Choose Solid Blue Chips to Offset Volatility

 | Jan 27, 2014 | 9:00 AM EST  | Comments
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"Don't wait for extraordinary opportunities. Seize common occasions and make them great. Weak men wait for opportunities; strong men make them." -- Orison Swett Marten

 The early turmoil in the New Year from emerging markets hit domestic equities hard last week and U.S. markets had their worst performance on a weekly basis since June 2012. Emerging market currencies had their biggest selloff in five years and volatility from these regions could continue for a while.

Emerging market pullbacks are being triggered by uncertainty around the Federal Reserve's operations to start to remove liquidity from the market and concerns around slowing Chinese growth. This turmoil has started to shake some of the complacency out of a market that had been on 'auto pilot' for quite some time.

I think investors needed a bit of a wake-up call as the returns the market bequeathed them in the previous 12 months were simply unsustainable. The rally in 2013 carried equities about 30% higher in only an approximately 5% yearly rise in earnings.

With the Federal Reserve finally set to start the 'taper',  having this sort of multiple expansion continuing into 2014 was a bit of a pipe dream. My belief is that emerging markets still have a ways to pull back but at some point in the near future they will provide a great long-term entry point.

I also believe big iron and copper miners as well as other commodity plays could remain under pressure. Prudent investors should make a list of solid blue-chip plays that should remain unperturbed with additional emerging market turmoil. Here are a couple of these that sell significantly under the market multiple and have good dividend yields as well. Adding some shares if the downturn continues looks like an attractive strategy right now.

I added some more shares on Friday of Microsoft (MSFT). As I noted last week, the company just released its best earnings report in years. The company easily beat on the top and bottom line. Microsoft showed strength in the enterprise in server software as well as gained significant market share in the server visualization software space.

Microsoft's two "cloud" segments, Azure and Microsoft 365, were even more impressive. They are growing at 100% plus annual rates and each is doing more than $1 billion in annual sales. I think 2014 is the year the market starts to recognize this critical and fast-growing part of Microsoft's business, especially if new leadership does a better job highlighting these cloud initiatives.

Microsoft is also selling at just 12.5x forward earnings, which is a 20% discount to the overall market multiple. This does not account for the company's over $70 billion net cash and market securities hoard – about 25% of its market capitalization. Finally, the company has a higher credit rating (AAA) than the U.S. government and also pays a 3% dividend as well.

I also added to my position in ConocoPhillips (COP) during Friday's rout. The stock has pulled back some 10% from recent highs and crossed the 4% dividend yield threshold. The shares offer reasonable valuation at just over 10x forward earnings and 5x operating cash flow.

The company does have some overseas operations, most notably in Libya. However, it continues to allocate 60% of its capital budget into its North American properties -- which include significant acreage in the Permian, Eagle Ford and Bakken shale formations. Production from these sources should grow in the teens in the coming years.

These are two safe plays with reasonable valuations and solid dividend yields that make sense while we get through this turmoil coming from emerging markets. Some high-yield sectors like real estate investment trusts (REITs) could also benefit if interest rates continue to decline on this latest flight to quality. This will be the topic for Tuesday's column.

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