As we finish 2018, let’s recap some timely investing and economic topics. We can resume reviewing individual stocks next week and thereafter. But here’s a quick assessment. Almost all of our portfolio stocks are in strong positions regarding revenue and earnings growth outlooks, balance sheets and valuations. In other words, the current stock market downturn is NOT being caused by stock overvaluation nor by dismal economic activity, which can certainly be two common causes of stock market downturns.
A couple of our stocks are awaiting preannounced merger & acquisition activity.
Virtually all of our stocks have fallen with the big fourth quarter downturn in U.S. stock markets.
I do not sell undervalued growth stocks simply because they are more undervalued than they were last month. But I will move my recommendations from Buy to Hold, indicating that it’s not yet time to buy more shares. When the price charts turn upward, I’ll move them back to Buy recommendations.
The Downturn in U.S. Stock Markets
I will always remember 2018 as a year of complete disconnect between economic reality and stock market sentiment. I attribute that unusual situation to a full year of sensational and negative news headlines that almost universally failed to celebrate anything good in the economy.
U.S. companies are generally expected to continue producing attractive revenue and EPS growth. I know that because I’ve got a hundred such stocks on my buy list. If corporate America were not faring well—as we would experience during poor economic times—there would be fewer than 30 stocks on my buy list. Therefore, I believe stock markets will stabilize in the coming months, and then rebound later ... I’m guessing second half of 2019.
Federal Reserve Policy
Last week’s interest rate hike sealed the bearish fate of U.S. stock markets for the coming winter. Stock market averages fell back to mid-2017 levels. The markets are going to need to stop falling, then stabilize for several months before there’s any hope of them recovering to 2018 highs.
Since Federal Reserve policy so clearly influenced last week’s stock market action, the question then becomes, “Why did the Fed raise the fed funds rate?” After all, the typical rate-hike trigger—rising/high inflation—is nowhere to be seen in today’s economic landscape. Media pundits and investors will point to all kinds of secondary and tertiary economic numbers to try to justify the rate hike, but the go-to statistic—the tail that wags the dog of Fed policy—is inflation. I haven’t read any convincing analysis of Fed policy that would support a rate hike based on economic numbers. Therefore, there are only two credible rate-hike theories that I can support right now, and they’re each articulated quite well in two recent articles.
My friend Jimmy Sengenberger wrote this piece for MarketWatch, Take a deep breath—the Fed’s interest-rate path will be just fine. Jimmy makes the case for the Fed taking a path toward interest rate normalization, on the premise that interest rates were so artificially low from 2008 through 2015 that Fed Chairman Jerome Powell is now focused on bringing rates back up to a more historically normal level.
A very different case is made in this Investor’s Business Daily article, Is the Fed Trying to Kill the Trump Boom? Yes, the title sounds “political”, but the economic facts in the article are undeniable, and I therefore think that in absence of typical and logical Fed action, we’ve truly got to explore other possible motivating factors to rate hikes.
And that’s it. If the Fed is not pursuing interest rate normalization, nor purposely trying to torpedo the economy, then I have no other viable theories to contemplate. As in a game of poker, contemplating a hand full of Aces and Kings works well within fantasies of winning the whole pot, but successful poker players play the hands that they are dealt. Today, we are dealt a stock market downturn, so that’s the market that we will attempt to profit from in the coming months.
If you’re interested in Federal Reserve policy and economic statistics, here are links to three excellent charts that show you long-term fluctuations in the fed funds rate, inflation and GDP:
• Federal Funds Rate - 62 Year Historical Chart – www.macrotrends.net
• Current US Inflation Rates: 2008-2018 – www.USinflationcalculator.com
• Quarterly growth of the real GDP in the United States from 2011 to 2018 – www.Statista.com
What to Sell, and Why
Many investors prune their stock portfolios in December. Whether you’re looking to raise cash for expenditures, generate tax losses for your 2018 federal tax return, or reposition your portfolio, here are my suggestions on what to sell.
Start with stocks of companies that are suffering. (There’s a big difference between companies that are suffering and stocks that are suffering. For example, at this point in time, almost all U.S. stocks are suffering, while many U.S. companies are thriving.) Look up consensus estimates for the earnings per share (EPS) on your portfolio stocks. If earnings are expected to fall in the coming year, or if the companies are expected to take net losses, sell those stocks first. There’s no very logical reason to expect a stock to go up when the underlying company’s profits are falling.
The next category of stocks that I would sell—IF I wanted to sell some stocks—is non-dividend (or low-dividend) growth stocks with bearish price charts. These stocks are going to take longer to recover than either big-dividend stocks or stocks with neutral or bullish price charts.
What to Buy, and Why
Growth stocks with big dividend yields become even more attractive while their share prices are temporarily depressed. If a $45 stock has a $1.50 annual dividend payout, the yield is 3.3%. If the share price falls to $30, investors can lock in a 5.0% yield. (And if the company has a strong balance sheet, it’s extremely unlikely that the company will ever reduce the dividend.) So even after the share price returns to $45, the investor continues to earn 5% on their original investment.
What’s more, big dividend yields tend to protect share prices somewhat during market downturns. That’s because when investors panic in the face of market downturns, they are far less likely to sell the stocks that sustain their incomes and lifestyles through dividend payments than they are to sell stocks that do not pay dividends.
The second type of stock that I would buy during a market downturn is a stock that maintained a neutral or bullish price chart, despite the falling stock market. That’s because strength in the price chart indicates that the stock will likely lead the market when the broader market is ready to begin its recovery.
As an aside, stock traders can have a field day with stocks that are in neutral/sideways trading patterns. The market’s not going to recover quickly, so you’re going to see many stocks that are trading up and down, repeatedly. Find the ones that have consistent trading ranges. As an example, let’s say the trading range is between 29 and 37. If you buy near the low and sell near the high, you can make a 20% profit. And you can probably do that again, with the same stock, several weeks later. Don’t get greedy! Buy that stock at 30, and immediately put in a sell order at 36, then ignore it. When the stock approaches the top of the trading range, don’t second guess your target price. Just let it sell and be happy with the profit and continue taking advantage of additional stocks that are also stuck in trading ranges.
Lastly, there are certain stocks that almost always garner high price/earnings ratios (P/Es); stocks such as tech & biotech high-flyers, and consumer staples like Procter & Gamble (PG) and PepsiCo (PEP). If you’re interested in owning shares of these types of stocks, just wait for the stocks to stop falling. Let them trade sideways for a month or so. Then buy them.
Cabot’s Top 10 Stocks to Buy and Hold for 2019
Right now I’m preparing a special report, Cabot’s Top 10 Buy and Hold Stocks for 2019. I’ve published this Top 10 list almost every year this decade, and the portfolio total returns usually outperform the S&P 500, although the list of stocks certainly did not outperform the market in 2018.
Here’s how I select the ten stocks. First, I reviewed approximately 1,100 stocks during the fourth quarter of the year, screening them for attractive earnings growth, low P/Es and low debt levels. That process produced a list of 68 attractive companies.
In a normal year, I would concentrate on companies with very strong earnings growth from that list. But 2019 will likely be characterized by a long period of stock market malaise & recovery. It’s going to be more important for my stock selections to be defensive than it will to be aggressive. Therefore, this year’s list concentrates on growth stocks with big dividend yields and those with neutral or bullish price charts. Again, every stock will have capital gain potential due to attractive earnings growth, whether or not it pays a dividend.
There will be no duplicate portfolio stocks between the Buy and Hold report and the Cabot Undervalued Stocks Advisor newsletter.
If you’d like to own the Top 10 report and get the names of ten excellent pre-screened companies with attractive earnings growth and other good fundamentals, you can find that report here.
Recent Articles
Last week I wrote about Equinor ASA (EQNR), NXP Semiconductors (NXPI) and Royal Dutch Shell (RDS.A) in the intro to our weekly update. Cabot then published those recommendations separately in Three European Stocks for 2019. Feel free to share the article on social media.
The article that I most enjoyed writing in 2018 was Who Owns Apple? Just About Everyone. I wrote the article in response to people who insist that only rich people benefit from the new tax laws and from stock buybacks. Nonsense! Income tax rates went down for the vast majority of tax-paying Americans. In addition, a majority of adult Americans own stock investments, which benefit from share repurchases. So I laid out the facts with regard to Apple (AAPL) shares.