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  1. Home
  2. / Investing

It's Not as Dangerous as It Seems

The Fed event can actually be good for many stocks.
By JIM CRAMER Oct 29, 2014 | 12:42 PM EDT
Stocks quotes in this article: CLX, CELG, GILD, HPQ, WDC, MSFT, BABA, GOOGL, TWTR, FB, PH, ETN

On a day devoted to Federal Reserve madness, the bubble callers are out in spades. What do the bubble callers focus on?

There are bubbles out there. Investors are not being compensated enough for the risk of owning certain high-yield bonds, particularly the ones in the oil patch issued by companies that need higher oil prices in order to hit their numbers. That is the most dangerous part of the entire financial supermarket, because the upside is so limited, and the downside is totally unfathomable.

I also see a bubble in European bonds. It is absurd that the French 10-year treasury offers a yield that is almost half of the yield offered by the U.S. 10-year treasury. The parity between Spanish paper and U.S. paper is ridiculous, even preposterous.

The bubbles in equities are more like helium balloons that aren't tied well. Actual pockets of total overvaluation are at risk at the drop of a Fed hat. Linking Fed largesse to most of the stocks I follow just won't work. The profits won't be affected by much, and the valuations are often compressed, once you have taken into account that the Fed generosity ends.

Let me give you three classic examples of stocks that are supposed to be overvalued because of the Fed.

Clorox (CLX) is about to report a quarter that will show very little to no growth. Yet the stock sells at 22x next year's earnings. You would think that this is a quintessential overvalued stock, given that slow growth and that high price-to-earnings multiple. You can argue that what's supporting the company is a 3% yield, a much better return than treasurys, and that there would be many sellers for this $12 billion company when rates increase.

Will that be the case? First, Clorox is a tremendous innovator of new products, with some amazing franchises that are not subject to disruptive technology. Look at Brita Filters, for those who want to save the environment from endless plastic bottles. Look at Burt's Bees, the perfect natural and organic health care brand. I have recently judged a barbecue contest, and we had to disqualify a contestant because we thought the ribs were bathed in Clorox's KC Masterpiece. I buy Glad bags at Costco. SOS, Liquid-Plumr, Formula 409,  Tilex, and Pine-Sol are underneath my sink. Would anyone use anything but Kingsford charcoal for a barbecue? It's like Kleenex.

Don't forget the most amazing product of all: Clorox itself and its derivatives. Clorox is the preferred CDC way to kill Ebola. Why? Clorox kills everything. The stuff is just lethal to bad germs and viruses.

If this stock gets hit hard when it reports, will you want to sell it? I think people will want to buy it, because of the brands and the cash generation. The stock won't be a big casualty of the end of a Federal bond-buying program. I think Clorox is more likely to be snapped up by a consumer brand company that's larger than be sold down hard. Even if the Fed take rates up eight times, you will still want Clorox, because a recession is just the right time to buy this darned stock.

The second group of overvalued stocks is biotechnology. Celgene (CELG) is up 25% year-to-date and is at its all-time high. That makes it a prime candidate to be assaulted by Fed's alleged new-found toughness. But Celgene has breakthrough products, such as a new psoriatic arthritis therapy, coupled with a pancreatic cancer drug and its amazing Revlimid blood cancer franchise. It also has a potential drug that can treat Crohn's disease.

Meanwhile, Celgene owns stakes in a dozen smaller biotechs that it can snatch up if they incubate something that could be a homerun. It has bought back 100 million shares in the last three years, because of its bountiful cash flow to leave share count at 830 million, giving it an astronomical $84 billion valuation. There is a huge "but." Celgene should be able to earn north of $6.50 on 2016, a typical outyear use to value this kind of stock.  

Celgene has about 18 % growth and sells at about 17x 2016 earnings. That is not expensive. Maybe it is, compared to Gilead (GILD), a $168-billion company that sells at less than 10x 2016 earnings. Gilead has a 16% growth rate that's accelerating rapidly because of its hepatitis C cure. Another company could always come in and take share away from Gilead, but it hasn't happened yet.

What about those stretched, smaller biotechs? The big pharmas (Merck, Pfizer, Lilly, Sanofi or Glaxo) are kicking the tires on any of them who has any promising drugs in phase three production. Maybe one of these little biotechs is working on a cure for Ebola. This might be speculative, but it would clearly drive the stock up. Short them on some Cleveland Fed head's pronouncement. Bet against them if Dallas Fed president Dick Fisher says the Fed's doing the wrong thing. Good luck.

Finally, technology is sector that is often regarded as a bubble. Let's look at old tech first. Hewlett-Packard (HPQ) sells at 9x earnings. That's the cheapest big-cap stock in the S&P 500. Western Digital (WDC), which has just reported a light quarter last night and rallied anyway, sells at 11x earnings. Microsoft (MSFT), with a huge buyback, big dividend, and 12% revenue growth, sells at 16x earnings. What are you going to do? Knock that one back to 14x earnings? Why should its business be hurt by the Fed? I can't see it.

Let's look at the Internet companies. Almost every firm rolled out coverage of Alibaba (BABA) with a buy today. Why not? It has a 40% growth rate but sells at less than 40x 2016 earnings estimates, and I think that is too low. Should the greatest growth retailer in the world sell at less than 1x its growth rate? Sure? It became public well below that. However, what are you supposed to pay for the best of the best? I think that this one will be bought all the way down if the Fed tightens hard, because it is a worldwide growth company.

Let's look at Google (GOOGL). That monster sells at 14x earnings. How is that dangerous? There is discipline. When stocks such as this disappoint, they are crushed. We saw this with both Twitter (TWTR) and Facebook (FB). They are punished. They can get punished some more. So can the cloud stocks, if they also disappoint. The reason you should like these stocks, to begin with, is the fact that they are not sensitive to rates.

You could argue that I am leaving out the most dangerous area of all: industrials. Won't they get crushed by the Fed? Sure, but that's why they were down so hard going into this reporting period. They have sprung back to life hard, as we saw yesterday with Parker Hannifin (PH) and today with Eaton (ETN). Sure, their earnings will be slowed, but they aren't going away. These companies are lean, mean machines, because of restructuring during the great recession. Once there are signs of growth in residential construction, for example, you would see an explosion in earnings.

I am not even counting the biggest area of the stock market: the financials. Why? Because they actually benefit from rate hikes.

There are concerns about what the Fed will do. So many stocks are poised for dramatic tightenings, when we are probably going to get something benign from the Fed. Just be careful. It is not as dangerous out there as it seems.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

Action Alerts PLUS, which Cramer co-manages as a charitable trust, is
long GOOGL, TWTR, FB, ETN, and MSFT.

TAGS: Investing | U.S. Equity | Stocks

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