Markets shift according to a straightforward selection process; as money becomes interested in better instruments or investments, money as a whole begins to rotate into different areas of the economy. As the yardstick changes, money changes its preferences as well; here is where the yardstick is today.
Well, first of, investors - including yourself - like to have the highest possible return while taking on the least amount of risk possible. Across the industry, United States government bonds are the closest thing to that definition. Today's ten-year treasury offers buyers a 3.8% annual yield at virtually zero risk, so this is now the yardstick to beat for the next best thing.
Because this yardstick is about to change in 2024, as the FED has been proposing rate cuts sometime this year, a lot of stocks are about to receive the right end of the coming money shift. Stocks like PepsiCo (NASDAQ: PEP) could be prime targets for reasons that will become clear in just a second, so stick around.
Leveling the playing field
There are two economies today that both the FED and investors need to be aware of. Starting with the ISM Manufacturing PMI index, readings would show that the economy has been in a heavy contraction during the past nine months, driving inflation and employment lower on that side of the economy.
If you are the FED, looking at the data within manufacturing could justify a decision to cut interest rates and start stimulating the economy into growth. However, if you switch to the ISM Services PMI index, the opposite is happening.
The services economy has been pumping out expansionary data for the past year, which is driving inflation and higher employment in that space. This can create a conflicting view in the FED's strategy, so what can you do to level the playing field and get the odds in your favor?
Siding with service-based stocks would mean a continuation trade in this case, where you would benefit from a continued expansion on that side. However, the big money could be made by siding with manufacturing-based stocks like PepsiCo.
If the FED ends up cutting rates as the whole market is expecting, a breakout of the manufacturing economy will trigger a bull run across all of the stocks that are likely to fall into positive contagion. Here is why PepsiCo is one of the prime choices for investors to keep if that happens.
Back a winner
Of course, when people try to pick out certain gems within the Consumer Discretionary Select Sector SPDR Fund (NYSEARCA: XLY), one stock wears the crown among all its peers in the beverage industry. If you thought of Coca-Cola (NYSE: KO), you are right.
So why would investors be more inclined to pick PepsiCo instead? Taking the brand moat and popularity out of the equation, here are the numbers to back the thesis, starting with its annualized dividend yield of 3.1% offered today.
If or when the FED cuts interest rates, the benchmark for risk-free yields (the ten-year bonds) will also lower its yardstick. This would make PepsiCo's yield all the more attractive in comparison; the problem is that Coca-Cola offers the same dividend.
So, the answer anyone is looking for can come down to other competitive metrics between the two industry giants. Starting with what typically drives stock prices, earnings growth expectations can be a good start to better understand what the market likes in the space.
Taking PepsiCo analyst projections, earnings are expected to grow by 7.4% in the next twelve months, an assumption making analysts land on a consensus price target of $186.9 a share for this stock, that is 10.1% higher than today's prices, by the way.
Regarding Coca-Cola, analysts only see a 4.5% growth in earnings, assigning a higher potential upside to PepsiCo in that department. Considering that Coca-Cola is trading at its 52-week high, while PepsiCo sits at a 14% discount, closing this gap becomes an attractive place to be in when the industry rebounds.
If the economy is set to grow more aggressively with lower interest rates, and the yardstick is about to shift, it can be suitable for your portfolio to side with the stocks promising better growth as a share of this bigger trend. Besides, even if the trend takes longer, a 3.1% dividend will still protect you from inflation today!
