Rising short-term interest rates and a flattening yield curve have boosted volatility in recent months. We asked 3 Fidelity portfolio managers if they thought December's selloffs left some dividend-paying stocks presenting compelling values, even after the market's 2019 bounce. Their answer: yes—in a wide variety of sectors.
A mall operator priced for bad news
Adam Kramer is the lead manager of Fidelity Multi-Asset Income Fund (FMSDX) and Fidelity Advisor Multi-Asset Income Fund (FWATX), and co-manager of Fidelity Strategic Dividend and Income Fund (FSDIX) and Fidelity Strategic Income Fund (FADMX). He thinks investors priced enough bad news into equities over the last quarter of 2018 to make dividend-paying stocks more attractive than high-yield bonds. In response, the Fidelity Multi-Asset Income Fund boosted its exposure to dividend equities.
Kramer sees upside in the industrials, pharma, technology, energy, materials, financials, and MLP sectors. He also likes some names in the REIT space. Kramer believes that too much pessimism is priced into the brick-and-mortar retail space in the age of e-tail. As one example of this trend, Kramer points to mall property owner Simon Property Group’s (SPG) stock performance over roughly the last 3 years.* During this period, Simon has grown its dividend by about 25%, yet he says investors have given no credit to the company’s valuation, as reflected by the sub-1% annualized total return on the stock.
Today, the stock has had a growing dividend yield, which reached 4.7%, and an overall valuation that offered a healthy downside cushion relative to the value of its real estate, according to Kramer. Simon Property's dividend yield was recently a full 2 percentage points higher than the 10-year Treasury's. That’s near the high end of SPG's yield premium from 2010 through 2018, when it ranged between zero and 2.5 percentage points. Kramer believes the current spread is too wide, in part because malls have begun to transform themselves into lifestyle destinations as big-box retailers have shut down and e-commerce continues to be integrated into brick-and-mortar retail.
Through January 31, 2019, Kramer has added Simon Properties stock to the Fidelity Multi-Asset Income Fund (FMSDX), because he believes it fits the fund's mandate of searching for an attractive yield with a large valuation cushion for error, which can eventually lead to outsized gains relative to other income-oriented asset classes in which the fund can invest.
"I think investors are ignoring the transformational and cash generation elements of the firm," he says.
Another look at bank stocks
"Recent market volatility hit bank stocks too hard, in my view," says John Sheehy, lead portfolio manager of Fidelity Equity Dividend Income Fund (FEQTX). Sheehy says that banks have suffered largely because of the flattening yield curve, in which short-term interest rates rise relative to longer-term rates. He notes that flat yield curves tend to hurt banking profits, and contribute to investor pessimism about both the financial sector and the broader US economy.
A complete inversion of the yield curve occurs when yields on shorter-maturity bonds are higher than those on longer-maturity bonds. The curve inverted very slightly recently, when the 1-year and 5-year Treasury notes yielded 2.56% and 2.47%, respectively, as of late February. An inverted yield curve has often signaled pending recessions in the past. That said, Sheehy points out that recessions historically have lagged inversions—in some cases by several years.
He notes that most US banks have very healthy finances and responsible lending standards. All things considered, he sees particular potential in banks with strong deposit franchises. Sheehy added to positions in 2 regional banks heading into 2019, PNC Financial Services Group (PNC) and Huntington Bancshares (HBAN), and his fund held meaningfully overweight positions in both stocks as of January 31, 2019.
Conglomerates' complexity can hide value
The relatively opaque nature of conglomerates makes them prime targets for hidden value, according to Gordon Scott, portfolio manager of Fidelity Advisor Dividend Growth Fund (FADAX).
"Conglomerates tend to be complex, hard-to-analyze businesses, which I think creates a recipe for me and analysts at Fidelity to find value that may go unrecognized by others," he says.
Scott considers General Electric (GE) a prime example of a company with so many businesses and moving parts that it can be difficult for investors to understand the total picture. GE represented the Dividend Growth Fund's third-largest holding as of January 31, 2019, after Scott added to the fund's position in the fourth quarter.
According to Scott, the scale and complexity of conglomerates can make it difficult for investors to pin down and analyze a firm's problems. In GE's case, he believes the firm addressed substantial challenges in 2018, including its long-term care insurance liabilities and declining earnings in its power segment.
In light of the significant decline in GE's stock price, Scott believes investors may be missing the value of GE's growing health care and aviation businesses. He sees the company’s announced sale of a small portion of its health care segment for more than $20 billion as a step toward unlocking its value. Further, Scott believes new CEO Larry Culp's background acquiring and improving businesses at Danaher makes him well-suited to maximizing value.
For another example of a misunderstood conglomerate, Scott points to Spectrum Brands Holdings (SPB)—another position he's increased in recent months. The firm provides consumer batteries, building hardware, small appliances, specialty pet supplies and auto-care products. Spectrum holds significant debts, which may have made investors wary recently. The company in January closed deals to sell its battery and auto-care businesses; Scott believes the proceeds will enable management to reduce the firm's debt load substantially, potentially benefiting the stock.
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