I’m a bit of a political junkie, but I was getting as tired of the mess in Washington as everybody else. It’s a relief to talk about what’s actually going on in corporations, the economy and the stock market! In other words, investors are going to finally turn their attention back to fundamentals. And in the past when we’ve been in fundamentally focused markets, our Blue Chip Growth stocks have typically prospered and substantially outperformed the S&P 500.
I look for a repeat performance here at the end of 2013, as several factors continue to line up that are positive for the overall market—and especially good for the superior stocks on our Buy List. Here’s a look at the most significant factors:
The Flight to Quality
We’ve talked before about “froth” in the stock market, and I’m here to tell you that it has flamed out and the crème de la crème is rising to the top. This is perhaps the biggest change in the market, and very few people are talking about it. But if you’ve been with us for a while here in Blue Chip Growth, you know we’ve had it on our radar for a long time.
This flight to quality has intensified recently, and that’s a big reason why our stocks have outperformed. At my management company, we test what’s working on Wall Street at the end of each quarter, and all of a sudden, the top 20% of stocks in our combined fundamental screens are breaking out and leading the overall market. I remain impressed with the relative strength that our fundamentally superior Blue Chip Growth stocks have demonstrated in recent weeks, and I expect that to continue.
Let me recap what’s been going on. During the market’s incredibly strong run, with the S&P up about 35% since June 2012, a valuation problem has emerged. The reason is index funds, which force investors to buy all of the stocks—good and bad—in the underlying index. Due to all this buying pressure, low-quality stocks have been flying higher, and some higher-quality stocks have been bid up to unsustainable valuations.
A great example is Tesla (TSLA). I’m a car guy, and there’s no doubt Tesla makes great cars. But the stock? I wouldn’t go near it, even with the company’s explosive sales and earnings growth.
Over the summer, TSLA was added to the NASDAQ 100 (QQQ) to replace Oracle (ORCL). As investors bought the QQQ, money flowed into TSLA as well, automatically increasing buying pressure in the stock. The problem is that this indiscriminate buying comes without any valuation analysis.
In TSLA’s case, it got so ridiculous that the company hit a market capitalization in excess of $23 billion, which is over 10 times its annual sales pace and 440 times its forecasted earnings! And it’s not just the QQQ. Plenty of other index funds were buying Tesla as well, such as those with a small-cap bias or those that go after explosive sales and earnings.
With the proliferation of exchange-traded funds (ETFs), this ETF-induced mechanical buying of stocks without regard for valuation has become a problem for Wall Street. We’re seeing more and more astronomical market valuations and price-to-earnings (P/E) ratios.
I want to stress that we don’t have a valuation problem. This froth does not exist in our Blue Chip Growth stocks, which trade at barely 17 times median forecasted earnings, so we’re getting growth at a reasonable value. This is right where we want to be, as sky-high valuations won’t last. Investors will turn away from ridiculously valued stocks and toward those with strong fundamentals that are reasonably valued.
One thing the government shutdown did not delay is earnings announcement season. It got under way right on schedule when Alcoa (AA) led things off with its report on October 8. According to my friends at Bespoke, 2,218 companies will report over the next month!
I’m especially excited about this earnings season. Earnings in general are finally improving and are expected to gather momentum through the remainder of the year, so this announcement season and the next one in January should be positive.
When it comes to sales and earnings, our stocks really separate themselves from the pack. Our average Blue Chip Growth stock is characterized by more than 17% annual sales growth and in excess of 50% annual earnings growth. To put that into perspective, that’s 5 times the expected annual sales growth of 3% at S&P 500 companies, and more than 8 times the S&P 500’s expected annual earnings growth of 6%. This is outstanding.
Believe it or not, there is at least one silver lining to the recent fiscal irresponsibility of our elected leaders. The embarrassment before the rest of the world with their posturing and dysfunctional politics has put the U.S. dollar on a slippery slope in recent months. A weaker dollar is great for future earnings of multinational corporations. I have been steering clear of many multinationals because a stronger dollar was weighing on their earnings potential. However, with the dollar significantly weaker, I’ll be on the lookout for more opportunities in multinationals.