The market is slowly grinding higher but it feels like the rally could peter out in the weeks ahead. February is traditionally a weak month for equities, and breadth of the sectors rallying is narrowing. It would be natural if the market took a breather while it consolidates its significant gains over the first six weeks of the year. In addition, we have the upcoming sequester cuts to get through and we need to assess the slowdown in consumer spending from the payroll tax holiday that expired at the end of last year. I continue to underweight consumer discretionary stocks due to this headwind as well as the implementation of the Affordable Care Act, which could raise costs and reduce margins for a wide swath of retailers and restaurants. The push to raise the minimum wage to $9 an hour will not help sentiment on this sector, either.
Unlike the average consumer, farmers are doing very well. 2012 was a stellar year for farm income due to the abundant issuance of crop insurance that mitigated the damage done by the massive drought over the summer, and crop prices were strong. The U.S. Department of Agriculture just came out with a report saying it believes 2013 will be the best year for farm income since 1973. Midwest farmland prices are also at record levels, rising 16% year over year in the fourth quarter alone (Notation 2). The balance sheets and income prospects for farmers have rarely been in better shape.
I will be rotating some of the money made on some my consumer discretionary picks as options expire today and next month into companies that serve the American farmer. One stock I will be adding to is Deere & Co. (DE). This iconic farm-equipment maker reported earnings this week that easily beat estimates by a quarter per share but the stock fell because of disappointing guidance. The company's guidance was based on an assumption that cash receipts for crops in the U.S. will fall almost 2% in 2013, which contradicts the USDA forecast and should prove to be overly conservative.
The just-completed quarter showed solid strength in North America farm-equipment sales. Surprisingly, the company did not see a significant gain from the construction market (just under 20% of overall sales). This should change over in the coming quarter as the housing market and commercial construction continue to improve. Both Jefferies & Co. and Credit Suisse raised their earnings estimates on the stock after the company reported results. I would look for other analysts to follow suit in the weeks ahead.
Deere sells at just 11x 2013's current earnings projections. The company has a solid balance sheet and the stock yields 2%.
Finally, the company has managed well through the ups and downs of the last decade. It has increased revenues at just under a 10% compound annual growth rate over the last nine years and has grown earnings per share at more than 20% CAGR over that same period.