventive-care equipment, which generate strong recurring revenue. “Its products are going to be relevant and needed, regardless of what the backdrop is with the insurance situation,” she says.
Health care spending on animals is growing just as quickly as spending on people. AllianceBernstein’s Tierney favors Zoetis, a company spun off from pharma giant Pfizer. He believes the company, which makes medicines for pets and livestock, is “innovating with products more than their peers are.”
In the human drug space, Nuveen’s Malik likes pharmaceutical staple Merck for its mid-to-high-single-digit revenue growth and solid drug pipeline, which includes emerging drugs to treat HIV and pneumococcal disease. Malik estimates that Merck’s Keytruda used to treat certain cancers, could be the top-selling drug in the world in five years, contributing $22 billion in revenues in 2024, helping drive margin expansion for years to come.
Health insurers are taking the most fire in America’s political skirmishes. But Benkendorf believes that “election uncertainty will give investors a chance at a bite of the apple” at companies that are trading more cheaply than they otherwise would. At 17 times earnings, Benkendorf likes UnitedHealth Group. He doesn’t think policy changes will disrupt the insurer anytime soon, and he praises UnitedHealth as an innovator in using data and technology to “better manage health care costs and drive better outcomes” for customers.
As Slimmon of Morgan Stanley puts it, “You’re gonna make a lot more money on the insurance companies than the [medical] devices” if health care spending accelerates next year. That’s because insurers’ stocks have already taken a far bigger hit owing to fears over the possibility of Medicare for All. Few have fallen as far as Cigna, whose share price is down 15% in the past 12 months. But the Connecticut insurer’s recent $67 billion acquisition of Express Scripts—one of the largest pharmacy benefits managers in the U.S.—has already boosted revenues and made Cigna a stronger competitor against UnitedHealth and Aetna. Assuming private insurance doesn’t go the way of the passenger pigeon, the company is a bargain.
Becton Dickinson (BDX)
Hologic (HOLX)
Zoetis (ZTS)
Merck (MRK)
UnitedHealth Group (UNH)
Cigna (CI)
The slowdown in manufacturing has been the rock dragging down U.S. economic expansion this year. The influential PMI index, for example, which measures activity among purchasing managers, dipped in September to its lowest levels since 2009. But American consumer spending is far less tied to manufacturing strength than it was in decades past—and it keeps plugging along. Nuveen’s Malik and others think the consumer will continue to buoy global growth in 2020, based on strong indicators like low unemployment, rising wages, and savings rates. But just in case economic growth cools off further, some investors are reorienting their strategies for profiting from that spending—looking at the kinds of companies that stay strong even when consumers begin pinching pennies.
In a downturn, consumers often show a “trade-down effect,” explains Parnassus’s Lori Keith. “Customers that may be shopping at Macy’s today trade down to some of the off-price retailers,” Keith suggests. That’s why many investors are eyeing TJX Companies, the parent of T.J. Maxx and Marshalls, among other discount stores. Schoenstein of Jensen Investment Management calls TJX “resilient economically,” with competitive prices and aspects of treasure hunting in-store that make it more immune not only to downturns but also to competition from e-commerce.
Schoenstein also likes General Mills, the food and cereal colossus that makes Cheerios and Lucky Charms. With “good products, strong market positions, [and] historically strong cash flow generation,” the stock is underappreciated, Schoenstein says, trading at 17 times earnings. And General Mills’ recent acquisition of pet food company Blue Buffalo opens the retailer up to a broader market of big consumer spending on four-legged friends.
Keith is also a fan of Clorox, a company whose namesake bleaches belie the breadth of its portfolio in consumer staples. Clorox can consistently exert pricing power for premium brands like Burt’s Bees and Hidden Valley. Innovation in new products contributes about three percentage points on average to the company’s annual sales growth, Keith says, and strong brand awareness and high market share make Clorox especially competitive.
Watts, the strategist at William O’Neil, singles out Home Depot for its above-average dividend yield (currently 2.3%) and strong revenue growth. The home-improvement retailer is seeing consistent demand from an older, affluent demographic for DIY products—a trend many investors believe would be resistant to any downturn. Watts notes that Home Depot has grown its dividend over the past five years and has posted revenue growth of almost 6% in the past 12 months.
Another big-box retailer, Target, has continued to prove it can thrive in an e-commerce universe. Target is poised to grow revenue next fiscal year by 3%—a small change in some industries but a healthy jump for a retailer.
Even if U.S. growth were to slow down, it wouldn’t keep the fast-growing affluent demographic in countries like China, Brazil, and Indonesia from spending on luxuries. Schroders’s Gautrey sees an upside in British retailer and “turnaround story” Burberry. The brand, known for high-end trench coats and myriad accessories, has a new designer in place who could spark sales with new products. It’s also one of the cheaper luxury consumer stocks out there. Gautrey says he wouldn’t be surprised if Burberry saw a bump of 50% or more in share price: “If things go well, it could be there within 12 months.”
TJX Companies (TJX)
General Mills (GIS)
Clorox (CLX)
Home Depot (HD)
Target (TGT)
Burberry (BURBY)
Between trade tensions in Asia and near-recessionary conditions in Europe that have hurt companies that export their goods there, international equities have had a tough run. After two years of underperforming American stocks, the MSCI Emerging Markets Index was trading at 13.5 times earnings at the end of October, compared with the S&P 500’s multiple of 22.3.
But one would be wise to remember that such dynamics “come in cycles,” says Jed Weiss, who manages Fidelity Investments’ International Growth Fund. “Twelve years ago, when I started running the growth fund, international stocks had beat the pants off U.S. stocks,” Weiss notes. Nowadays, he adds, “if you can block out the scary headlines and just focus on the underlying stock ideas, there’s a lot of value to be had.”
Among those investment ideas: buying shares in financial-services companies that are capitalizing on demographic shifts within emerging markets. With more people in countries like China, Thailand, and Malaysia entering the middle class, multinational insurers like Hong Kong-based AIA Group are in a position to take advantage. In these and other markets, “citizens don’t benefit from the same kind of social safety net we have in the U.S. and Europe,” Weiss says. AIA, which has seen its stock rally more than 30% in the past 12 months, has been in the market for decades and benefits from brand recognition and a strong track record.
Banks, too, are taking advantage of favorable demographics in emerging markets. India’s largest private sector bank, HDFC Bank, has made major strides in a domestic market still dominated by publicly backed financial institutions. With an array of consumer and commercial offerings including checking and savings accounts, mortgages, car loans, credit cards, and personal and business loans, HDFC is well positioned in a country with a massive population that is still largely underbanked. “They’ve been able to eat market share because they have a lower-cost business model and are not bloated with too many branches and employees,” Vontobel’s Benkendorf says of HDFC. “India itself is a great country to invest in; you have very good demographics and a good accounting and legal structure. It’s a very good long-term growth story at large.”
Alibaba Group continues to have one of the more impressive growth stories in global business. Despite China’s economy showing signs of weakness, the world’s largest retailer continues to deliver exceptional results, with revenues swelling 43% over the past year and forecast to continue that impressive trajectory. Alibaba’s Ant Financial affiliate, which operates Alipay, gives the company massive exposure to the rapidly growing mobile payments space.
For those apprehensive about picking out individual stocks in faraway markets, there are always foreign-targeted exchange-traded funds to look to. The iShares Core MSCI Total International Stock (IXUS) and Vanguard FTSE All-World Ex-U.S. (VEU) ETFs are presently research firm Morningstar’s top-rated funds focused on international equities. Each fund tracks underlying indexes across both developed and emerging markets, according to Morningstar analyst Daniel Sotiroff, and both are “market-cap weighted” to emphasize larger companies, which tend to be less volatile. What’s more, their fees are “probably some of the lowest you’re going to see,” Sotiroff notes, with each charging annual expenses of 0.09% of assets, or $9 per $10,000 invested. “They’re two of the better-performing funds out there, and [low fees are] a big part of it.”
In Japan, sweeping changes to corporate governance standards in recent years have led to improved returns. “Japan is probably the place where we see the most mispriced opportunities among developed markets,” says Katie Koch, cohead of fundamental equity at Goldman Sachs Asset Management. Nidec provides exposure to Japan’s market in a forward-thinking sector: electric motors and related components that could be critical to the electric-car fleet of the future. While Nidec’s recent financial results have underwhelmed, its forward-looking metrics are promising. Revenues and earnings per share are estimated to grow 14% and 44%, respectively, in the fiscal year ending in March 2021. And those figures could accelerate as the EV market grows.
AIA Group (AAGIY)
HDFC Bank (HDB)
Alibaba Group (BABA)
iShares Core MSCI Total International Stock (IXUS)
Vanguard FTSE All-World Ex-U.S. (VEU)
Nidec (NJDCY)
A year ago, our investment team believed that rising interest rates and grim trade tensions would be a drag on the stock market. We predicted that when it came to earning steady returns, the best offense would be a good defense. As it turned out, U.S. stocks did just fine—and senior writer Jen Wieczner’s “Safety Meets Strength” portfolio did even better. Over 12 months, her 30 stock picks averaged returns of 20.2%, including dividends, compared with 14.4% for the S&P 500. An interesting footnote: Seven of our nine non-U.S. picks beat the S&P, even as global stocks in general lagged American ones. Here, a roundup of our hits and misses.
Some of our best-performing picks were in Asia, where fast-growing middle-class populations drove big gains for Meituan Dianping (the “Grubhub of China”) and Hong Kong casino operator Melco Resorts & Entertainment. And while tariff battles hurt some semiconductor makers, our picks Taiwan Semiconductor and U.S.-based Texas Instruments returned 48% and 30%, respectively.
U.S. tech giants have generated a huge share of the past decade’s stock gains, and 2019 kept that trend alive. We got market-beating returns from Facebook, Alphabet, and Amazon—but we have doubts that the party will last much longer.
We foresaw that a volatile year would mean more business for brokerages and traders; we didn’t realize how much technology changes and competition would hurt their profits. Shares in TD Ameritrade fell 25% as a zero-commissions battle eroded earnings across the brokerage industry. Options- and futures-trading giants CME Group and CBOE were also laggards.
In a year when healthcare stocks in general underperformed, we reaped big returns on two innovators whose products won approval from the FDA: Exact Sciences, which makes noninvasive colorectal screening tests, and Vertex Pharmaceuticals, which develops therapies for cystic fibrosis.
A version of this article appears in the November 2019 issue of Fortune as part of the 2020 Investor’s Guide with the headline “Stocks and Funds.”