When the going gets tough, the tough go shopping. And that’s just what most members of the Barron’s Roundtable have been doing amid the stock market’s historic, coronavirus-instigated rout.
As stock prices have plummeted by more than 25%, ending a mostly glorious 11-year bull run, our investment experts say they’re snapping up names they never thought they’d be able to buy so cheaply, along with more shares of companies like Walt Disney (DIS) that they already own and love.
That’s not to say that any of our 10 seers has an especially sanguine view of the economic outlook, as the U.S. braces for what will almost surely be a larger health crisis and a reordering of public life. Most think a recession is a near certainty as both the manufacturing and service sectors retrench, although the duration and severity of a downturn are unsure. As for the stock market’s future trajectory, as Roundtable member Henry Ellenbogen of Durable Capital Partners puts it, “If anyone tells you they know where the market will bottom, stop listening.”
Here’s a look at what our panelists are buying, and what they think about the bigger picture.
Q: The markets are a mess, Scott. What’s an investor to do?
A: Scott Black: If you own good-quality stocks, don’t sell. Take the long view. Stocks have compounded nicely over time. By the same token, if you have cash on the sidelines, the tsunami hasn’t ended. Keep your money in a short-term Treasury fund, and I emphasize Treasury. Don’t put it in a non-Treasury money-market fund because there could be defaults.
China will have negative growth in gross domestic product in the first or second quarter. A lot of people are positing the U.S. will have 1% real growth for the full year, but it is impossible to know. I initially expected S&P 500 index (.SPX) profits to rise only 6% this year, while S&P itself expected operating earnings to be up 10.5%. Now, we will be fortunate if earnings are flat at around last year’s $157. I expect earnings to fall, especially as energy-sector earnings will probably be negative.
Q: Are you buying amid the rout?
A: I bought Oracle (ORCL) because it has only 15% exposure to Asia. The stock was selling for 11½ times the next 12 months’ expected earnings. This factors in about 2% to 3% revenue growth, and 6% profit growth. Oracle bought back more than $10 billion of stock in the first six months of the current fiscal year. The company generates nothing but free cash. It is trading at the lowest price/earnings multiple in years.
I missed United Parcel Service (UPS) on the way up, when shares reached $125. I have been buying recently at an average price of $90. UPS is trading between 11 and 12 times expected earnings, down from a P/E multiple of 15 to 18 times. If people have to stay home, they shop on Amazon.com (AMZN). UPS has an exclusive delivery deal with Amazon.
We also bought two companies that could be recession-resistant. Merck (MRK) has a blockbuster drug in Keytruda, with $14 billion in annualized sales. Merck isn’t a runaway train, but will probably grow earnings 6% or 7% this year and has a 13 P/E. And, we bought Novartis (NVS) The P/E multiple is 13-plus. The company has three relatively new drugs with more than $1 billion in annualized revenue. You don’t get to buy Merck and Novartis with a 13-handle very often. They generate lots of free cash.
Q: In January, you recommended Royal Caribbean (RCL), down about 75% since then. Have you sold?
A: I probably should have exited a long time ago, but didn’t.
Q: What are the economic implications of the coronavirus?
A: Todd Ahlsten: We are in an earnings recession, with a very high probability of an economic recession. Whether you are a small business owner, in hospitality, airlines, or retail, or have leverage, the fallout from the virus] exposes those weaknesses. Financial stress will be high. Banks and home equity are in better shape than in 2008, but if activity temporarily goes to zero for small businesses, layoffs will hit, and that will hit consumer balance sheets.
Q: You were cautious about the market at the Roundtable. Now what?
A: The S&P 500 bottomed in December 2018 around 2350, when there was a high probability of a recession. We can see the market rewinding the gains of last year and going back to where it was on Christmas Eve 2018. We will know more in 30 to 60 days on the virus, but if earnings come down 10% or more this year, you can look at December 2018 [levels] and haircut them 10% to 20% for a framework of where the downside risk could be. The airline industry and mall-based retailing—and also the energy patch—will have massive earnings reductions. There is going to be an earnings crater.
Q: Where is monetary policy headed?
A: There’s a high probability of a 50-basis-point [half-percentage point] U.S. interest rate cut this coming week, and rates could be zero by April. There could be dire consequences for European banks, which have been making money off positive U.S. rates.
Q: Are you buying any stocks now?
A: We still own all our Roundtable picks and bought more of stocks like Deere (DE) and Comcast (CMCSA). They have an excellent three-year view. As for new names, we think about earnings power over three to 10 years and want long-term winners in secular growth businesses with wide moats. Applied Materials (AMAT) is a leading supplier of semiconductor fab equipment. The stock cratered. Data centers and the internet are going to suck down a lot of energy, and we need to get performance per watt way up. Applied Materials is a part of that. Over the next three to 10 years, there is a lot of earnings growth. Short term, there will be lowered earnings expectations.
Q: Are you finding any bargains in the rubble, Meryl?
A: Meryl Witmer: We have been putting cash to work. At the start of the year, everything seemed priced for where it should trade in two years. We use an 8% to 9% discount rate, which implied everything should have been 15% to 20% lower—and here we are. It is interesting to see the theory of value investing play out.
Q: At long last.
A: Charles Schwab (SCHW) is something we’re buying. It is sensitive to net interest income, which will be lower, but Schwab is a good company that tries to delight the customer. We think it will close its acquisition of TD Ameritrade Holding (AMTD) relatively soon, which is good. We looked at the stock before the deal and thought it was too expensive around $40. Then it went to $50, and now it is $33. We are excited by that. Schwab has at least $3 a share of earnings power over the next few years. And, it might benefit from the trouble Robinhood has had.
We’re also buying Phillips 66 (PSX). It has a refining business, midstream assets, gas stations, and convenience stores, and a business that makes plastics from natural gas. That division is underearning now, but will tighten up in the next few years. We expect Phillips to have $10 of earnings power. We started buying it around $70; now, it’s $55, and we continue to buy. We think we’ll be quite delighted. Phillips has a good balance sheet and a good capital allocator in its CEO.
Q: Anything else?
A: We bought Ingevity (NGVT) when it was spun out of WestRock (WRK) in 2016 at $25 a share. It went up to $115. We sold it. Now it is $39. I never thought we’d get a second bite. Ingevity makes activated carbon, used in automobiles to absorb gas fumes. Every car in the U.S. must have a system that absorbs gas fumes. The company also makes specialty chemicals from tall oil, a byproduct of paper manufacturing. They are used in adhesives, oil drilling, pavements, and other things. On the activated carbon side, there is a growth engine built in, due to more stringent regulations rolling out in the U.S. China and Brazil have also upped their regulations. Earnings could grow from around $5 this year to more than $6 in a couple of years.
Q: What lies ahead, Bill?
A: William Priest: At year end, we were looking at fading concerns and modest market returns. By March 9, everything had changed as the spread of the virus accelerated outside China. If it spreads through the end of March, a recession is almost a given. But recessions aren’t the end of the world; they have happened before. The question is, how do you fight this? Monetary policy isn’t going to work here. We need fiscal-policy solutions. Modern monetary theory is coming. We are going to evolve from a Milton Friedman world to something very different. Quantitative easing was the forerunner.
Q: What do you mean, exactly?
A: Under the Friedman model, the central bank would create reserves that the commercial banking system could take down to make loans. Through that mechanism, investments would be made and the economy would grow. And vice versa: If there was too much inflation, you took money out of the system. That model is going away. You will see the central bank working much more closely with the Treasury to allow cheap financing of fiscal budgets. Commercial banks’ role in money creation will diminish.
If I were president, I would announce a major infrastructure plan. If you announce a trillion-dollar plan, that’s almost 5% of GDP, financed extremely cheaply. It would be hard politically to get this done without a recession, but it could be a big positive. The recession could be mild.
Q: What’s your outlook for bonds?
A: Unless we get a significant amount of inflation, I don’t see the bond market deteriorating much. The credit markets are where I’d spend a lot of worry. Leverage in the system is huge, and is kind of covered up. There is a desire on the part of many institutions to avoid mark-to-market; they love mark-to-model. I’m talking about venture capital, private debt, private equity.
Q: Do any stocks appeal to you now?
A: I recommended Walt Disney at the January Roundtable. It has gotten smoked, down about 35% since then. I still like it.
And I still think some health-care names will be good. Centene (CNC) and UnitedHealth Group (UNH) are two big holdings we continue to like. Merck (MRK) is a big player in vaccines; it potentially could be a winner. Amgen (AMGN), which is big in biologics, is another potential winner. Also, the financial exchanges are likely to do well. I own a lot of CME Group (CME). It tends to protect you when the market is selling off, and is almost a diversifier when the market goes up. It’s a great company.
Rupal J. Bhansali
Q: How does the current crisis compare with 2008?
A: Rupal J. Bhansali: On one hand, it is worse than 2008, which was isolated to the housing sector with some spillover to the mortgage-backed securities market. This slowdown—and the hit—are more widespread. Many companies have taken on a lot of debt in the past 10 years, as the cost of debt servicing was manageable. But debt has to be repaid and refinanced. That will be exposed in this cycle. The Fed could rescue the banks in 2008. It can’t rescue the corporate sector, so the pain will be more widespread among the investor base.
A recession is inevitable, in my view. Markets weren’t paying attention to the risks of the corporate debt binge, which I’ve been flagging for a while. A setback like this reveals the fragility of the corporate structure—and it is worldwide.
Q: Do you see a continued flight to bonds?
A: It isn’t surprising to see investors rotate out of risk assets into safe ones, with U.S. Treasuries as the key beneficiary. It feels like a crowded trade. Any respite in the health crisis, either through a cure for the virus, a vaccine, or containment of new cases, could cause Treasuries to sell off, as investors reallocate to riskier assets.
Q: What should investors do?
A: I am finding buying opportunities in the consumer-discretionary sector, while consumer staples feel overvalued. The No. 1 priority is to review your portfolio and see which companies are most exposed: those with high fixed costs and volatile revenue streams. Airlines come to mind. Investors’ first concern tends to be earnings risk. At times like this, they should first think about balance-sheet risk. Earnings will be hit because there will be a global economic slowdown, but companies with strong balance sheets, preferably net cash, and resilient business models could see that demand for their products and services is secure, even if it is delayed.
The other big risk is illiquidity. In Europe, a lot of exchange-traded funds are trading at discounts to net asset value, which has fallen. This suggests people think the underlying assets can’t be liquidated. It’s particularly true in the bond market, but also the equity market. In addition, watch the high-yield market, a leading indicator for equities that tends to be a good barometer of stress in the system.
Q: Have we hit bottom yet?
A: Henry Ellenbogen: If anyone tells you they know where the market will bottom, stop listening. The bull market was approaching its 11th anniversary. Valuations were extended. We knew we were going to have a down market, but not what would cause it. Now we know it was caused by uncertainty about three factors: the duration of the virus, its near- and longer-term impact on the economy, and a divided political environment in an election year. The market is wrestling with the first two; there is a wide range of possible outcomes. With the election, at least, there is time certainty.
The market is starting to get attractive. I’m spending a lot of time thinking about what companies we want to own on the other side of this. Which will be the leaders? Currently, all stocks are being treated similarly. But all companies aren’t going to come out the same way. We have a shopping list, and we are buying.
Q: What have you snagged?
A: Quaker Chemical (KWR) is a cyclical company with a good balance sheet. It entered the downturn strong and will exit stronger, but the range of earnings in the next two years is uncertain. Quaker sells chemicals and lubricants to global industries. It has service professionals on-site at its largest customers, helping to ensure they run efficiently. The company has a high-90% customer retention rate.
Quaker recently merged with Houghton International, creating the market leader. Yet it has only a 15% market share. The deal synergies are significant. Quaker has created a global operating platform to do acquisitions. The company is tied to global GDP and tends to outpace it. It generates good cash flow, and will benefit significantly from lower oil prices, which will somewhat offset the decline in global GDP.
We also bought West Pharmaceutical Services (WST). It is a more stable business with a strong balance sheet that has good earnings visibility and will exit the downturn stronger. West makes containers for drugs, in particular biologics, contained in a liquid. It has a more-than-70% market share in stoppers for liquid drug containers. The cost of what West does is less than 1% of the product’s price. It is the global market leader and continues to gain share in biologics, a segment growing faster than the drug industry. The traditional business was around the stoppers, but increasingly the company has moved up the value chain to sell a whole solution, driving faster revenue growth, profit margins, and return on capital. West has no debt. There might be attractive acquisition opportunities for it, as well.
Q: How does the economy look to you?
A: Sonal Desai: For the full year, U.S. real GDP could be 2% to 2.25% (versus 2.5% to 2.75% estimated in January). Regarding the virus, people tend to be healthier [here] than in China, so it’s a better starting point. [We have a] younger population, relative to Italy. And, the Federal Reserve has cut rates and is likely to cut again. If I’m correct, the economy is set up for a recovery, and the global economy is slowly coming back. That’s why we don’t see a global meltdown similar to the financial crisis. This might be a different kind of panic that has a lot to do with starting [equity] valuations.
Q: Where is the U.S. dollar headed?
A: The euro zone is likely to be weaker in recovering than the U.S. I expect the European Central Bank to be accommodative for longer. I prefer the dollar to the euro, but I like the Japanese yen against the dollar. The yen makes a good hedge. In periods of risk aversion, Japanese investors bring money home, causing the yen to appreciate.
Q: What about the bond market?
A: I expect Treasuries to be well-supported until we get greater clarity on the U.S. fiscal policy response—and some visibility on how Covid-19 evolves in the U.S. Corporate bonds will remain stressed. We look for companies that have good balance sheets and liquidity to withstand this uncertainty.
I’m not buying right now, but looking carefully. My high-yield debt team was concerned coming into the year about how much spreads in BB-rated credits had contracted. Now, as they are beginning to blow out, we may find opportunities. We are looking for segments of the market that should be relatively immune to the current environment—for example, pay TV.
Q: Is this selloff overdone?
A: James Anderson: Despite the human damage [from the virus], it is hard to understand among the companies we own why the present value of future cash flows has collapsed as much as it has. I can understand why companies with balance-sheet issues might have big problems.
Kering (PPRUF), the luxury-goods company, was one of my January picks. They will have a difficult six to nine months, but the present price discounts future progress in a questionable manner. Spotify Technology (SPOT) is even stranger because its business this year won’t be particularly affected. If we’re all spending more time at home, we’ll probably listen to more music, not less.
My two Chinese picks— Meituan Dianping (MPNG) and Alibaba Group Holding (BABA)—aren’t wholly immune, but the perception is that the willingness to tolerate this period has been greater among Chinese companies than in the West. And, ASML Holding’s (ASML) long-run dominance in its business and its level of profitability make it something one shouldn’t worry about.
Finally, this crisis will reinforce the power of Tesla’s (TSLA) position because the traditional car companies, with their low returns, and in many cases vulnerable balance sheets, could be in trouble if the crisis persists for more than a month or two. I don’t see, and Tesla doesn’t see, the plunge in oil prices as a threat to their business. People buy Teslas because they are great cars.
Q: Do any new names tempt you?
A: I am intrigued by Illumina (ILMN). It is hard to argue that we are going to do less gene sequencing than before the virus crisis. The drop in Illumina’s share price [about 30% this year] has put it back on the list of names I find attractive.
Q: What do you make of the policy responses put forth to quell the crisis?
A: I’m not sure cutting interest rates makes much difference. We need to think about a much deeper change in fiscal policy. Governments should borrow more money if they can borrow with nominal and real rates at such low levels. It is the ideal time to invest heavily globally in green renewable energy programs.
Q: Is there any reason for cheer?
A: Mario Gabelli: We assume there will be a pretty sharp correction in economic activity in March, April, and May. If we come up with a Covid-19 solution that will be visible in the summer and implemented in 2021, comparisons will be better next year. I assume governments of the world will put a substantial amount of money into the system, and that the Russians and Saudis will come to an oil agreement in July or August.
Q: Should investors buy, sell, or wait?
A: If I’m a taxable client, I can’t buy a 10-year Treasury bond at current low rates. I have to rebalance my portfolio from fixed income to equities. In January, I offered several plays on alternative renewable energy, including Avangrid (AGR), controlled by Iberdrola (IBDRY), and NextEra Energy Partners (NEP). We’re buying them now.
I’ve been buying Liberty Braves (BATRA), which has fallen sharply, though stadiums will be shut for several months. Also, I’m looking at equipment-rental companies that could benefit from an infrastructure bill. I recommended Herc Holdings (HRI) a couple of times. It went from $28 to the $50s three times since it was spun out of Hertz Global Holdings (HTZ). Now, it’s back to $26. Crane (CR) is another infrastructure company I own. It has come down sharply; I’ve been nibbling every day.
Abby Joseph Cohen
Q: What lies ahead for the U.S.?
A: Abby Joseph Cohen: As of a few days ago, [Goldman Sachs] expected first-quarter real GDP growth of 0.7%, zero in the second quarter, 1% in the third, and 1.2% for the full year. For China, the GDP estimate is 5.5%, and for global growth, 2.6%. The concern I have here is consumer and business confidence. That’s why a response from government officials is essential.
Q: Are you worried about a financial crisis?
A: One concern is the oil patch: The energy majors, according to analysis from our team, will be fine with oil at $40 a barrel. That gives them enough cash flow; they can pay dividends. The real crunch is going to come for smaller operators and fracking operators, some of which need $50 to $60 oil.
The leverage in the system is nowhere near where it was before the financial crisis. While there could be pockets of credit-related problems because underlying businesses aren’t doing well, we don’t see this as a financial crisis. We see this as a health crisis. When people feel calmer because the worst of the health news has passed or they feel government is doing the right things, we’ll start to see different behaviors.
Q: What about the stock market?
A: We could be bouncing along at extremely attractive valuations for a while because investors are looking for a catalyst to move up. The catalyst will be the worst health news passing. If it takes four to six weeks to get to the peak of new reported [virus] cases, we are talking about things maybe looking better in April for communities afflicted now. Things could begin to look better in the third quarter, and, by the fourth quarter, economic data should look better.
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