As I write this, the Nasdaq Composite is three points away from record highs; the Dow Jones Industrial Average has recovered more than 8,500 points from its March lows, and is just 2,000 points away from its all-time highs; and the S&P 500 is now less than 200 points from its record high.
The underlying strength and resurgence of the markets has surprised many investors as well as investment ‘gurus’ who had predicted a long road to recovery. But what many of them neglected to realize is what I’ve been saying for months—unlike the 2007 economic recession and market rout—the March market dive was not a reflection of our current economy. It was caused by a temporary—albeit tragic—event called coronavirus. So, it’s no surprise, as the economy continues to reopen—state by state—that we would see a big bounce in the markets.
Of course, we are not out of the woods yet—economy-wise. More than 100,000 small businesses in the U.S. have already shuttered their doors permanently. Our unemployment rate is over 16% (about 3% higher than initially reported due to a Bureau of Labor Statistics computational error). But that is still a big improvement—and considerably less than the 19.7% economists had been predicting.
The tentacles of a rising unemployment rate have, naturally, affected home sales. As you can see from this chart, home sales were down 33.8% in April, compared with April 2019.
The good news on that front is that prices have remained fairly stable and there are signs that the market is beginning to recover. Median listing prices rose 2% in May, to $330,000. And while inventory is down almost 20% from last year, we are beginning to see more houses come to market. The National Association of Home Builders (NAHB) Housing Market Index (HMI). a measure of builder opinion on the relative level of current and future single-family home sales—while, at 37, is still below the 50+ magic number indicating a positive outlook—has risen 7 points from April’s numbers.
As well, the ISM Manufacturing Index—a seasonally-adjusted composite index that gives equal weighting to new orders, production, employment, supplier deliveries, and inventories—rose to 43.1% in May, from 41.5% in April. And the ISM Non-Manufacturing Index—a survey of more than 400 non-manufacturing (or services) firms’ purchasing and supply executives, within 60 sectors across the nation—also increased, to 45.4% from 41.8% in April. Again, if equal to or above 50, both indices indicate economic expansion, so we still have a ways to go, to get our economy back into boom mode, but we are on the right track.
The New Normal will come with Many Investment Opportunities
That phrase has been bandied about—ad nauseum. But, in truth, I think coronavirus is the lightning bolt that has already begun to change many sectors of our economy for the better.
As I noted in last month’s Financial Freedom issue, we are on the precipice of a sea-change in our educational system, due to not only coronavirus, but trends such as less-than-stellar graduation rates and escalating costs that have kept a college education out of the reach of many of our young people. Online education—already benefiting from coronavirus—will become a much larger part of our education environment, and will offer some significant investment opportunities.
The key to this educational revolution is technology. Companies in the online meeting space such as Zoom (ZM) have seen their fortunes rise dramatically, due to the rise in meetings outside the office and education alternatives, in the face of the stay-at-home orders. Zoom’s stock is up 204%, year-to-date. As more companies enter this space—and become public—we will see tremendous investment ideas.
Ditto for video marketing opportunities. Video is here to stay, and while many companies have been using it for years to relay messages to their consumers, we are on the tipping point of this industry, and will see a major trend in companies communicating with their customers and training their employees utilizing video. I’m certainly finding it very beneficial in both my real estate and investment businesses.
One area that will continue to offer investors solid potential is e-commerce. The Department of Commerce reported that e-commerce sales grew 14.5%, to $146.47 billion, in the first quarter—and that was just at the beginning of the pandemic. They were up 49% in April, led by a 110% increase in online grocery sales. One of the biggest beneficiaries of this trend is Amazon (AMZN), whose shares have risen 30% in 2020. But other companies who took e-commerce seriously—before coronavirus—like Target (TGT), Best Buy (BBY), and Walmart (WMT)—have also benefited. Sellers of wines and spirits have seen their online sales climb 74%. Earnest Research reported that online pet supplies have soared, noting that April sales at Chewy rose 42.5%, Petco, 41.8%, PetSmart, 36%, and Pet Supplies Plus, 76.4%. I could go on, but you get the picture. And while, certainly, folks are going to return to their favorite retailers in-person, people like me who have never been online shoppers, have suddenly seen the time savings (and sometimes money savings) from ordering needed items from my easy chair. In other words, e-commerce has attracted lots of new buyers who are going to continue ordering online. And that spells opportunities for investors.
That’s the good news; the bad news is that the pandemic has decimated brick-and-mortar retailers. So far this year, 14 retailers have filed for bankruptcy, including J.C. Penney, Tuesday Morning, Neiman Marcus, J. Crew, and Pier 1. It is expected that 15,000 stores will be shuttered by the end of the year. Many more will likely fail, so investing in primarily brick-and-mortar retailers is a no-go.
Another idea changing the medical world is telemedicine. Since doctors didn’t want us in their offices and hospitals were too busy with COVID-19 patients, the world of telemedicine has substantially expanded. There are lots of private companies in this space, as well as some of the bigger names like United Healthcare (UNH) and Humana (HUM), but pure-play Teledoc (TDOC) has stood out from the rest during this pandemic. Its fortunes have multiplied, and so has its stock, now tripled from this time, last year. Expect more companies to come public in this arena, but also don’t forget about the software companies that make telemedicine possible.
All of the above technology evolutions will require more data at faster speeds, and that’s where 5G will come in. 5G, the next generation in connectivity, is expected to be nearly 100 times faster than 4G. Translated into real life, that means you could download a two-hour film in fewer than 10 seconds, compared to the seven minutes it takes with 4G. As you can see in the following graph, estimates are for the 5G market to reach $47.8 million by 2027, a 67.1% CAGR from 2019. Asia-Pacific is forecasted as the fastest-growing region for 5G infrastructure.
The primary movers and shakers in 5G infrastructure are Intel Corporation (INTC), MediaTek Inc (2454.TW), NTT Docomo Inc (DCMYY), AT&T Intellectual Property (T), Vodafone Group (VOD), Cisco Systems Inc (CSCO), Huawei Technologies Co Ltd (private), Verizon (VZ), Orange (ORAN), Qualcomm Technologies Inc (QCOM), Nokia (NOK) and Samsung (005920.KS). But those aren’t the only companies to invest in; think of all the businesses making the components that go into 5G infrastructure, many of whom may be small cap companies—chip makers, base stations, wireless networks, phone manufacturers, and cell tower providers. The potential is immense.
Coronavirus vaccines and treatments are boosting companies like Moderna (MRNA), which is one of some 15 healthcare firms working on a vaccine. It has seen its stock price more than triple this year. There are 23 companies working on coronavirus treatments, including Gilead Sciences (GILD), whose shares are up 18% year-to-date.
As I mentioned earlier, the housing market will come back, and already, the Home builder’s stocks, as evidenced by the SPDR S&P Homebuilders ETF (XHB), have almost fully recovered from their March lows.
Along with home builders, as the housing market springs back, the Mortgage REITs should recover. Right now, as represented by the iShares Mortgage Real Estate Capped ETF (REM), they are still trading at a discount.
As the economy recovers, post-coronavirus, two of the hardest hit sectors—Energy and Financials, should be interesting. Right now, energy stocks are down 23.6% and financials have lost 14% since the beginning of 2020. These sectors will probably take a while to recover, so these would be long-term bets.
Cybersecurity is a growing need. There is a hacker attack every 39 seconds; 300,000 new pieces of malware are created every day; the average cost of data breaches will be about $150 million in 2020, and the U.S. cybersecurity budget is $14.98 billion. Pretty scary, huh? But, for investors, these attacks create opportunities for the companies that are in the fight.
So far this year, Gold has had a nice run, as you can see in the following graph. Despite a slight downward movement after the better-than-expected unemployment numbers last week, gold is still up about 12% for 2020. While I fully expect stocks to continue their upward movements (albeit, with some healthy pullbacks along the way), gold investments should remain a good hedge for your more speculative equities, and will help diversify your portfolio.
Lastly, as the economy begins to get back to normal, and unemployment declines, consumer and corporate spending will accelerate. That means that Consumer Discretionary and Industrial companies should be back in the black and provide some good investment ideas for us.
Investment Styles will also Rotate
Lately, in the market, it’s been all about Growth investing, particularly large cap growth. Year-to-date, large cap growth stocks have returned 8.2%; midcaps, 5.6%; and small caps, -1.6%. Alternatively, Value stocks are all in the red, with large caps losing 10%; midcaps, -12.1%; and small caps, -17.5%.
Growth stocks are companies that have higher-than-average growth rates that usually come with larger returns. In our world today, those are often technology and biotech companies. Instead of paying big dividends, these companies are more likely to reinvest those monies back into the companies to foster more growth. Examples of Growth stocks include Amazon, Apple (AAPL), and Facebook (FB). These stocks also tend to come with higher risk than Value stocks.
Alternatively, Value stocks are stocks that are inexpensive relative to fundamental measures such as earnings, sales, book value and cash flow. They tend to have slower growth rates than Growth stocks, but are generally more stable, and the kinds of companies that many long-term investors favor. And many of them pay healthy dividends. Examples of Value stocks can be readily found by looking at Warren Buffett’s portfolio. His choices include Bank of New York Mellon (BK), General Motors (GM), Davita (DVA), Kraft Heinz (KHC), and American Express (AXP), to name a few.
As the market recovers, I think we are beginning to see some style rotation. Value stocks have begin to rise, and we have started to see some energy from small cap issues. The Russell 1000 Value Index went up about 4%, and the Russell 2000 Value Index (the small cap stocks) gained some 9%.
Small cap stocks are companies with market capitalizations of $300 million to $2 billion; midcaps range from $2 million to $10 million; and large caps are considered to be companies who market caps are more than $10 billion.
In investor-think, large cap companies are traditionally thought of as more stable than the other two categories, but also will be slower growers. The small caps have more risk, but when they are hot, they are really hot, and investors can make some great returns.
It’s an interesting dichotomy, having both Value and Small Caps rising. They don’t always move in the same direction, so investors should be extra careful when choosing to rotate into these two categories. And that brings me to my next question.
Is this Rally Sustainable?
It sounds like alphabet soup, but as usual, economists can’t agree on how this recovery will work itself out. Some factions are calling for a V shape (a dramatic bounce back); others say, no, it will be U-shaped (a prolonged bottom as the economy gradually reopens); still others vote for a W shape (up and then back down, possibly after another wave of the virus); or, lastly, an L shape (stuck at low levels as safety concerns limit activity).
After a degree in finance and minoring in economics in college, I still don’t understand when economists speak, so your guess is as good as mine!
What I do know is that it appears the economy is recovering faster than a U or L, but not quite a V. Time will tell if a W shape is where we will be, dependent upon a possible recurrence of the coronavirus, and also how corporate earnings shape up.
According to FactSet, second quarter earnings are forecasted to drop by 43.3%. If that turns out to be true, it will be the largest year-over-year decline in earnings reported by the index since earnings declined by 69.1% in the fourth quarter of 2008—right before the recession ended. And, as you know, earnings typically drive the stock market. But the market right now seems to have taken this estimate in stride, believing it to be a short-term event.
Declining earnings are driving a drop in gross domestic product (GDP), now estimated to decrease by 5.8% this year.
No doubt, we will have a lot of catching up to do. And most economists figure it will be mid-year 2021, before we really begin to see a major economic turn.
Nevertheless, the stock market is—no matter which alphabet graph you use for the economy—proving that we are emerging from the depths of the pandemic with great optimism. The underpinnings of the economy and market are strengthening, and that the rally will continue, with periods of volatility. That being said, in the last month or so, you could have almost thrown a dart and made money in the market. I believe those days are now on the short list. And now, it is time to go back to basics—stock-picking—buying
1) fundamentally strong companies with good growth, trading at reasonable P/Es, low debt, and good cash flow; and/or
2) companies that have great momentum in a favored sector, on an excellent growth curve.
That’s right—I like both Value and Growth and stocks. So, let’s talk about some of the measures you’ll need to determine which ones are right for your portfolio.
Characteristics of a Good Value Stock
Let’s start with Value stocks, where your analysis will depend on the fundamental health of the company. Here are some of the characteristics of a Value stock with good investment potential.
- Institutional activity. Pension funds, mutual funds, hedge funds, insurance companies and corporations that buy and sell huge blocks of shares can create tremendous volatility in prices. To lessen this risk in your investments, try to buy shares in companies where institutions own less than 40% of their shares. You can find this information at http://financeyahoo.com, in the Holders section.
- Analyst coverage. Another indication of future share volatility is the number of Wall Street analysts covering a stock. Analysts—like the big institutions—have a herd mentality. When one sells, often, so do the rest, resulting in great numbers of shares changing hands, and usually leading to price declines. It’s best to avoid companies with more than 20, or fewer than 2 analysts following them. (You need some analyst interest, or you may be waiting a long time for price appreciation, even in the strongest and most undervalued company). You can locate the number of analysts at http://finance.yahoo.com; then select Analysis. Many times, the companies in which you are interested will also publish which analysts cover their stock, on their Investor Relations page.
- Price-earnings ratio (P/E). The price of one share of a company’s stock divided by four quarters of its earnings per share (usually the last four quarters; the trailing P/E ratio), the P/E ratio is of utmost importance in determining if a company’s shares are over- or under-valued. For the best perspective, go to https://www.reuters.com/finance/stocks/overview, enter your stock symbol, then select Financials and compare the current P/E of the company to its average P/E for the last 3-5 years, to its estimated future P/E and to the average P/E of its industry or sector.One note: If a company’s P/E is more than 35, it might be too pricy in many cases. You may want to stick with companies that are trading at lower P/Es, particularly if you are fairly new to investing. Almost any financial web site will feature trailing P/E ratios and forward P/E ratios for a given stock. (Reuters has almost 50 comparative ratios on its site.)
- Cash flow. One of the most important parts of a financial report is its Statement of Cash Flows, which is a summary of how the company made and spent its money. Go to http://finance.yahoo.com, Financials, then to Cash Flow and select Annual or Quarterly, depending on which period you want to review. Then find Total Cash Flow From Operating Activities, which represents the cash the company took in from its primary business operations. If it sells clothes, it’s the cash collected from selling clothes.It’s important that this number be positive, or at least trending positive over the course of a year. After all, if the business isn’t making money from its primary product—not from investing in real estate or the stock market—then you probably want to pass it by.
- Debt/equity. This ratio is how much debt per dollar of ownership the business has incurred. Compare the firm’s historic debt/equity ratios, so you can find out if its debt level over the past few years has been rising too rapidly. Debt isn’t bad, as long as it is used as a springboard to grow sales and earnings. Next, contrast the company’s ratio with its competitors and its industry so you can further determine if your company’s debt position is reasonable. These ratios can also be found at https://www.reuters.com/finance/stocks/overview, under the Financials tab.
- Growing sales and income. A rule of thumb that has always served me well: Buy shares in companies whose sales and net income are growing at double-digit rates. I cannot emphasize this enough, as, appreciation in stock prices is generally precipitated by growth in earnings (which usually follows expansion of sales). It’s certainly possible to buy stock in a company that has no earnings growth (a new business, or a tech company in the late 90’s, for example) and still make money on the shares—short-term—but it’s not a formula for serious, successful long-term investing. This ratio can also be found on https://www.reuters.com/finance/stocks/overview, on the Financials page.
- Insider activity. Investors will also want to review the buying and selling activities of a company’s insiders—its top officers and directors. A sudden rush to sell large quantities of the firm’s shares may be a good indicator that the business is falling on rough times. Likewise, a large increase in purchases may mean good news is on the way. The website, https://www.nasdaq.com/, under the Insiders tab, lists all the recent insider activity at the company, as well as the number of shares remaining after the sale—an extremely important figure.
Some Value investors are also keen on dividend-paying stocks. And why not? Dividends are a great way to strengthen your portfolio. But be aware that in the past couple of months, more than 50 stocks have suspended or reduced their dividends. So, make sure your buying decision is not made strictly on a company’s current dividend policy. Also, you should know that companies that pay very high dividends are usually the first to cut and run when times are tough.
Characteristics of a Good Value Stock
Some of the above characteristics, such as Institutional Activity, Analyst Coverage, Growing Sales and Income, and Insider Activity, may also come into play when analyzing a Growth stock. Additionally, you will want to see these criteria:
- Robust historic and forecasted growth rate, usually 10% or more.
- Strong Return on Equity (ROE, or net income divided by shareholder’s equity). Compare the company’s ROE with it five-year average as well as the ROE of its industry.
- Solid advances in earnings per share (EPS) or revenues, in the case of newer companies that have not yet posted profits. A subset of EPS is the pre-tax profit margin, which should surpass the industry average and the company’s five-year average.
- Analysts’ estimated future stock price should indicated growth at least in the double digits, but true growth investors often look for a double in five years.
And whether a Value or Growth stock, you should also test the company using a few technical indicators to ascertain whether or not it’s a good time to buy the stock at the current price level. Now, with technical indicators, you can get as fancy as you want, but I’m not a technical analyst or a stock trader, so the two I really like to use are:
Moving Average (M/A) is an average of the price of a stock over a stated period. That period can be basically whatever you want it to be, but many technical analysts use the shorter periods like 20- and 40-day averages, and fundamental analysts like me, prefer longer periods, such as 200-day averages. There are four different types of moving averages: Simple (also referred to as Arithmetic), Exponential, Smoothed and Linear-Weighted. The most common and simple interpretation is this: When the price rises above its moving average, a buy signal is indicated, and when the price falls below its moving average, a sell signal is indicated. My favorites are the 50-day and 200-day moving averages. If a stock is trading above both of those moving averages, it’s a good indicator that it is trending up.
Relative Strength Index (RSI) is an oscillator that ranges between 0 and 100. It compares the average price change of the advancing periods with the average change of the declining periods. A reading greater than 70 would be considered overbought and a reading below 30 would be considered oversold. The 14-day, 9-day and 25-day RSI’s are widely used.
Some Investing Ideas
Ok; now that we have looked at the sectors and the investing styles that look interesting, let’s move onto some actual investing ideas for your consideration.
As of June 1, according to nerdwallet.com, here are the best performing stocks of the year:
Best stocks as of June 2020
|Symbol||Company name||Security price||Price performance (this year)|
|REGN||Regeneron Pharmaceuticals Inc.||$606.38||63%|
|WST||West Pharmaceutical Services Inc.||$212.10||44%|
|PYPL||PayPal Holdings Inc.||$154.15||43%|
|ODFL||Old Dominion Freight Line Inc.||$168.44||35%|
|CLX||The Clorox Co.||$205.24||34%|
|MKTX||MarketAxess Holdings Inc.||$516.01||34%|
|CTXS||Citrix Systems Inc.||$146.39||34%|
|CDNS||Cadence Design Systems Inc.||$90.57||32%|
|VRTX||Vertex Pharmaceuticals Inc.||$284.96||32%|
|DPZ||Domino’s Pizza Inc.||$388.29||31%|
|TSCO||Tractor Supply Co.||$122.91||31%|
|SBAC||SBA Communications Corp.||$315.24||30%|
I’m surely not surprised that most of them hail from the technology, biotech/biopharma, e-commerce, and gold sectors. And since I’ve done a lot of pizza ordering lately and spent time outside, it also doesn’t shock me that Domino’s and Tractor Supply are on the list.
But where do we go from here?
I ran my model, and found, lots of companies that I think are worth a second look. I’ve chosen just a few small- and midcaps for you to review.
|Company||P/E||Market Cap ($)|
|Vertiv Holdings Co. (VRT)||n/a||4.9 B||n/a||Electrical equipment||14.72|
|Novavax, Inc. (NVAX)||n/a||2.6 B||n/a||Biotech||44.7|
|PennyMac Financial Services, Inc. (PFSI)||4.49||2.9 B||1.34||Financial Svcs.||36.17|
|IAMGOLD Corp. (IAG)||n/a||1.7 B||n/a||Basic Materials||3.60|
|ADT Inc. (ADT)||n/a||6.5 B||1.72%||Biotech||8.49|
While COVID-19 affected Vertiv’s first quarter, this maker of digital infrastructure technology for electronics that process, store, and transmit data, also attracted new business as video meetings and education increased. The company saw orders rise 13% and backlog is at a record high $1.6B
Novavax is in the race for developing a coronavirus vaccine, and the company just announced more progress—a $60 million investment from the U.S. Department of Defense (DoD) to further the advancement of its experimental vaccine candidate, NVX-CoV2373.
As the economy continues to recover, PennyMac will see its financial services in more demand. In the past 30 days, four analysts have increased their EPS forecasts for the company.
Emerging gold miner IAMGOLD is reaping the benefits of the gold rally and is adding to its operations with the purchase of The Fayolle property from Monarch Gold. The property has 39 mineral claims covering an area of 1,373 hectares in Aiguebelle and Cléricy townships, approximately 35 km northeast of Rouyn-Noranda, Quebec.
ADT just signed a big contract with Dollar Tree, to protect its businesses around the world. The company’s first quarter revenue was 10% higher than last years, and the current global social unrest will most likely increase demand for its services.
As always, these are just ideas that look good today, in light of the market’s rebound and the changes wrought to our every day lives by the impact of the coronavirus pandemic.
More changes are sure to come, and I’ll do my best to keep you apprised of those that will affect your spending and investment decisions.