John’s Commentary – Oct 15 2018

This note should be read as a follow-up to my commentary of 2 weeks ago recommending to prepare for “a much better buying opportunity in coming weeks” due to signals that “suggest a sharp change in market psychology can emerge very soon.”

The decline may well be over, but that is not my best guess. The indications of internal market weakness failed to show significant enough improvement in Friday’s global up-market to convince me to buy the market just yet. Still, I suggest that you have a shopping list at-ready as my current caution could change on a dime anytime this week [or next]. And, if a stock has already reached a very attractive price, fear of further market decline should not keep you from taking advantage of that price now – just do not use all of your buy-the-dip buying power at one time or in one place. If there is more correction to come, as I believe, 2600 [give or take 50 points] on the S&P500 seems like a reasonable target.

For better or worse, here are some possible do’s and some [as far as I am concerned] definite don’ts. Utilities [or the XLU ETF] are historically expensive and are unlikely to offer attractive returns going forward and do not even seem like a hiding place where one can safely collect dividends. Telecom companies such as VZ, T, and especially CTL, with its potential growth and extraordinary yield, make for excellent substitute holdings at current levels. Though not historically expensive, most consumer staples stocks [vaguely represented by the ETF XLP] also seem not worthwhile given increasing cost and branding pressures – and do look to me to be relatively expensive. A sample exception to this would be Constellation Brands [STZ] given its continued brilliant investments in new line extensions and new segments [cannabis].

Companies in non-growth cyclical industries that are globally competitive should be avoided unless they offer advances in efficiency or productivity. Examples on the negative side are companies like F, FCA, and WHR. But one can find cases like Borg-Warner within the auto area that offers dramatic advances in efficiency, yet its pricing in the market is tainted by the auto association. If GM is as far-advanced in autonomous driving as some believe [not far behind Alphabet], then GM is cheap enough to also be an exception. In any case, GM is not worth selling here if it is already in a portfolio [which I hope has not been the case up to this point].

I also suggest, for better or worse, that some popular go-to issues, such as Apple, Netflix, and Facebook, should not be on buy lists as I do not view potential reward to be worth what I believe to be risks that are not fully appreciated..

Most traditional retailers [ETF: XRT] have achieved decent recoveries in stock prices this year to the point that the risk-to-reward is not worth it. Non-traditional exceptions in the retail space might be Costco [COST] and Amazon [AMZN]. Amazon, in particular, continues to sprout new and profitable multi-billion businesses racing toward $20B in revenue. Added to the 2 already huge and dominant business segments that continue to grow over 50% per year, this puts AMZN in position to further accelerate revenue and profit growth. It is not for the faint-of-heart, but the stock could get really interesting on a further pull-back into a range of 1650-1580 if one has a long-term investment horizon and believe in what AMZN is doing. Buying AMZN is not necessarily a “do” but offers a reasonable super-growth investment vehicle to add to a portfolio of lower P/E value and growth issues. There remains some chance that the bull market has ended – in which case such a purchase now would carry above-average risk. That is not my view at this time.

The case of Amazon offers an excellent point to transition to the DO’s, as it and most of the companies noted as positive exceptions share the desired characteristics of improving efficiency and/or productivity. Companies that can do this well for themselves or others will become more important as rising costs pressure profit margins, labor shortages spread, and energy efficiency becomes more urgent for cost and environmental reasons. This suggests that long-term investors should still look to the leading companies driving change, including the broad and variably-priced cloud-computing/big data [BOX, SPLK, ADSK, DATA, VMW], 5G connectivity [CTL, ZAYO, RHT] , semiconductor [CY, QCOM, NVDA, MLNX], semiconductor equipment [RTEC, LRCX], biotechnology [ETFs XBI & IBB, ABBV as examples plus many smaller companies], aerospace [AJRD], and industrial process [IOTS] industries . There is a lot of

on-going change in media/entertainment where many interesting risks and opportunities can be found. Many of the stocks in these industries will offer a very bumpy ride for investors but are probably well worth the volatility.

Outside of these broad themes, operating and profitable precious metals companies along with metals themselves have reached values and a time in the macro-economic cycle that offer an attractive buying opportunity. My choices in this area would be high-quality picks Goldcorp [GG] and Wheaton Precious Metals [WPM]. Similarly, a large array and variety of companies across the energy sector represent good intermediate [not long-term] risk/reward in the economic and geopolitical environments that I see. Oil refiners [some chemical companies among them] that benefit from changing environmental rules that affect supply and demand, particularly in marine fuels, seem very attractive. Exploration & production companies, primarily those with heavy exposure to the Delaware Basin in the Permian, will begin to show big profitability soon [APA, OXY, MTDR, JAG, & ROSE among many] and share prices are likely going to respond by out-performing the market. And, related to the Permian and other areas of growing production, there are opportunities in oil service, processing, and transport. The time finally looks right for many energy and precious metals companies.

Finally, if one has a true contrarian streak, the home-building industry is an interesting place to look. Companies there are so inexpensive based on current financials and operating results [a number of them showing up on Ray Mullaney’s quantitative value screens] that, if current fears do not materialize, the stocks could experience a good-sized revaluation. Could be interesting and a worthwhile diversification to a portfolio, but keep exposure low.

Again, do not spend all your potential buying power immediately – be patient. But using these guidelines, lower market prices over the next week or two probably represent a reasonable time to increase or regain exposure to equities.

John Stewart
Chief Investment Strategist

By | 2018-12-13T14:50:50+00:00 October 15th, 2018|John's Notes|0 Comments