The continued poor economy will draw consumers to fix their own houses and cars, and to shop in dollar stores, says equity analyst Chris Johnson. He recommends some of these consumer-oriented defensive names, as well as some names from the “smoke it, eat it, wash with it” category of companies whose products continue to sell even in sputtering economic conditions.
Kate Stalter: I’m speaking with Chris Johnson. He’s the founder of Johnson Research Group. Chris, obviously there’s been a lot of market volatility recently. What should individual investors be doing right now?
Chris Johnson: Well, outside of just telling everybody they need to be pulling onto the sidelines, Kate, I think this is one of those periods where you really have to look at the cash flow and where the trends in the market are leading us. There’s a lot of volatility in the market, and that tends to lead to knee-jerk reactions.
Just to throw out a couple of things that we’ve been watching: When you look at the S&P 500, we’ve been in a trading range right around that 1,200 to 1,240 level at the top and then 1,100 to 1,120 at the bottom.
We’re expecting to see investors continue to get more cautious as the uncertainty in the market continues to remain in charge of the day-to-day tape. So in other words, I don’t see the volatility going away.
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As a result, the cash flow has been moving away from some of the riskier segments of the market—small-cap stocks, not necessarily technology, technology has fared fairly well—but really that small- to mid-cap area. We hear the terms “risk off” and “risk on,” which kind of annoys me, as it changes on a day-to-day basis.
We’re seeing a constant risk-off situation, in that small-caps have continued to lag the rest of the market. That tells you that speculators are not alive and well in this market, and any bull market needs to have a good amount of speculation.
For that reason, we’re seeing a lot of money go into the areas that aren’t a big surprise: consumer staples, utilities. These quite frankly are the areas that we think are going to outpace the market as we head into the last quarter of the year.
Kate Stalter: Are there any particular names that you are watching right now that you believe can show some future potential?
Chris Johnson: Absolutely. Outside of those defensive areas. There’s kind of a yield grab going on, where everybody is looking for a high-dividend-yielding stock as a result of no yields in money markets or CDs, but outside of that universe.
So in other words, where do I think there is going to be growth? Look at the do-it-yourself companies. We’ve got a couple of things that we’ve been talking about: If you can hit it with a hammer, or it’s nails, lumber, etc., it’s not necessarily going to be great, except if it’s in the do-it-yourself field.
One of the areas we’ve really liked is the auto parts companies or the actual retailers—AutoZone (AZO), O’Reilly Automotive (ORLY). These are just an example. You’re going to see more and more people underneath their car doing their own work as the economy remains sluggish. If you can kind of tie it into a do-it-yourselfer, that’s what we’re interested in.
The other thing that we’re really looking at is kind of the joke: If you smoke it, eat it, wash with it, that’s going to be company that’s going to be attractive. Those are the companies like Lorillard (LO), Philip Morris (PM), Altria (MO), Procter & Gamble (PG). I don’t see those going away in terms of demand through the fourth quarter.
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Kate Stalter: Now when you are looking at some of these consumer staples or defensive names, are you considering the dividend as well as the possible price appreciation?
Chris Johnson: To some degree, yes. I think you’re going to get both right now. Obviously the higher the prices go, the lower the dividend yield is going to go. That’s just the relationship between dividend and price.
Right now, investors are being drawn very quickly to those areas, because they’re scurrying, looking for some sort of dividend yield. So that, in part, makes it attractive to us, because that’s what is in demand for the market.
These companies, outside of that are operating in areas where we think you’re going to see continued good sales. Let’s face it, we’re not going to stop buying soap and things like this. We’re going to continue to take showers, but we’re going to cut down on some of the higher-end retail areas. I think for that reason, you look at the Procter & Gambles.
Stay away perhaps, from some of the transportation companies here and there, because obviously there’s a tie with the economy and how well inventories are moving across the country.
Another area again that I think that goes along with the AutoZones and those types of companies are the deep discount retailers. Your dollar stores—Family Dollar (FDO), Dollar Tree (DLTR).
These are companies that were a little whimsical last year. Everybody was saying that you should watch these because more and more people are shopping in them, almost as if they were joking. But that really has been the case.
If you look at Procter & Gamble, they’ve just announced recently that they’re going after this barbell approach, of going after the high-end and the low-end retailers. Those low-end retail companies like Family Dollar, they really fit in with that. I think that’s going to be an area that you’re going to see appreciate very quickly here.
Kate Stalter: One of the things that investors are wondering about—and you alluded to this early on, Chris, with your views on staying on the sidelines—obviously a lot of folks are invested in mutual funds, besides just individual stocks. What would you say to people who do have mutual funds, long-term holdings? Should they sit through a correction, or sell? How do you see that?
Chris Johnson: You know, that’s a really good question, Kate. Your mutual-fund investors are typically what I’ll call “set it and forget it,” or Ron Popeil investors. In this particular case, it’s very hard to tell people, “You’re going to want to sell want out of that mutual fund.”
You have to look at it from the perspective of a greater picture. If we think there’s another 10% to 20% downside on this market, which I do think there is a possibility, then yeah, absolutely you want to get out of some of those mutual funds that are what I would refer to as high-beta. So in other words, they’re going to move faster than the market.
Typically again, going back to that comment I had on the risk-off trade right now, when you see small-cap stocks and the iShares Russell 2000 Index ETF (IWM), when you see that lagging the market, it tells you that investors aren’t investing with speculation.
Therefore, I’d be avoiding some of those high-beta funds right now, and quite frankly, I wouldn’t say across the board, but in many cases it’s a good time to be selling those funds into cash.
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The other side of that is your much longer-term 401(k) type of investment or IRAs, where you may not necessarily want to sell the fund. This is a great opportunity if you’re making those contributions to IRAs, etc., or trimming some contributions to your 401(k), you’re dollar-cost averaging in, so you’re buying some of these shares at lower prices. Over the long run, when we’re talking ten to 20 years, that’s going to pay off for you.
So the message is: If you’re making these investments for a longer-term period, don’t stop buying if you’ve already committed to being in this market. Continue to buy, even though the prices are going lower because that dollar-cost average is going to help you over the long term.