(01/27/14) Fidelity Fund Favorites for 2014

Over the past year, stock prices have risen much faster than earnings, so the P/E ratio of the S&P 500 has risen from 14.2 to 18.1 over the past year; this suggests that further P/E expansion is likely to be harder to come by this year, cautions John Boyd, editor of Fidelity Monitor & Insight.

This means that corporate earnings growth will likely be the bigger determining factor in what stocks return. And, with corporate profit margins at, or very near, all-time highs, the prospect of even fatter margins boosting earnings is unlikely.

So, sales growth will be the likely driver of earnings and that, in turn, depends on the strength of the economy.

From a price versus earnings growth perspective, large-cap growth stocks offer the best value, while mid- and small growth stocks are not far behind.

Value stocks, as a whole, are less attractively priced. Among industry sectors, consumer discretionary and technology offer the best combination of growth expectations and price.

Some of our favorite growth funds to play these areas include Fidelity Capital Appreciation (US:FDCAX), which has over 34% in consumer discretionary stocks, along with Fidelity Blue Chip Growth (US:FBGRX), Fidelity Small Cap Growth (US:FCPGX), and Fidelity Trend (US:FTRNX), all of which have over 45% in those two sectors.

For a more conservative approach to growth, Fidelity Contrafund (US:FCNTX), Fidelity Growth & Income (US:FGRIX), and Fidelity Mega Cap Stock (US:FGRTX) fit the bill nicely.

We don't look for gains like last year, but returns in the high single-digits seems a reasonable view. If there is a surprise though, we think it will be that the economy grows faster than most assume. If that is the case, stocks could deliver surprisingly strong gains again.

We remain wary about the outlook for bond funds, based on our view that the economy will continue to get healthier with growth accelerating this year.

This will put upward pressure on longer term interest rates. In announcing its decision to taper, the Fed also pledged to keep short-term rates low until “well after” the unemployment rate falls to 6.5%, which should mean, at least, all of 2014.

Therefore, we favor bonds of shorter duration, such as Fidelity Short-Term Bond (US:FSHBX), and those that take on credit risk, such as the high yield fund Fidelity Capital & Income (US:FAGIX).

While the yield advantage offered by high yield funds over investment-grade funds has narrowed, the default rates on high yield have fallen as well. Fidelity Total Bond (US:FTBFX), which has about 15% in high yield, is a less risky option.