Current environment and 2019 outlook:
After a hot start to the year, we expected the stock market to slow down. Even early in the year, we projected higher volatility (both up and down) and suggested not chasing the rally, but rather buy on the dips cautiously, as we believed the US economy, especially, was in pretty good shape.
- Ultimately, we believe US stocks will show good returns for the year in total.
- We understand that buying during a dip is easier said than done, as the dips are usually accompanied by big unknowns or clear negatives that seem insurmountable.
- Our buying-the-dip assumes a resolution to the trade/tariff stand-offs, as the negative economic impact becomes more apparent. (This morning’s May jobs report may be an early harbinger, along with the rapid decline in bond yields over the last three months.) Conversely, the longer the trade war(s) persist, the more volatility will limit near-term stock market appreciation.
- For investors with a 6-12 month horizon, we think the May swoon has created many attractive buys. By the time it is apparent that things seem to be stabilizing/improving, stocks will likely be higher and much of the opportunity will be missed.
Even after the market’s rebound this week after the May swoon, stock valuations are reasonable with the market now trading at about 16.2x next 12 months estimated EPS.
Evidence is accumulating that the US economy is softening somewhat, and international economies are certainly weak. As a result, a Fed rate cut is now in the market’s base case, perhaps as early as next month. This is a major change in market expectations, with diametrically opposed implications:
- Lower rates make equities appear more attractive and can incentivize companies to invest.
- Lower rates are an indication of an economy in a downtrend, which is a headwind to equities.
In a lower interest rate environment, companies with strong dividend yields can provide attractive current income. In this subset, stocks with growing businesses can generate good price appreciation in addition.
We are a Value investor, and our process is bottom-up, driven by research on individual stocks. Valuation ALWAYS matters to future returns, and we don’t typically invest thematically.
Since we focus on Value overall, we look at the less expensive names in any given sector. As always, it’s important to separate good companies at a cheap price from damaged companies that are cheap for a reason. We like companies with strong balance sheets and solid business franchises within their target market and generally prefer better businesses in better industries.
In the current investing environment, with softening macros and lower interest rates in the market, stocks with good dividend yields and reasonable business momentum should perform very well from here, providing capital appreciation as well. These may be found across a variety of economic sectors. Here are a few opportunities from different industries that we believe are compelling at current prices:
- CVS HEALTH ‒ CVS $54.27 ‒ CVS’s acquisition of Aetna has created a new paradigm for consumer health. On Wednesday, the company rolled out its vision and projections for the combined company, and financial guidance for the next few years was a pleasant surprise. Benefits from merger synergies, infrastructure modernization and business transformation can be large. Demographics and economics are working in the company’s favor. Debt level is above management’s long-term target but will be rapidly paid down from free cash flow generation. The stock trades at less than 8x next year’s EPS and at a 3.7% dividend yield. Matrix target – $85+.
- HOME DEPOT ‒ HD $198.19 ‒ This is a business that is executing well, with few overhangs. Growth slowed recently, in part due to poor early spring weather and a deceleration in housing activity from high prices and higher mortgage rates. Recent trends have been better, and the company should be a beneficiary of recent rapid decline in interest rates. Given its product assortment, HD is less exposed to the Amazon effect than most other retailers; even so, it has also built a strong e-commerce channel itself. Cost pressures from tariffs on imported goods is smaller than on many other distributors and is manageable. Management is strong with a shareholder focus. It trades below 18x next year’s EPS, reasonable for the quality, and at a 2.8% yield. Matrix target – $225+.
- AT&T ‒ T $32.37 ‒ The company is a key leader in wireless communications, which provides a strong profit and cash flow base for the enterprise. Wireless services will be augmented by the 5G transition just beginning, and T is an advantaged early mover in this technology. Its purchase of DirecTV in 2015 has proved to be troublesome, but profit contribution will stabilize this year. The benefits of the Time Warner acquisition are not fully recognized by the market, which includes strong free cash flow contribution and solid profit growth, with the potential to be an important player in video content streaming. The company has made good progress paying down acquisition debt via asset sales and cash thrown off by the business. Near-term earnings growth will be modest (but positive), though the valuation is undemanding. The stock trades at 9x forward EPS, with a 6.4% yield. Matrix target – $42+.
Disclosures: Matrix Asset Advisors owns a position in each of the stocks for our clients, and continues to buy them for new accounts. My family and I own positions (either directly or indirectly through our mutual funds, Matrix Advisors Value Fund – MAVFX, Matrix Advisors Dividend Fund – MADFX). Matrix does NO investment banking.