I have never been one to make a lot of predictions, but I do believe it is both helpful and important to gather up our observations and apply our brain power to developing a picture of what the world is likely to look like in the future. The trends, themes, and "facts on the ground" that have informed our investment strategies do not obey the rules of the calendar, so turning the page to 2015 really provides us an opportunity to assess our game plan, rather than some signal to make major changes because the world has changed with the dropping of the ball in Times Square. So, here we go with some thoughts for the New Year.
As I have written previously, in order for the stock market to continue to do well, it will have to make the transition from being driven by higher price/earnings (P/E) ratios to being driven by higher earnings. The Federal Reserve's unprecedented monetary stimulus has kept interest rates at extremely low levels, and this has inflated P/E ratios as investors are willing to pay more for each dollar of future earnings. The Fed has stated that it will be watching the employment situation very closely in determining when to start raising interest rates. So, when we have seen much better than expected jobs numbers, the market has tended to sell off. This is the stock market in full-blown "Good news is bad news" mode. So, the Fed has already taken away the proverbial punch bowl of Quantitative Easing, and the next step will be the first in a round of interest hikes. The good news is that this will (we would assume) accompany a stronger economy that is producing more jobs and improved corporate earnings. That transition, though, is likely to give investors a very bumpy ride.
As I wrote in the last post, I am leaning toward the stronger economy thesis, and that could make the Consumer Discretionary sector an area worth our attention. My goal, though, is to find stocks that stand to benefit from long-term, secular trends; a stronger economy is just an added tailwind for those stocks. In fact, three of the stocks I mentioned last time--VISA (V, $259), Mastercard (MA, $84), and FedEx (FDX, $171)--are not even in the Consumer Discretionary sector, but do stand to benefit from a more robust economy (as well as from the longer term trends we considered). The fact that Disney (DIS, $93) had to turn away Christmas visitors to its Magic Kingdom in Orlando and Disneyland in California because the theme parks had reached maximum capacity is not, by itself, the basis for an investment, but there is a lot more to like about the company. ESPN, arguably, is the most important piece of Disney's business, with sporting events fast becoming the last remnant of watching live television broadcasts. And it is now less than a year until the release of the new Star Wars movie. Does it really make sense that Apple (AAPL, $108), with a market capitalization of $647 billion, is worth four times more than DIS (market capitalization of $160 billion)? This is not a knock against AAPL, which has developed the most ubiquitous piece of technology on the planet, the iPhone (if you don't believe that, just try having a conversation with someone who is incessantly checking their text messages). But DIS has Luke Skywalker, Mickey Mouse, the Marvel characters, Frozen, ESPN, and ABC all under its roof. That's quite a collection of assets, and while any movie studio can make an animated or live-action feature, only Disney can cast what are now Disney characters in films--and market them as toys, games, stuffed animals, etc. I have recently discovered that our grandson, whose favorite character has been Thomas the Train, is now a huge Mickey Mouse fan. So, I'll raise a glass to Mickey and live football games. Pass the Skittles and the Ro-Tel, please.
The organic orgy of healthier eating continues, even as I continue to enjoy one of my favorite comfort foods, the chili and tamales from Huey's here in Memphis. It's worth noting that long-time favorite holding Whole Foods Market (WFM, $50) is down 12% over the past year while Kroger (KR, $63) was up 61%. The latter seems to be doing everything right, while the former has suffered from the curse of familiarity and high expectations. WFM is actually up about 30% over the past three months after hitting a low of $36 in the summer, and while the stock may not return to its glory days, it still has room to grow. Two companies that make the healthier stuff are Hain Celestial (HAIN, $55; recently split two-for-one) and Whitewave Foods (WWAV, $34).
On the subject of health, pharmacy chain CVS has quit selling cigarettes and re-branded itself as CVS Health. I guess it doesn't make sense for the cashier to ask if you'd like a pack of Marlboro Reds to go with that Z-Pak prescription as you're coughing on all of the other customers in line. This is probably the future of health care, with nurse practitioners staffing the CVS walk-in Minute Clinic. I have some friends who visited their local CVS Minute Clinic when they came down with the flu, and I expect this to be a continuing trend. Another thing about CVS Health (CVS, $95) that I like is its strong dividend history--dividend growth, to be specific, an average annual dividend growth of 10% over the past twelve years. Although the yield is only about 1.4%, I much prefer dividend growth over high current yield. CVS pays out just 34% of earnings in dividends and is rated A+ by S&P.
Most people, it would seem, have devoted a majority of their attention to either loving or hating the Affordable Care Act (ACA, or "Obamacare"), and very little attention to figuring out what it actually means for the health care system. What it should mean is that more people in the population will have health insurance--and fewer people uninsured. For companies that deliver healthcare, that should mean more paying customers (even if it is the insurance doing the paying). A company such as HCA Holdings (HCA, $73), which operates hospitals and surgery centers, could see its bottom line enhanced by having fewer patients who can't pay. The problem, though, is that reimbursement issues could offset some of those positive effects. How it will all shake out is still somewhat murky,but the ACA is one of those "facts on the ground," and whether we love it or hate it, we need to watch closely for how it might affect our investments.
The ACA aside, there are other enduring trends and themes in healthcare that we have considered before. Reducing costs in the system is one of them, and that is why the generic drug companies continue to look interesting. We first looked at Actavis (ACT, $260) when it was known as Watson Pharmaceuticals, and the stock has had a stellar run since then. Shares are up some 300% over the past three years. Now it appears that ACT has beat out Valeant Pharmaceuticals (VRX, $144) in the bidding for Allergan (AGN, $212), the maker of Botox. While I would never recommend buying a stock on takeover speculation alone, I do suspect that a number of these specialty drug companies could be attractive acquisition candidates.
In future posts we'll continue to look at any number of stocks that should benefit from a stronger economy and improved incomes. A note of caution about the market here, though. Many of the stocks mentioned here have appreciated sharply over the course of this bull market, and they may be the very ones to fall the hardest in a meaningful sell-off. It is always important to view our money invested in stocks as being needed only for some distant tomorrow--that is, we shouldn't need those funds for at least three to five years. That allows us to take market declines in stride, without having to reach for the antacid. This long time horizon actually gives individual investors an edge, because we can sit tight while others panic. Things may get unpleasant, but they don't have to be deadly. And just how unpleasant could they get? Well, it is not unusual for the market to correct by 10% to 15% in the course of an ongoing bull market. A 15% decline in the Dow Jones Industrial Average from its recent high of around 18,000 would put the index just above 15,000. That would make some headlines. The market has started off 2015 with a bang, but the bang is a move down, so far. These may be some transitional labor pains, leading to the birth of a new market that is driven by a more robust economy and an improved employment picture that can break free of the midwife of Federal Reserve stimulus. And who doesn't hope for a healthy baby?
Life is short. Get busy. And Happy New Year!
Jim
Please post any comments or questions to the Comments section.
Disclosure/Disclaimer: My family members and/or I own shares of V, MA, FDX, DIS, AAPL, WFM, HAIN, WWAV, CVS, ACT, HCA, and VRX. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.
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