Stupid Hats
Almost forgot that this is "Jobs Week" didn't you? In New York's Times Square, tourists from all over the world rang in the new year by standing in the cold rain for hours on end, so that they could watch an illuminated ball drop. Party!! Almost as much fun as taking down holiday decorations. Maybe even more productive than counting paper clips.
Actually, the fun was just starting. Shortly after the ball dropped came a bevy of December manufacturing PMIs that fell even harder. First, the Caixin survey for China showed that smaller manufacturers are slowing down alongside the larger firms covered by the CFLP. Then it was off to Europe where both Italy and France printed in the hole, as well. In fact, the only nation to put surprisingly impressive numbers to the tape overnight was the UK. Those crazy Brexiteers.
The unfortunate response to the evidence of reduced growth, and perhaps reduced demand across at least three of planet earth's nine largest economies, was an overt flight to safety. Yeah, that's right. Party. Those stupid hats? They hit the ground a few minutes after that ball made its descent. Global markets? Equity index futures? Oil? Still feeling around for an overnight floor that they can call their own.
Marking Time
The term to "mark time" is often used to describe the act of waiting. In the ranks, the term is the simplest of all drill commands: The order is to march in place while waiting for further instruction. What I make poor attempt to illustrate here for you is that the marking of time is not pointless. The one calling cadence might bark this command when noticing one of those in his or her charge to be "out of step." Those marching will, upon hearing this command, ensure that they themselves are indeed marching in step, while regaining their cover and alignment, which means spacing marchers 40 inches front to back, and four inches between the shoulders of adjacent marchers. Are you in step? Are your actions aligned with your intent?
From what I see, quite a few investors are simply marking time. That is fine, as long as the investor's state of inertia has not been provoked through panic, or perpetuated by fear. Every one of us needs to regain our cover and alignment from time to time. Everyone of us needs to alter course, to adjust... or else, like a group of marchers left unattended, we'll find ourselves a long way from our goals.
What better time to make sure that these goals are pursued with an appropriate mix of aggression balanced with finesse? Remember this, my young friends. Every one of us will err as we traverse the path ahead. Every one of us has made mistakes in our past due to the simple fact that we do not know everything. Our best defense against our own arrogance will be an impenetrable set of core disciplines.
Now, let us proceed. For to truly taste the joy of reaching our destination, we must also allow ourselves to experience with great elan, the victories and even the defeats of the journey itself.
Even the longest journey begins with a first step. You know that you are smart. You know that you can be a rock in a windstorm. We both know that confidence is key. Now, rock and roll.
Happy New Year
As I peruse the written thoughts of many smart ( and highly esteemed) people, I am mildly surprised by one commonality. Without naming names, expected GDP growth for 2019 is as varied as one might imagine, as are expectations for what the U.S. Treasury's 10-year note might eventually yield. Favored sectors? Spin the wheel, dude. Red or black.
The commonality that I mentioned? A whole lot of these kids expect to see sizable gains made in equity prices in the coming year. Quite a few look for increases of 20% for the S&P 500, a few a great deal more than that. Even the most cautious expect something in the neighborhood of a 10% positive move. Fanciful, if one asks me. Forgive me if I proceed slowly. Forgive me if I allow instinct to guide for now.
I do see a case for this group optimism. There are in fact, several catalysts. The Fed slows downs its trajectory for not only rate hikes, but for balance sheet management. Presidents Trump and Xi come to a deal that all agree is a win-win. While economic growth slows globally, the domestic economy chugs along nicely, and the S&P 500 somehow avoids anything resembling, or coming close to an earnings recession even though more than 40% of said earnings come from abroad.
Oh, and on top of that, as the rest of the planet enters into this expected worsening slowdown, their respective central banks do nothing that might be perceived as dovish... this way the U.S. dollar remains in orbit around the green planet. Yep, there certainly is a path. All we have to do is bat a thousand.
Conditions
The super, grooviest thing that I think U.S. equities have going for them right now is that they are undervalued according to both five-year and 10-year average forward looking P/E ratios. At 14.2x forward looking earnings, the S&P 500 is now priced a bit below the 10-year average, and about a mile and a half below the "free money-palooza" perverse conditions created by the Bernanke-Yellen years at the Fed. Those forward-looking valuations have been screaming ever lower for about three months now, despite third-quarter earnings results that reminded sports fans of the steroid era in baseball. Hmm, pretty good analogy for cause and effect there, Sarge. Oh, thank you.
Now, I have to be a bit brief here, because this article is at the point where it could become a sixty page thesis. I would love to do that for you, but the truth is that such an effort would likely bore the socks off of you. Here, however is my two cents.
In addition to the above mentioned conditions, add the current government shutdown, as well as an increased level of political risk as the U.S. legislature changes in complexion. Add to that, the fact that many folks have not yet taken a good look at how badly their retirement or brokerage accounts have been damaged. Those quarterly statements will hit residential mailboxes at just about the same time as the beefy credit card bills that newly confident consumers engaged in the building of during the month of December. Then for those of you who do your income taxes but once a year (most Americans), and happen to own homes in blue states, this spring will bring sticker shock, further eroding this recent confidence.
Sectors of Fire
Even in a risky environment, there will be places to take cover. We already know that fourth-quarter earnings are expected to show a significantly slower pace of growth from a record-setting third quarter. In fact, revenue across the S&P 500 are only expected to show growth of little more than 5% for the entire calendar year ahead.
Revenue growth is expected to end up around 8.9% for 2018 after Q4 results are done rolling in. The recent strength across the utility sector left that group in second place among the eleven for the year, despite the fact that the utilities experienced easily the slowest revenue growth over that time period. And despite the fact that these utilities are also the only sector expected to broadly experience outright contraction in revenue for Q4. Hmm. What else? The utilities, at least those among the S&P 500, are also one of only two sectors currently trading at forward looking P/Es that are above that group's five and 10-year averages. Ripe for the scalp? Perhaps, but after the fear is out of the marketplace, which it is obviously not.
Now, let's look at energy. The group turned in what has easily been the worst performance for 2018. The key underlying commodity lies in wreckage. OPEC tries to impact prices by announcing productions cuts. Smaller U.S. producers hit problems, as evidenced by both small-cap energy performance for both debt and equity alike. Energy stocks also trade at the deepest discount, in terms of forward looking P/Es, to the group's five and 10-year averages. This despite the fact that the group easily led all sectors in year-over-year revenue growth for the third quarter, and is projected to land in third place for Q4.
You all know that I had been adding to oil longs in late December. Was that smart? Well, I'll know the answer to that question down the road a bit. In the meantime, as long as the investor keys in on the larger names that engage in both exploration as well as production, then one can at least expect sizable dividend payments that not only rival that of more-defensive sectors, but actually beat them -- while one marks time, all the while exposing oneself to potential growth. Why? Because that's part of being diversified, and diversification is a core tenet of disciplined investment. On top of that, I think oil pops later in the year based on production cuts, inventory runoffs, and better-than-expected sustainable demand.
Just a Thought
What about health care? Does the risk increase after the Texas challenge to the ACA, or does this risk abate now that the Democrats take control over the House of Representatives? Perhaps. Obvious benefactors would be hospital stocks, as the focus possibly shifts from outright repeal to hopefully some kind of repair. Now, what happens to drug stocks? Merck (MRK) and Pfizer (PFE) finished the year as the top performers among the thirty constituents of the Dow Jones Industrial Average. Will the focus remain on pricing reform, or shift, as some think, toward coverage expansion?
That's not entirely up to Congress, as my thought here is that at least some drug prices are now visibly reaching the limits beyond the means of folks who truly need treatment. This is where the laws of elastic demand will, I believe, force drug companies to seek the expanded coverage route in greater size than what we have seen previously. This may end up benefiting not only consumers, but the companies themselves.
Pfizer was really a name that I meandered into for their (now recently increased) dividend. My other names in the space have both performed well -- Abbott Labs (ABT) -- and not so well -- Amgen (AMGN) -- for various reasons. Pfizer, though, not only may benefit from the changing environment, but from merging the firm's consumer health care business into a joint venture with GlaxoSmithkline (GSK) that will be 32% owned by Pfizer. This deal will reduce costs for both firms, and is expected to be accretive somewhat for Pfizer moving forward.
My thought is that it is probably okay to maintain a long position in Pfizer. The behavior appears stable. Downside risk is not what I would consider to be outsized, even after a good year. The 36-month beta stands at just 0.75. That combined with the 3.3% dividend yield make this, for me, a desirable position. Note, though, that the Pitchfork has not been strictly obeyed throughout the year, that the trend remains very much intact, while standard Fibonacci levels do appear playable for the short-to-medium-term crowd.
Pfizer
--Status: Add on dips.
--Target Price: $49
--Panic Point: $39
Trade Idea (minimal lots)
--Purchase 100 shares of PFE at or close to the last sale $43.65;
--Sell one PFE June $49 call (Last: $0.71) in order to reduce basis to $42.95. By then, dividend payments (next payment of $0.36 to shareholders of record on Feb. 1) should knock another $0.72 off of this investor's net basis.
Economics (All Times Eastern)
08:55 - Redbook (Weekly): Last 7.8% y/y.
09:45 - Markit Manufacturing PMI (Dec-F): Flashed 53.9.
