To make sense of the uncertainties ahead, balance buying opportunities from the US market pullback with resurgent growth in China. Here's a strategy for investors, writes MoneyShow's Jim Jubak, also of Jubak's Picks.
It's time for some heavy lifting for the last months of 2012. That will mean using a barbell strategy, in which you load a portfolio with stocks clustered at opposite ends (supposedly) of a spectrum.
For the remainder of 2012, I'm suggesting a barbell strategy heavy on US domestic stocks that match up with my call for slow but better-than-expected economic growth in the United States and—at the other end of the barbell—overseas stocks that match up well with my call for a slow but clearly discernible reacceleration of China's economy.
(See my October 15 column, "5 Stocks for a Still-Slow Economy," for my US outlook, and my October 24 post for my current take on China.)
At each end of that barbell, though, I'm going to add a little extra weight in the form of a few US technology stocks and a few global commodity stocks.
Why is this superweighted barbell strategy attractive? Well, let's take a look at where we are in the market.
On One End, the US Pullback
Right now, the US market is in the midst of a mild but worrying retreat, amounting to 3.9% (so far) from the 1,466 high on the S&P 500 for 2012 on September 14 to the 1,408 close on October 24.
The retreat is more worrying than the magnitude of that drop indicates, because much of the damage has been done on earnings for the third quarter that missed Wall Street estimates, and on lowered guidance for earnings and revenue for the fourth quarter or into 2013.
Caterpillar (CAT), which reported Monday, is typical: The company lowered guidance for the full year of 2012, with projected revenue falling to $66 billion from $68 billion. It also talked about weakness in its overseas markets, particularly China, in the first half of 2013.
Or take a look at McDonald's (MCD), which reported October 19. The company missed Wall Street earnings estimates by 4 cents a share—due, in part, to an 8-cents-per-share hit to results from a strong US dollar. Operating income was down 4%—but flat in constant currency terms—and global revenue was flat but up 4% in constant currency.
The company said it expects the near-term environment to remain challenging, and as an indication, talked about October same-store sales trending negative. Watching the reaction of Wall Street analysts to that comment on the conference call brought to mind a nature documentary of wolves taking down a caribou.
These are exactly the kind of comments that rattle investors when a market is near a top—even though they don't much matter after a correction. When stocks are coming off a top like that of September 14—when the entire market seems expensive—misses and lowered guidance for the quarter take on an importance that has more to do with the worries that come with a top than with the erosion of fundamental stories.
Face it: Investors get nervous when stocks move back up to the top of their ranges or toward important highs. It's why indexes frequently take more than one run at a high before breaking through to new territory.
In a Pullback, Bargains Emerge
If we do get a correction—say, if the S&P 500 drops back to its 200-day moving average at 1,376, roughly 40 points lower than the October 24 close—and investors start hearing Wall Street analysts say, "Stocks are now oversold," results like those that McDonald's delivered are going to look very different.
Instead of worrying that sluggish growth in the United States will make it hard for the company to beat last year's good same-store sales growth, investors will notice that they can buy the other McDonald's story, the slightly more long-term story, at $85 or so—about 10% cheaper than the $94.09 the stock sold for on October 16.
That other story was front and center in the company's conference call, but nobody seemed to be paying attention. McDonald's continued to gain share in China and in the US domestic market, the company said.
Because it has deeper pockets than just about any of its quick-service-restaurant peers (we don't call it fast food anymore, my dear), the company refreshes its restaurants at a faster pace than the competition does—and a refresh is good for a 6% to 7% lift in sales at a restaurant, the company added.
Now, if you wish you'd sold McDonald's, down 7.2% from its October high as of the close on October 24, with the idea of rebuying it at a lower price, I can't say I blame you. But I wouldn't worry too much. The long-term fundamental story at McDonald's is intact, and at the end of this correction, you can bet that Wall Street will be telling folks to buy this bargain. (McDonald's is a member of my Jubak's Picks portfolio.)
Of course, you might like to do better than follow McDonald's shares down to $85 and then back up to $94 in the short term—even though the stock is paying a 3.53% dividend. For that, I think you need to look at the first end of my barbell: stocks for a slow-growing but better-than-expected US economy.
|pagebreak|Buy US Stocks 'Experts' Are Wrong About
What you're looking for here are individual stocks where the pessimists—be they CEOs, economists, or Wall Street analysts—are wrong about growth prospects for the US economy or for some part of it. When a company does demonstrate that the consensus on growth is wrong, the market jumps in surprise.
That's exactly what happened with Lumber Liquidators (LL), one of the stocks I named on October 15 in my "slow-growth portfolio." On October 24, the company beat third-quarter Wall Street earnings projections by 12 cents a share (reporting 46 cents instead of 34 cents), and reported an 18.8% increase in revenue, to $204 million versus the $189 million consensus.
Lumber Liquidators followed that up by raising guidance for 2012 to earnings of $1.53 to $1.59 a share, from a prior $1.30 to $1.42, and revenue of $791 million to $799 million, from prior guidance of $750 million to $775 million.
The numbers further down the quarterly report weren't too shabby, either. Comparable-store sales, for example, increased by 12% in the quarter, driven by an 11.7% increase in store traffic. And while the company guided Wall Street to expect comparable-store sales in the high single digits in the fourth quarter, management noted that the sweet spot of comparable sales growth—22%—at its stores came at stores open for 13 to 36 months.
The company has been growing its store count in recent years—adding roughly 25 this year, for example—so Lumber Liquidators has a good pipeline of maturing stores to feed into its numbers.
To my regret, I didn't add Lumber Liquidators to my Jubak's Picks portfolio back on October 15, so the portfolio missed out on Wednesday's pop to an all-time high, closing at $55.81. You're obviously taking on more risk buying near that high than 10% or 15% lower, but I think once a stock has taken out its previous high, shares often have solid momentum to go higher.
If you like that logic, I'd also recommend PulteGroup (PHM) from my "slow-growth portfolio" list.
If you like even your slow-growth surprises better after a pullback, I'd recommend Costco (COST), which I added to Jubak's Picks on Wednesday, and Dollar General (DG), which I'm adding now. The stocks were down 6.7% and 10.8%, respectively, from their September highs as of Wednesday's close.
|pagebreak|Overweight in Tech
If this alternative appeals to you, you should also take a look at superweighting this end of the barbell with some of the technology stocks that have sold off recently.
Unlike the S&P 500, which is still has 40 points or so to go to hit its 200-day moving average, the technology-heavy Nasdaq Composite is just about to enter "oversold" territory. The index closed at 2,981 on Wednesday, with the 200-day moving average just 9 points lower at 2,972.
Now remember, you don't want to buy just any depressed technology stock—although the entire sector will bounce together if we do get an oversold rally. What you'd like to find are technology stocks that have sold off on near-term worries, but that have fundamentally great growth stories.
For that combo, I'd look to the Apple (AAPL) and Samsung Electronics (SSNLF) ecosystem of stocks I identified in my October 11 column, "5 iPhone Stocks That Aren't Apple."
I think these stocks have been living in fear of Apple's October 25 earnings report. Nobody knew what the company would report for the September quarter, what guidance it would issue for the December quarter—Apple has a tradition of lowballing guidance—or how investors would react to those numbers.
Now that Apple's numbers are out, and after the market has had a chance to react, it will be time to add from a group that includes Qualcomm (QCOM), Broadcom (BRCM), Skyworks Solutions (SWKS), Avago Technologies (AVGO), and Tatsuta Electric Wire & Cable (which trades as 5809.JP in Tokyo).
I added Qualcomm to Jubak's Picks on October 12.
On the Other End, China Moving Forward
I've written about the other end of the barbell—China stocks—very recently, so let me just summarize the argument I made in "4 Good (and 5 Bad) China Stocks."
I think we're seeing reasonably convincing signs that the Chinese economy hit a bottom, in terms of growth, in the third quarter, and that in September it started to show a reacceleration from that low point of growth.
In the early stages of a hope-based rally in China's stock markets, I suggested owning the big commodity and export names that Chinese traders would see as the best ways to play a surge in government stimulus. Then, I suggested, as the rally on hope changed to a rally on evidence, I'd move to own domestically oriented Chinese stocks.
That transition may be taking place faster than I expected. It now looks as if the consensus in China is that growth is accelerating enough so that the People's Bank won't need to cut interest rates. In this environment, I think some of the financial stocks such as AIA Group (AAGIY) or Ping An Insurance (PNGAY) look timelier than the commodity or industrial exporters.
The increasing belief that China's economy did indeed put in its growth bottom in September, along with the disappointment that the People's Bank won't cut interest rates, make shares of commodity companies that export to China a better bet than Chinese commodity companies and exporters themselves.
Hence my recommendation to superweight this end of the barbell with the shares of such companies as BHP Billiton (BHP), an Australian commodity producer of just about everything; Peabody Energy (BTU), a US coal producer with a big presence in Australia's coal fields; copper giant Freeport McMoRan Copper & Gold (FCX); and Brazilian iron ore producer Vale (VALE), which just reported a 66% drop in third quarter profits.
Vale is the cheapest, BHP Billiton has some momentum, and Peabody has moved strongly to the upside recently. (Freeport McMoRan is already a member of my Jubak's Picks portfolio.)
Your decision will depend on how strong you think the recovery in China's growth rate will be. The stronger your projection, the more inclined you should be to go with the cheaper Vale.
And (do I have to say it?) a post-election disaster on the politics of the US fiscal cliff would require, at the very least, a rethinking of the US end of this barbell.
