This year's market forecasts were all over the map. It's always the case but more so this time. Unsettled by world events and the on-going pantomime in Washington, analysts spent a lot of time hedging their predictions. Who can blame them? However, one common thread emerged. The U.S. stock market is the place to be in 2013. Even the outright pessimists came to that conclusion. As Vanguard founder John Bogle grudgingly conceded: "What's so frightening is that alternatives to U.S. equities are so poor".
Here at Internet Wealth Builder we are more upbeat than Mr. Bogle but we do agree with him about American stocks. Not that it's likely to be a banner year for the S&P 500. There are still a lot of headwinds but the fundamentals are promising.
We are off to a good start. December's U.S. housing starts surged 12%, the fastest rate since pre-crash June 2008. Concern about a double-dip recession has receded and there are signs of better corporate earnings growth. Several other factors have also started to energize the market and encourage investors.
For one, U.S. manufacturers are becoming more productive as a result of lay-offs and other cost cutting. This has made U.S. exports competitive, especially in the heavy machinery and civil aircraft sectors. Consumer-based companies such as McDonalds and Starbucks are expanding their international networks. Meanwhile, we are seeing a spurt in U.S. oil and gas production. There is more "in-sourcing" as companies repatriate foreign jobs and services because of shrinking cost differentials.
At the same time, institutions, especially the pension funds, are bailing out of the fixed-income markets and buying stocks, especially higher-yielding blue chips, so that they can meet their actuarial requirements. We are also seeing a flow of money into U.S. equities from the now cash-rich developing countries such as Brazil and South Africa.
We should keep in mind too that American investors tend to be more optimistic than their Canadian counterparts. Despite all the political turmoil, European disasters, and a spluttering recovery, Standard & Poor's 500 stocks racked up double-digit growth in both 2011 and 2012. We could see a similar performance this year. U.S. stock market valuations are still attractive and, as Mr. Bogle pointed out, investors have nowhere else to go.
The problem, as I pointed out last month, is that it's likely to be a bumpy ride. As a matter of fact, we could have a tale of two markets. During the next few months, U.S. stocks will probably ride a rollercoaster as European problems bubble over and the American politicians continue to bicker. Then, in the second half, there is a good chance that we will enjoy some solid growth.
American consumers are the key. They need to spend more. People were badly scarred by the financial meltdown and are still paying down personal debt. However, a lot of items such as cars need replacing and before long we are going to see a great deal of pent-up consumption.
There are a lot of mixed signals. The market is promising but there is no rising tide. Most money managers remain cautiously optimistic. To give you an idea of the general feeling, a recent Investment News 2013 survey of 592 financial advisors showed that 45% of the respondents were going to increase their exposure to the U.S. stocks this year. At the same time, 59% of these advisors indicated that they preferred dividend-paying stocks over growth stocks. That seems to me to be the right approach. It's also the reason why I like the integrated telecom industry.
U.S. telecoms turned in an excellent performance last year but still have a lot of upside potential. This sector is on the move. Consumers are becoming voracious in their appetite for mobile communications, video and Internet as well as text. Meanwhile, the boom in wireless subscriptions has slowed but is still flourishing.
At the same time, the telecoms are generating substantial cash flows from their traditional services. For now they have the best of both worlds. Yields from the U.S. telecom stocks are at record highs and likely to remain that way, although a few of the payout ratios are cause for concern. In short, some of these stocks are ideally suited for investors seeking above average income and capital gains.
One company that I particularly like is CenturyLink which I advised buying last month at $39.91 as one of my top picks for 2013 (all dollar amounts are in U.S. currency). It closed Friday at $41.15 and pays a $2.90 dividend to yield 7%. Here is some more detail.
Based in Munroe, Louisiana, CenturyLink is the third largest exchange carrier and Internet service provider in the United States. Annual revenues are in the $18 billion range and Century's market capitalization exceeds $26 billion.
Surprisingly for a long established giant, CenturyLink is aggressive. It has grown steadily for four years through acquisitions that provided access to new markets, including a joint venture in Hong Kong, and boosted revenues. The purchase of Savvis in 2011 was particularly significant and gave the company a foothold in the red hot "cloud" computer services market. Cloud provides users with remote storage and computer services and is regarded by many experts as the wave of the future.
Earnings of about $2.95 a share are expected in 2013 but this is after adjustment for amortization and acquisition costs. A base of 14 million landline customers should generate a cash flow of about $5.70 a share and protect the dividend.
Of course, it's not an entirely rosy picture. Absorbing major acquisitions is always difficult and there could be setbacks. Moreover, new telecom regulations are always a possibility although there are none on the horizon.
My most serious concern is that CenturyLink will continue to expand abroad and overreach while mopping up high-tech corporations. This would eventually endanger the attractive dividend and is something I will monitor closely.
Action now: Century Link was added to our Recommended List last month and remains a Buy at $41.15 with an increased target of $45. I have set a $35 revisit level. We suggest that Canadian investors hold these shares in a registered retirement plan such as an RRSP or RRIF. That way the dividends will be exempt from the 15% withholding tax.
Another market sector that I like is U.S. banking, which is steadily regaining favour after four years in the doghouse. Despite credit downgrades and continuing lawsuits, as well as an emerging Libor scandal, American banks turned in a relatively good performance last year. Their stocks responded. Bank of America (NYSE: BAC) rose 105% while Citigroup (NYSE: C) gained 48%. They have had a good run, so much so that investors are being advised by some experts to cash in their positions now that the party is over.
I have a slightly different take on the situation. A year ago U.S. banks were a big question mark and many of the major players were trading at a discount to their net book value. It was a high-risk industry. Since then most of the larger banks have strengthened their balance sheets and put the show back on the road. So while investors should certainly take some of their well-earned profits off the table this is not an overvalued sector. I think that many of the bank stocks are now suitable for longer-term investors seeking growth and dividend income.
Not that U.S. banking is out of the woods. Loan growth remains sluggish and interest rate spreads are being squeezed by the Federal Reserve's easy money policy. That having been said, there are clear signs of improvement in the system. Executives are no longer resorting to accounting tricks to boost earnings. Provisions for loan losses have been contracting and there is solid growth in mortgage revenues as housing picks up. The Federal Deposit Insurance Corporation (FDIC) reported that commercial banks and savings institutions racked up third-quarter earnings of $37.6 billion, a 6.6% year-over-year increase.
The banks are also rebuilding their balance sheets. They have been unloading non-performing assets and spinning off suspect derivatives. Progress is slow but analysts believe that the large banks will pass the Fed's stress tests and be approved for dividend increases and significant buybacks this year. There are still a lot of problems but U.S. banking is on the mend.
JPMorgan Chase (JPM)When it comes to individual bank stocks, Wells Fargo (WFC) looks extremely attractive and Gordon added it to our Buy List last week. Another major U.S. bank stock that I like is JPMorgan Chase. One of the most profitable blue-chip financial institutions, JPM is poised to do well.
Priced at $47.85, the stock trades at only 8.32 times forecasted 2013 earnings of $5.75 a share. To put that in context, the industry multiple is 11 and JPM was trading at 23 times earnings before the crash in 2008, following which results became erratic. JPMorgan Chase is relatively cheap and excellent value. It's my February Pick of the Month.
A multinational banking corporation with assets of $2 trillion, JPM is actually a combination of several U.S. banking giants, including Chase Manhattan and Chemical Bank. Structured as a holding company, it operates through six divisions that include the high-profile Investment Banking and Commercial Banking. Annual revenues are in the $110 billion range and market capital exceeds $170 billion.
This is one of the few financial companies that emerged from the crisis of 2008-09 in considerably better shape than when it went in. As a matter of fact, management took advantage of the turmoil to acquire Bear Stearns and Washington Mutual for pennies on the dollar.
I particularly like JPMorgan (JPM) at this stage because, unlike some of its peers, the bank is reporting consistent earnings growth and remains extremely well diversified. It is positioned to benefit as the recovery continues. Profit from Investment Banking is growing at double-digit rates and analysts expect a 20% growth rate in the Visa division's income over the next five years.
Recent fourth-quarter numbers were surprisingly good. Record profit of $1.39 a share easily beat the $1.16 consensus forecast. Following this year's stress test, we should see the dividend increased to $1.60 coupled with an $11 billion share buyback program.
There are a couple of clouds on the horizon. The high-profile Libor scandal is still unraveling. This fraudulent manipulation of interest rates could result in penalties for American and European institutions. JPMorgan has been subpoenaed along with other banks and civil lawsuits are working their way through the New York courts. The bank incurred $3.9 billion worth of litigation fees in connection with Libor and other issues during the first nine months of 2012.
Another concern is that the bank's profit margins remain tight. There is intense competition for credit-worthy borrowers. As a result, a lot of the industry's earnings growth has resulted from higher fees rather than traditional business.
Both of these factors, neither of which is seriously material, are built into my forecast. However, investors should be prepared for the Libor scandal and concerns about capital requirements and profit margins to surface during 2013 and possibly cause JPM, along with other bank stocks, to sell off briefly.
To sum up, everything points to JPMorgan having an excellent year with earnings of about $5.75 a share and then racking up double-digit earnings growth over the next few years even if the recovery moves sideways. We could see earnings of $6.30 a share or more in 2014.
Action now: Trading at $47.85, the shares are a Buy with a target of $55. If the dividend is increased to $1.60, as expected, the stock will yield 3.3% based on its present price. Therefore, investors should hold the shares in a RRIF or RRSP in order to avoid the 15% withholding tax. I have set a $40 revisit level.