Ed Hyman, one of the best economic forecasters in the business, says he doesn't expect a U.S. recession for at least another three years.
In contrast, money managers describe the economy as "late cycle." So they're selling hard, trying to avoid being the last ones out the door.
In the background, insiders at companies continue to buy aggressively, especially relative to selling, a particularly bullish signal according to Vickers Insider Weekly.
Whom to believe?
I'm going with Ed Hyman and the insiders. My logic is simple.
Hyman, an economist at Evercore ISI, has been ranked No. 1 in economics for 38 years running in surveys by Institutional Investor. Insiders know the business world better than anyone else on the planet, since they have the front-row seats. The majority of money managers consistently lag the market. So I think the question of who might be right is a no-brainer.
A little drill down on insider activity supports the bullish case for stocks here. Insiders are shunning the defensive names that the crowd in the market and many strategists now favor, outside of a few like Tyson Foods (TSN), J.M. Smucker (SJM), and Sprouts Farmers Market (SFM). And insiders are particularly bullish on the cyclical sectors getting hit the hardest: energy, chemicals, industrials, auto parts and tech. This array of preferences by insiders reinforces the contrarian nature of their bullish call right now.
One of the cyclical areas they favor the most is also one area hit the hardest, or housing-related names. The SPDR S&P Homebuilders (XHB) exchange traded fund, which holds home builders and home-related retailers, is down 30.7% from its peak this year, compared with an 18% decline for the S&P 500 Index (.SPX).
Because insiders like this group so much, I recently suggested a dozen home-related retailers and building suppliers in my stock newsletter, Brush Up on Stocks. The two largest-cap names in the group I just suggested are Home Depot (HD) and Lowe's Cos. (LOW). Both look like solid buys in the current weakness.
Home Depot and Lowe's are two very different companies even if they are in the same space. The first one rules the sector because its business is humming like an efficient machine, though there's room to make it better. Lowe's has been a broken fixer-upper for years. But it is finally getting the attention it needs, under new management.
Before we get to more details on Home Depot and Lowe's, let's take a look at the big-picture reasons why they look attractive, even though investors hate them.
- Employment and consumer confidence remain strong. This supports retail and home-improvement spending.
- There's always a home repair to do somewhere. Investors worry about a slowdown in home sales because rising mortgage rates hurt affordability. They are right to worry. But even in a slowdown, which is happening, home repairs continue to pile up. Houses in the U.S. are 40 years old, on average. If anyone does back away from buying a new home to trade up, they're probably going to do some remodeling. And sales of older (existing) homes is a much bigger part of the mix now compared with new homes, says Goldman Sachs analyst Kwaku Abrokwah. This also supports spending on remodeling.
- Home prices will continue to rise. This makes people feel richer, so they are more apt to fund renovations. Outside of the financial crisis, home prices have pretty much always kept rising even during recessions, points out T.J. Thornton, the head of U.S. equity-product management at Jefferies.
In short, consumers will continue to spend on home improvement, which helps Home Depot and Lowe's a lot. Remodeling is more important to Home Depot and Lowe's than home sales, yet investors are dumping these two along with the home builders because of the slowdown in home sales. That doesn't make sense.
"We feel really good about the macro environment for home improvement," Lowe's CEO Marvin Ellison said in a recent call with investors. Likewise, Home Depot recently told analysts in early December it sees no signs that the slowing housing market has impacted sales, Stifel analyst John Baugh wrote in a recent note. He has a $200 price target on Home Depot.
Here's one more positive: These two are in a large, fragmented sector. So they can continue to grow by taking market share. The sector does $900 billion in annual revenue. Yet Home Depot and Lowe's account for less than $200 billion of that. There's $700 billion in market share up for grabs.
Home Depot is the world's largest home-improvement retailer. It's spent a lot of time in recent years improving its distribution system and logistics. So it is a pretty well-run company. This helps explain why comparable-store sales grew 4.8% in the third quarter, and overall revenue was up 5.1%.
Home Depot still has room for improvement. It's been upgrading its website to compete with Amazon.com (AMZN). Progress here explains why online sales grew 28% in the third quarter. Retailers overall continue to figure out the online game and get more like Amazon.com, and Home Depot is a good example of this. In the background, Home Depot is improving delivery speeds, including for large, bulky items.
Lowe's needs some home improvement of its own. Its sales-per-square-foot productivity is 30% below Home Depot's, notes Deutsche Bank analyst Mike Baker. Comparable-store sales growth is much lower than at Home Depot, or 1.5% in the third quarter vs. 4.8%.
But it looks like Lowe's is getting the help it needs. And this should boost the stock considerably over the next year or two. The company has a whole new top layer of management since July, including CEO Ellison, who brings experience from his time at Home Depot. Lowe's has also brought in new board members.
The new leaders at Lowe's spent the first several months on the job getting their footing and figuring out what is wrong with the company. They recently began to make changes.
They're closing less-productive stores. They've cleaned out $500 million worth of inventory at a 40% discount to exit slow-moving items and focus on more popular and more profitable items — a "reset" of the business. Lowe's is bringing in powerful brands like Craftsman in tools. It is also improving logistics and distribution to eliminate the chain's ongoing issue of being out of stock in too many items too often.
"Rather than trying to chase quick fixes, we want to fix it at the root, and we think we're doing that," CEO Ellison said in the third quarter conference call. "And that's why we believe that, going into 2019, you'll see this company start to have sustainable improvement month over month, quarter over quarter."
What about homebuilders?
Deutsche Bank analyst Nishu Sood recently published a note saying investors should favor homebuilders in the more affordable, entry-level end of that market. That's a contrarian view. (Goldman Sachs, for example, favors homebuilders serving more affluent buyers, like Toll Brothers (TOL)).
But this contrarian view is supported by insiders. Home-building company insiders are generally shunning their own shares with two exceptions: Beazer Homes (BZH) and Meritage Homes (MTH). Both have a big presence in entry-level homes with lower price tags.
Sood argues that this end of the market will be the strongest because first-time home buying is more need-driven than discretionary trade-up buying. The urge to trade up is stifled by rising mortgage rates, since that means swapping a cheaper mortgage for a pricier one. There's also less supply in the entry-level market.
And ongoing monster rent hikes in many parts of the country also nudge people toward home purchases, says Matt Watson, portfolio manager for James Advantage Funds (GLRBX).
Beazer Homes and Meritage Homes look cheap enough to buy. Homebuilders begin to look attractive when they trade below one times book value, says Alvaro Lacayo, who covers the sector at Gabelli & Co. Beazer Homes trades at half of book value, and Meritage Homes goes for 0.9 times book.
Like the homes these two companies sell, their shares are inexpensive.
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested HD, LOW, BZH and MTH in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist Group, and he attended Columbia Business School in the Knight-Bagehot program.
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