Investors have been feeling a lot of pain — which means they have two burning questions: Is this the cusp of a prolonged malaise that will send stocks even lower? If so, should I bail out now and move to cash?
The answer to both questions is "no." That's the take of stock newsletter gurus I consult at the end of each year for an outlook and favorite stocks. Why should you care what these newsletter writers think? Because they have great records. They've consistently ranked among the top 10 newsletters tracked by Hulbert Financial Digest, for years. Having a good record doesn't mean they will be right, of course. But it does suggest they're better at keeping their wits about them when so many investors are skittish and neurotic.
Chances are that stocks will finish 2019 significantly higher — perhaps with 8% gains. The basic reason for this: There's no recession on the horizon for 2019, and 2020 could be a good year for stocks as well since it's an election year. Markets often perform well in election years because politicians juice gains to win votes. Meanwhile, share valuations are starting to look attractive, especially in the eight favored names the stock-letter gurus single out below.
"Is the pullback telling us something? Or is it just a normal pullback after a good run. I think it is more of the latter," says George Putnam, a value investor who pens The Turnaround Report. "I wouldn't read too much into the current situation."
Putnam knows how tough it is to forecast recessions, and that steep market declines are often one of the best signals. But he also knows markets predict many more recessions than actually happen. Putnam cites the big market drawdown in 2011, which had many analysts forecasting a double-dip recession that never happened.
Meanwhile, John Buckingham, editor of the Prudent Speculator newsletter, points out that 10% drawdowns happen more than once a year, on average, and that even 20% pullbacks are fairly common. He thinks short-term moves get exaggerated now because so many investors have a trading mentality.
Take advantage of it the U.S. market's weakness, Buckingham says, because the selling has created "extraordinarily reasonable" valuations. Buckingham's logic is that profit growth, dividend growth and the economy will all be OK in 2019. "We don't think we are going to see recession for the foreseeable future. I'm very optimistic as we go into the new year," he says. Moreover, any recession that does happen over the next few years will be mild, and not the beginning of a multi-year malaise. One reason is that there are no euphoric excesses anywhere in the market or the economy — the kind of dynamic that often leads to a major train wreck for economic growth.
Kelley Wright, managing editor of IQ Trends, says investors could see a relief rally in January, and that 2019 will finish up about 8%. Part of his reasoning is that there will be no recession over the next two years. Wright thinks the Fed will be on pause in 2019, and that 2020 will bring a bull market because of the election year effect.
Next year won't be without problems. Putnam points out that many companies have a lot of debt that is coming due soon. "It may be hard for weaker companies to refinance their debt, particularly if the market remains volatile, which I expect." He won't single out suspects. But he expects trouble in the telecom and hospital sectors.
Favorite stocks for 2019
All three of these letter writers are adamant that the best approach to investing is to have a broadly diversified portfolio that you plan on holding for the long-term. But they agreed to single out a few favorite stocks and sectors.
With oil prices and the SPDR S&P Oil & Gas Exploration and Production exchange traded fund (XOP) down more than 40%, bargains abound in the energy sector. Giants like Exxon Mobil (XOM), Royal Dutch Shell (RDS/A), and Chevron (CVX) may look appealing, but Putnam likes to focus on smaller energy companies that have recently emerged from bankruptcy.
One reason is that smaller energy names are down a lot more than the large caps. But the ones recently out of bankruptcy see additional selling pressure from creditors who don't really want the newly issued stock they got as part of the reorganization. "Typically when a company comes out of bankruptcy the stock will trade badly for awhile because creditors are getting out," Putnam says.
Here, he cites Halcon Resources (HK), Bonanza Creek Energy (BCEI), and Midstates Petroleum (MPO). "They have very clean balance sheets. They are drilling in good areas. They have shareholder friendly boards. And they have been really beaten up since they came out of bankruptcy," Putnam says.
Technology stocks have been hammered in this pullback, especially semiconductor-related stocks such as former chip-sector darling NVIDIA (NVDA). "The massive decline more than discounts the modest downturn in the semiconductor cycle," Buckingham says.
This has created a shopper's paradise for value investors like Buckingham. He singles out Lam Research (LRCX), which supplies equipment used to make chips. It is down almost 50% from 52-week highs and it now trades for less than eight times forward earnings, which looks attractive to Buckingham.
Buckingham predicts that chip-sector growth will pick up again in 2020, and the market will start pricing that in during 2019. Lam Research has a strong balance sheet to power through, and investors currently get paid a 3.6% dividend yield while they wait for sentiment to improve on the group. Buckingham thinks the stock will recover to around $230 in time, a gain of 87% from recent levels of around $123.
A bank shot on e-commerce
As online sales continue to ramp up, so will demand for that boxes used to ship all the stuff people buy. This supports demand growth for the container board sold by WestRock (WRK), Buckingham says.
This stock is down on concerns about weak container board pricing and oversupply. But Buckingham thinks WestRock will post as much as 15% earnings growth next year, partly because of e-commerce-related demand. WestRock trades for less than eight times earnings and its yield currently tops 5%. Buckingham thinks the shares will eventually trade back up to the upper $70 range — more than double recent levels.
Discounted 'Dividend Aristocrats'
One way to gauge valuation is to track a company's dividend yield. Over two or three decades, the shares of quality blue-chip names continually trade down until their dividend yields hit the same ceiling. This repetitive high-yield signals an attractive valuation and a good entry point. (The higher the dividend yield, the cheaper the stock.)
Wright, at IQ Trends, uses this system to identify entry points for companies with strong balance sheets and long histories of raising dividends. The repetitive high-yield is where "investors in their collective wisdom have considered stocks undervalued," he says.
In the recent selloff, plenty of stocks look attractive in his system. For a solid mix of sectors, he singles out a bank, a drug company, and a consumer staples business. JPMorgan Chase (JPM) historically bottoms out when its yield hits 3.3%. It is there now. AbbVie (ABBV) looks cheap when its yield hits 4.5%. AbbVie's yield is above that level now, at around 5%. Altria (MO) looks cheap when its stock falls so much that its yield rises to 7%. The shares currently yield above 6.5%, which is close enough to make Altria a buy, Wright says.
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