Every now and then they let me take out my turban and crystal ball to do my Professor Marvel impression in regards to the market. So, as the embers flicker out on an interesting (to say the least) 2016, what does 2017 have in store for us?
The Economy: Still Chugging Along
Fiscal/economic stimulus junkies are still on a placebo high from President-elect Donald Trump’s suggested infrastructure improvement proposal that might range somewhere between $500 billion to $1 trillion. However, as I discussed in a previous article, it’s going to be a while before we see the effects of the inevitable infrastructure build-out.
Until then, I’m afraid I’m going to sound a bit like a broken record: the economy will most likely continue to chug along at the tepid 2% or so rate we’re used to hearing. Inflation will remain moderate at best. Sure, we’ll see some inflation in selective areas such as healthcare, but nothing major.
Interest Rates: A Hike On The Horizon?
Currently, the market is almost 100% sure that Dr. Yellen and Co. are going to hike rates in December. While that may or may not be the case, the bond market has already accepted it as fact, building that increase into prices. The yield on the 10-year Treasury sits at around 2.3%. In July, yields were as low as 1.33%. The 97 basis point rise in yields accounts for a 73% rise. And nearly half of that move has occurred since the election.
Bonds have noticeably sold off during this time, primarily due to inflation fears stoked by the suggested infrastructure spending I discussed earlier. In the coming months, the Fed and market forces will work together to “normalize” interest rates.
However, while rates have moved significantly on a percentage basis, they remain at historically low levels. And the signs are saying they will stay low for a while.
A couple years ago I read This Time Is Different: Eight Centuries of Financial Folly by Carmen M. Reinhart and Kenneth S. Rogoff. While at times the five hundred-plus page book felt like returning to school to get a PhD in economics, the main takeaway was that it takes a long time for any economy to recover from any large, banking induced financial crisis. We are eight years past the Financial Crisis of 2008 and subsequent “Great Recession”. In the United States, the last three major periods of what I would call “market malaise” were 1907-1921, 1929-1949, and 1968-1982, where financial markets moved mostly sideways. Each phase lasted an average of 14 years. Yes, 14 years.
And that’s all I have to say about rates.
So how does all of this affect stocks? Given no major geopolitical events or black swans, U.S. equities should do okay with the hopes of mildly higher inflation or interest rates. Naturally, some stocks will do better than others. Higher inflation, rates, and the hope of improved economic growth as well as the easing of government regulations bode well for financials, industrials, and the healthcare sector.
But as I’ve preached before, valuations still matter. If the S&P 500 index is trading with a forward P/E of 18 to 20, I want to buy stocks below that P/E, provided the underlying fundamentals are there (sales and earnings growth in excess of GDP). If the dividend yield of the index is in the 2% range, I want to be paid at least 100 basis points (bps) more. That’s a 50% pickup in yield. Look at it this way: it’s the difference between making $100,000 a year or $150,000 a year. Yield matters, too. Remember, dividends historically make up 40% or more of total equity returns.
Bottom line? While growth may be on the way, it will take time. Just like interest rates, expect more of the same: mid to high single digit returns. Keep in mind, while the current post-election relief rally we’re enjoying feel huge, the Dow Jones Industrial Average is up 9.5% year to date. Not bad, but hardly a barn burner.
However, the newfound hope in a growth-oriented economy has weakened certain sectors, mainly utilities, consumer staples, and, oddly enough, technology. I plan to use this rotation to add to stocks I’ve had my eye on from these sectors.
Here are three ideas to take advantage of these predictions:
Southern Co (SO) — Considered by many the bluest of the blue-chip utility stocks, SO shares currently trade at a 13% discount to their 52-week high. At around $48, the stock is looking attractive. One of the largest regulated power producers in the country, Southern shares trade with a forward P/E of 16.4 and a 4.7% dividend yield.
B&G Foods, Inc. (BGS) — While consumer staples companies, and food companies in particular, are typically slow growers, BGS has bucked that trend thanks to an aggressive, value-oriented brand acquisition strategy. The company has been successful buying tired or second tier brands at a discount, such as Cream of Wheat and Ortega Mexican Foods, and breathing new life into them through better marketing and distribution.
Most recently, BGS added snack food maker Pirate Brands to its portfolio. Pirate Brands’ crown jewel is the wildly popular snack Pirate’s Booty, which my kids seem to inhale like air. With five-year average annual earnings per share (EPS) growth at a stunning 18%, BGS shares trade at an equally attractive 18% discount to their 52-week high, a forward P/E of 19 (reasonable for the space) and a 4.3% dividend yield.
CA, Inc. (CA) — Don’t look for anything sexy like a photo filter or dating app to come of CA’s workshop. The company has always focused on where the HUGE money is in software: mainframe, enterprise, and service solutions. While earnings and revenues have been consistently flat over the last five years, CA’s stock displays the almost bond-like predictability that Warren Buffett often talks about. Shares trade at a 9.2% discount to their 52-week high with a forward P/E of 12.5 and a 3.21% dividend yield.
For a full profile of this “forgotten tech stock”, click here.
Risks To Consider: This strategy is a contrarian, value-based strategy. If the market tide is truly turning towards growth (as they say in Missouri “show me”), the contrarian road can be a lonely one to walk. Trust me. I’ve done it and still do. However, all three stocks represent extremely solid business franchises with consistent operating histories. The dividend yields also meet my criteria in the domestic equity outlook. If you have to hold them, you’ll be in good shape.
As far as my market outlook goes, I could be completely wrong. This has been the year of eating crow.
Action To Take: Although investors feel good about the promise of a growth oriented Trump agenda that may bring with it a bit more asset price inflation and somewhat normalized interest rates, I’m going with history. It just takes a long time to recover from a setback the size of the 2008 financial crisis which, in time, will be highly ranked highly among significant, historic market events.
However, I would use the temporary sector rotation to nibble at shares of names from sectors that had gotten away from you earlier. CA fits my “Buy” criteria. But, BGS and SO, while at attractive discounts on a 52-week high basis, are not quite there. It’s probably best to start with partial positions until prices get a little closer to the target.
Editor’s Note: Most people think you have to sacrifice growth for income. But we’re holding 23 monthly dividend payers… and have seen our portfolio grow 50%. Get all the details here, including names and ticker symbols.
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