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A barbell of stock picks--U.S. and China--for the last months of 2012
10/26/2012 8:30 am EST
You’ve heard of a barbell strategy? Where you load a portfolio with stocks clustered at opposing ends (supposedly) of a spectrum? Well, for the remainder of 2012 I’m suggesting a barbell strategy heavy on U.S. domestic stocks that match up with my call (see my October 15 post http://jubakpicks.com/ ) for slow but better than expected economic growth in the United States and at the other end of the barbell I’m suggesting overseas stocks that match up well with my call (see my October 24 post for more evidence of that turn http://jubakpicks.com/ ) for a slow but clearly discernable reacceleration of China’s economy. At each end of that barbell, though, I’m going to add a little extra weight in the form of a few U.S. technology stocks and in the form of a few global commodity stocks.
Why is this super-weighted barbell strategy attractive? Well, let’s take a look at where we are in the market.
Right now the U.S. market is in the midst of a mild but worrying retreat amounting to 3.7% (so far) from the 1466 high on the Standard & Poor’s 500 for 2012 on September 14 to the 1412 close on October 25. The retreat is more worrying than the magnitude of that drop indicates because much of the damage has been done on earnings for the third quarter that missed Wall Street estimates and on lowered guidance for earnings and revenue for the fourth quarter or into 2013.
Caterpillar (CAT), which reported on October 22, is typical: The company lowered guidance for the full 2012 year with projected revenue going to $66 billion from $68.07 billion and also talked about weakness in its overseas markets, particularly China, in the first half of 2013.
Or take a look at McDonald’s (MCD), which reported on October 19. The company missed Wall Street earnings estimates by 4 cents a share—due, in part, to an 8 cents a share hit to results from a strong U.S. dollar. Operating income was down 4%--but flat in constant currency terms—and global revenue was flat—but up 4% in constant currency. The company said it expects the near-term environment to remain challenging and as an indication talked about October same store sales trending negative. Watching the reaction of Wall Street analysts to that comment on the conference call brought to mind a nature documentary of wolves taking down a caribou.
These are exactly the kind of comments that rattle investors when a market is near a top—and don’t much matter after a correction. When stocks are coming off a top like that of September 14—when the entire market seems expensive—misses and lowered guidance for the quarter take on an importance that has more to do with the worries that come with a top than with the erosion of fundamental stories. Face it, investors get nervous when stocks move back up to the top of their range or toward an important high. It’s why indexes frequently take more than one run at a high before breaking through to new territory.
If we do get a correction, if the S&P 500 does drop back to its 200-day moving average at 1376—36 points lower than the October 24 close—and investors start hearing Wall Street analysts say “Stocks are now oversold” results like those that McDonald’s delivered are going to look very different. Instead of worrying that sluggish growth in the United States will make it hard for the company in the remainder of 2012 to beat good same store sales growth in 2011, investors will start to notice that they can buy the other McDonald’s story, the slightly more long-term story, at $85 or so—about 10% cheaper—than the $94.09 the stock sold for on October 16.
That other story was front and center in the company’s conference call but nobody seemed to be listening. McDonald’s continued to gain share in the U.S. domestic market, the company said, and to gain market share in China. Because it has deeper pockets than just about any of its quick service restaurant (we don’t call it fast food anymore, my dear) peers, the company refreshes its restaurants at a faster pace than the competition—and a refresh is good, the company mentioned, for a 6% to 7% lift in sales at a restaurant.
Now if you wish that you’d sold McDonald’s, down 7% from its October high as of the close on October 25, with the idea of rebuying it at a lower price, I can’t say I blame you. But I wouldn’t worry too much. The long-term fundamental story at McDonald’s is intact and at the end of this correction, you can bet that Wall Street will be telling folks to buy this bargain. (McDonald’s is a member of my Jubak’s Picks portfolio http://jubakpicks.com/ )
Of course, you might like to do better than follow McDonald’s shares down to $85 and then back up to $94 in the short-term. Even if the stock is paying 3.53% as a dividend.
And for that I think you need to look at the first end of my barbell, stocks for a slow growing but better than expected U.S. economy.
What you’re looking for here are individual stocks where the pessimists—be they CEOs, or economists, or Wall Street analysts—are wrong about growth prospects for the U.S. economy or for some part of it.
When a company does demonstrate that the consensus on growth is wrong, the market jumps in surprise.
That’s exactly what happened with Lumber Liquidators (LL), one of the stocks I had named as a slow growth etc. pick. On October 24, the company beat third quarter Wall Street earnings projections by 12 cents a share (reporting 46 cents instead of 34 cents) and reported an 18.8% increase in revenue to $204 million versus the $189 million consensus. Lumber Liquidators then followed that up by raising guidance for 2012 to earnings of $1.53 to $1.59 a share (from a prior $1.30 to $1.42) and revenue of $791 million to $799 million from prior guidance of $750 million to $775 million.
The numbers further down the quarterly report weren’t too shabby either. Comparable store sales, for example, increased by 12% in the quarter driven by an 11.7% increase in store traffic. And while the company guided Wall Street to expect comparable store sales in the high single digits in the fourth quarter, management did note that the sweet spot of comparable sales growth—22%--at its stores came at stores open for 13 to 36 months. The company has been growing its store count in recent years—roughly 25 in 2012, for example, so Lumber Liquidators has a good pipeline of maturing stores to feed into its numbers.
To my regret, I didn’t add Lumber Liquidators to my Jubak’s Picks portfolio back on October 15 so the portfolio missed out on the October 24 pop to an all-time high. You’re obviously taking on more risk in buying near that high than 10% or 15% lower, but I think once a stock has taken out its previous high—which Lumber Liquidators did when it closed at $55.81 on October 24 (well above the September 14 closing high of $53.73)—shares often have solid momentum to go higher.
If you like that logic, I’d also recommend PulteGroup (PHM) from my slow growth etc list.
If you like even your slow growth surprises better after a pull back I’d recommend Costco (COST), which I added to Jubak’s Picks on October 24, and Dollar General (DG), which I’m adding today. The stocks were down 6.7% and 10.8%, respectively, from their September highs as of the close on October 24.
And if that second alternative appeals to you, you should take a look at super-weighting this end if the barbell with some of the technology stocks that have sold off recently. Unlike the S&P 500, which is still has 40 points or so to go to hit its 200-day moving, the technology-heavy NASDAQ Composite is just about to enter “oversold” territory. The index closed at 2981 on October 24 with the 200-day moving average just 9 points lower at 2972.
Now remember, you don’t want to buy just any depressed technology stock—although the entire sector will bounce together if we do get an oversold rally. What you’d like to find are technology stocks that have sold off on near term worries but that have fundamentally great growth stories. For that combo I’d look to the Apple/Samsung ecosystem stocks that I identified in my October 12 post http://jubakpicks.com/2012/10/12/profits-from-the-iphone-flow-to-more-stocks-than-just-apple-here-are-five-that-could-outperform-even-the-mother-ship/ I think these stocks have been living in fear of Apple’s (AAPL) October 25 earnings report since nobody knew what the company would report for the September quarter or what guidance it would issue for the December quarter (Apple has a tradition of low-balling guidance and certainly the company did cut guidance big time for the December quarter when it reported yesterday.)—and because no one knew what investor reaction to those numbers would be. Now that Apple’s numbers are behind us and the market has had a chance to react, I think it’s a reasonable time to add from a group that includes Qualcomm (QCOM), Broadcom (BRCM), Skyworks Solutions (SWKS), Avago Technologies (AVGO) and Tatsuta Electric Wire & Cable (5809.JP in Tokyo). I added Qualcomm to Jubak’s Picks http://jubakpicks.com/ on October 12.)
I’ve written about the other end of the barbell—China stocks—very recently so let me just summarize the argument I made in http://jubakpicks.com/2012/10/19/good-china-stocks-and-bad-china-stocks-and-how-to-use-them/ on October 19. I think we’re seeing reasonably convincing signs that the Chinese economy hit a growth bottom in the third quarter and that, in fact, September started to show a reacceleration from that low point of growth. In the early stages of a rally in China’s stock markets on hope, I suggested owning the big commodity and export names that Chinese traders would see as the best way to play a surge in stimulus from China’s government. Then, I suggested, as the rally on hope changed to a rally on evidence, I’d move to own domestically oriented Chinese stocks. That transition may be taking place faster than I expected since it now looks like the consensus in China is that growth is accelerating enough so that the People’s Bank won’t need to cut interest rates. In this environment I think some of the financial stocks such as AIA Group (1299.HK in Hong Kong or AAGIY in New York) or Ping An Insurance (2318.HK in Hong Kong or PNGAY in New York) look timelier than the commodity or industrial exporters.
The increasing belief that China’s economy did indeed put in its growth bottom in September—and the disappointment that the People’s Bank won’t cut interest rates—makes shares of commodity companies that export to China a better bet than Chinese commodity companies and exporters themselves.
Hence my recommendation to super-weight this end of the barbell with the shares of companies like BHP Billiton (BHP), an Australian commodity producer of just about everything, Peabody Energy (BTU), a U.S. coal producer with a big presence in Australia’s coal fields, copper-giant Freeport McMoRan Copper & Gold (FCX) and Brazil’s iron-ore producer Vale (VALE), which just reported a 66% drop in third quarter profits. Vale is the cheapest, BHP Billiton has some momentum, and Peabody has moved strongly to the upside recently. (Freeport McMoRan is already a member of my Jubak’s Picks portfolio.) Your decision will depend on how strong you think the recovery in China’s rate of growth will be. The stronger your projection, the more inclined you should be to go with the cheaper Vale.
And do I have to say it? A post-election disaster on the politics of the U.S. fiscal cliff would require a rethink of the U.S. end of this barbell at the least.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of AIA Group, Apple, Freeport McMoRan Copper & Gold, and Ping An Insurance as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/