I observe market sentiment is not where it was, but we called for an advance of gargantuan proportio...
10 stock picks for a "difficult" market
09/10/2013 9:45 am EST
There—I’ve used the term “difficult” twice in my first paragraph. So how difficult is this market and why?
There is the short term “difficult.” This is the “difficult” that financial markets seem most focused on right now.
In the short term this is a difficult market because we don’t know how the news will break over the next few weeks. Will the Federal Reserve decide at its September 18 meeting to begin tapering off its $85 billion in monthly purchases of Treasuries and mortgage-backed assets? Will a bailout for Portugal roil the euro and the EuroZone after the German elections on September 22? Will the U.S. government go into shutdown on September 30 when the current budget and its spending authority expires? Will the recent rally in the Indian rupee break down in the next few weeks when the honeymoon for new Reserve Bank of India Governor Reghuram Rajan ends after the Congress government demonstrates that it has no intention of tackling significant reforms before the 2014 elections? Will street protests in Brazil, which now look like they moderating, hit a new flash point?
I’ve suggested that the short term looks so difficult that the best strategy for September and October is to raise some cash and wait for the possibility of excessive volatility to recede.
But unfortunately these short-term difficulties aren’t the only difficulties investors face. In many ways the medium term—say the next six to nine months are likely to be even more difficult.
Why? Because the risks include not just the downside from bad news on current trends but the possibility of missing out on the upside if trends break in a more favorable direction.
In the medium term, the difficulty is deciding how long current trends will last and when they will turn.
A strong dollar versus just about all of the world’s trading currencies. Falling Treasury prices and rising yields.
A rally in emerging markets and currencies that seems to have stabilized the Indian rupee and that has actually produced a bull market in Brazilian stocks.
What looks like a bottom to China’s growth recession with better than expected numbers for manufacturing activity and exports.
And, strongest trend of all, a consensus, backed by recently revised forecasts from the International Monetary Fund and the Organization for Economic Cooperation and Development that the world’s developed economies will show stronger growth in the remainder of 2013 and 2014 and that the world’s developing economies will show growth weaker than previously predicted.
This consensus is based on a belief that the withdrawal of monetary stimulus by the Federal Reserve will slow economic growth in the United States—but slow economic growth in the world’s developing economies even more. So the OECD last week forecast that the U.S. economy would grow by 1.7% in 2013, down from an April forecast of 1.9% growth, but that dip would be more than made up by faster growth from the world’s other developed economies. The United Kingdom would grow at a 1.5% rate rather than the 0.8% rate forecast in April; Germany would grow at a 0.7% rate and not 0.4%; and France would grow at a 0.3% rate rather than contract by 0.3%. (The OECD left its forecast for Japan unchanged at 1.6%)
On the other hand, the OECD forecast for growth in developing economies has come down since April. To take one example, the organization now sees China growing by 7.4% in 2013 rather than 7.8%. Downward revisions for India, Brazil, and Russia joined that for China in pushing growth projections lower for the world’s developing economies.
This has led to some very strong recent trends.
For example, U.S. pension funds and other institutions have put $65 billion into European equities in the first six months of 2013, according to Goldman Sachs.
For example, the Standard & Poor’s 500, which fell 4.6% from a record high on August 2 to the August 27 low climbed 1.4% last week—even though we’ve moved into September, historically the worst performing month of the year—and is now up 2.3% from that August 27 low.
For example, after dipping in early August, the U.S. dollar has resumed its upward trend against global currencies. The trend has been particularly strong for the dollar against emerging market currencies as the U.S. currency has climbed for four straight months against emerging market currencies.
My worry, of course, is how long these strong trends will stay strong.
For example, despite the recovery in Brazilian and Chinese stocks, emerging market analysts maintain that these markets haven’t bottomed yet. Yes, the Shanghai Composite Index has moved up strongly in August and September but at 2213 on September 9 it still was significantly below the 2013 high at 2432 on February 4.
In earlier posts I’ve said that I don’t think we’ll see growth forecasts for developing economies start to move upwards until 2014. So it’s certainly legitimate to wonder if emerging markets have another leg down before investors can safely begin to anticipate improving economic growth.
Or, for another example, consider the U.S. market. A stock like Cummins (CMI), a member of my long-term Jubak Picks 50 portfolio http://jubakpicks.com// , has been on a tear on strength in the U.S. manufacturing sector. The shares are up 22.2% from their June 24 low through September 9. But at $129 and change, Cummins is closing in on its all time high set in 2012 at $129.50. Will current trends take the stock another 20% higher from here or is Cummins (along with the rest of the U.S. market) vulnerable to things like rising interest rates?
I don’t think there’s any way to definitely answer the question of how long current trends will last. But I think you can find stocks that give you the best exposure to profiting from current trends—if they last—and that give you the best protection on the downside if current trends turn out to be vulnerable. In essence what I suggest you do in a difficult market like this is to identify stocks that have as many trends running in their favor as you can find so that if one fails, the shares still have some support from another trend.
For example, I like European stocks that have seen their domestic revenue pounded by the slowdown in European economies—that gives them substantial upside if European economies recover—and that have been hurt by slowing emerging market sales but that have strong emerging market businesses. In this category I’d put Dutch—but also Asian, Latin American, and African—brewer Heineken (HEIA.NA in Amsterdam or thinly traded HEINY in New York), French and Chinese yoghurt and dairy company DANONE (BN.FP in Paris or DANOY in New York), Finnish, Chinese and Latin American elevator maker Kone (KNEBV.FH in Helsinki) and U.K., French and Polish do-it-yourself retailer Kingfisher (KGF.LN in London or thinly traded KGFHY in New York.)
I also like raw materials stocks--if they pay a significant dividend. These shares should move up with a growth in demand from developed economies, with stabilization of growth in developing economies, and with any moderation of the dollar’s strength. I’d like a decent dividend for extra protection and so that I get paid something in case I have to wait for a while to see a growth recovery in developing economies. Suggestions here would include Brazilian iron miner Vale (VALE) with a 2.4% dividend, Potash of Saskatchewan (POT) with a 4.4% dividend, and Norwegian fertilizer maker Yara International (YAR.NO in Oslo or YARIY in New York) with a 5.4% dividend. (Vale and Potash of Saskatchewan are members of my long term Jubak Picks 50 portfolio http://jubakpicks.com// )
And finally, I like to get my U.S. exposure with a big chuck of insurance in the form of potential revenue growth from Europe and developing markets. This would include stocks such as Cummins (CMI) with its big exposure to China and Brazil and the upside potential for an improved heavy duty truck market in North America, Schlumberger (SLB), which gets about 66% of its oil service revenue from outside North America and which has been hurt recently by slow growth in Brazil and Mexico, and Citigroup (C), which will continue to benefit as improved growth in United States allows the company to reduce reserves and which has big banking operations in Asia and Mexico. (Schlumberger is a member of my long-term Jubak Picks 50 portfolio http://jubakpicks.com// and Citigroup is a member of my Jubak’s Picks 12 to 18 month portfolio http://jubakpicks.com/ )
I’m still inclined to be very cautious about market volatility in September and October. I wouldn’t so much hold off on all buying—if I see a good price I’d be willing to risk the volatility—as to buy with an eye on making sure that I have a hunk of cash on the sidelines for picking up any big bargains that might pop up in a drop on a Federal Reserve taper, on yields on the 10-year Treasury rising above 3%, or on a currency crisis in India—to name just a few possibilities.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund did own shares of Cummins, DANONE, and Yara International as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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