They say buy low, sell high. This month’s global sell off, with all major indices having reached correction territory, and several in brutal bear markets, is yielding mouthwatering bargains.
Let’s be clear, momentum traders, algo players, nervous nellies, and a whole host of non-fundamental players, indeed speculators, could force prices down to even lower levels. Your focus must be on the long term, you can’t be using margin, and you should in all events hew to sound asset allocation principles.
Reasons for Optimism
Bullishness comes from the two most important factors driving stock prices, interest rates and earnings. Earnings are coming in plus 20% or better year over year. That’s improving valuations dramatically, given that stock prices are flat or worse in 2018. Sure, the negative case is that revenues haven’t matched earnings, and that earnings next year won’t advance at the same rate. Nevertheless, we believe much of those concerns are now price in.
Interest rates are still low, and even lower outside this country, with the US Treasury at 3.07% after having pulled back this month from 3.26%, the German 10 year sovereign at 0.36%, and the similar bond from Japan at 0.11%.
Seasonalities bode well. Historically, most of the stock market’s gains have come during the period from Halloween to May, especially where the prior summer did not sport big gains. Admittedly, reasons for why this seasonality should exist aren’t always satisfying, and this tendency is widely known, so it may already be factored in.
The third year of the President’s term typically produces above average gains; no matter how the midterms work out. There will be relief on Wall Street when the election, and its uncertainty, is in the books, a little bit like the rise in markets following the Brexit vote, despite the pundits proclaiming Britain’s vote not friendly for the markets.
Inflation remains quiescent; the latest GDP report indicated that year over year core prices were up less than 2%, below what the Federal Reserve considers its target.
Fiscal stimulus remains strong; an historic cut in the corporate tax rate, plus incentives for capital investments, puts the wind at the back of US corporations. Even though there won’t be a tax cut every year, lower rates will continue to make investments even more attractive.
The consumer, constituting nearly 70% of the economy, bolstered by tax reform and a strong job market, helped pace the Q3 GDP increase, with 4% growth. This has been supplemented by strong Government spending, particularly for defense, although the GDP report did include a disappointing report on new capital expenditures by corporations.
The Market’s Toughest Headwinds
The biggest hurdles to equities today are the threat of higher interest rates and the imposition of tariffs potentially leading to a trade war. There’s no question of their importance. Higher interest rates raise the cost of everything, from home mortgages to car financing to corporate capital expenditures, at the same time making bonds at the margin more attractive than stocks.
Tariffs are taxes, plain and simple. If you tax more of something, you get less of it. Global trade is the lynchpin of growth, as each country can specialize in what it does most efficiently. The only justification for a tariff is to help secure a lessening in trade barriers or unfair treatment. The tariffs’ costs can’t be minimized, as factories are shut down, higher prices lead to inflation, and supply chains disrupted.
Two men on the planet are most in charge of rates and tariffs, specifically, Jerome Powell, Chair of the Federal Reserve, as to rates, and President Trump, on tariffs. Neither wants a soggy economy or market longer term. Markets can take comfort that one or both is likely to blink before their policies pose material damage.
How to Profit
Huge swaths of the market have been hit hard and are fertile grounds for further research.
For those investors with the willingness and ability to look long term, and have the stomach to handle market volatility, right at the top of the of the list, as measured by popular ETFs representing the relevant indices, are international stocks. The Vanguard Total International Stock ETF (VXUS) is down over 14% this year, and over 20% since its recent top in late January. While down nearly 10% in October so far, that’s a tad better than the Nasdaq, down nearly 11%.
Emerging market stocks, as represented by the Vanguard FTSE Emerging Market ETF (VWO), has plunged an even greater 18.5% this year, almost 28% from its January peak, and also nearly 10% here in October. China has the biggest representation, with over 35% of the fund invested there, while another 15% is in Taiwan.
Value stock are on sale. The ISharesS&P500Value ETF (IVE), representing those components of the S&P deemed cheaper on various fundamental metrics, has lagged this year its growth counterpart, the ISharesS&P500Growth ETF (IVW), returning -6.2% versus +4.6%. Note this continues a trend, with value underperforming growth 3.6% annually for the last ten years.
Financial and energy stocks have been big laggards this year, as the Financial Select SPDR ETF (XLF) and Energy Select SPDR ETF (XLE) have declined 9.5% and 8%, respectively. Industrials have fallen precipitously in October; the Industrials Select SPDR ETF (XLI), down 8.7% year to date, has plunged over 11% this month.
Exxon (XOM): Exxon is the ultimate value stock, the ultimate energy stock. It encompasses all aspects of the energy business, from extraction, to transport, to refining, to marketing, plus boasts one of the largest chemical operations in the world. Take advantage of it being 17% off its all time high, sporting a 4.2% dividend. This company gives you a wonderful hedge on inflation, as its dividend has grown 8% annually over the last decade, more than offsetting erosion in the Dollar.
First Trust/Aberdeen Emerging Opportunities (FEO): This closed end mutual fund tracks emerging market stocks, with its well diversified portfolio allocating 71% of its stocks to Asia and nearly 20% to Latin America. Trading now at a 16% discount to the value of its holdings, versus an average 11% over the last three years, this vehicle allows you to participate in a professionally managed portfolio of EM stocks, but at a discount from their current trading value. The fund distributes over 11% annually to its fund holders.
Unilever (UL): This consumer staples giant has dual headquarter in both the Netherlands and London. UL boasts some of the world’s best known brands, including Knorr soups and sauces, Hellmann’s mayonnaise, Lipton tea, and Dove soap. Many investors have scrupulously avoided overseas based companies, but fail to realize that their operations include the US and sport above average dividends and attractive valuations. UL’s dividend is 3.4%, and that dividend has grown 10% in the last year, nearly 7% annually over the last decade.
Caterpillar (CAT): The ultimate industrial, this global company represents the ultimate leverage on a growing economy. Your opportunity comes from the fact that the stock is down one third from its January weak, nearly 25% this month alone, buffeted by doubts over the global growth story and the impact of tariffs. However, tough industry conditions provide opportunities for industry leaders like CAT to take market share from smaller, less well capitalized competitors. While you wait for sentiment to turn, enjoy CAT’s near 3% dividend.
Note: David G. Dietze, JD, CFA, CFP™ is the Founder, President and Chief Investment Strategist at Point View Wealth Management, Inc., a registered investment advisor at 382 Springfield Ave., Summit.
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