2016 was wild and woolly. It started with markets selling off, concerns of Chinese economic weakness and an overly aggressive Federal Reserve. By Feb. 11, the Dow had descended to 15,660, its low for the year, with oil dropping to $26.21 a barrel, a 12-year low.
Strategists were flummoxed at key points. The majority erroneously predicted the result and market response to both Brexit, the U.K.’s historic vote to leave the European Union, and our presidential election. By year end, the Dow was poised to summit 20,000, up nearly 30% from that February nadir.
Opinions differ as to the market outlook for 2017. Some point to the stimulatory effects of tax cuts, infrastructure spending and a lighter regulatory load.
Others are cautious, suggesting some of these hoped for changes have already been priced in. They cite the potential for delays on implementation of the new regime, plus push back from fiscally conservative members of Congress. Higher interest rates will not be a positive, while a stronger dollar may adversely impact our multinationals.
In any event, it’s a market of stocks, not a stock market. Below are our picks for 2017, which we believe are poised for superior result no matter the vagaries.
How did we do last year? Our picks edged out the S&P 500, as measured by the SPDR S&P 500 ETF (SPY, Financial), including dividends, led by Flextronics (FLEX, Financial), AT&T (T, Financial) and Walmart (WMT, Financial), up 35%, 31% and 24%, respectively!
Health care
Health care is 2016’s only negative performing sector. Politicians on both sides of the aisle have pummeled it since the summer of 2015. Martin Shkreli’s Turing Pharmaceutical was a catalyst, with its unconscionable 56-fold price increase on an important drug that was justified by no research and development efforts.
Hillary’s September 2015 tweet: “Price gouging… in the specialty drug market is outrageous.” is said to have cost a biotech ETF $160 billion in just a week.
Now, following the Trump victory, investors remain confused. What will his pledge to dismantle Obamacare mean for the industry?
First, even if Obamacare is terminated, surely something very similar may rise in its ashes. Health insurance coverage must be fairly universal if Trump really wants to carry through in his pledge that preexisting conditions continue to be covered.
Given the low stock prices now prevailing, we think the additional downside if further adverse political regulation occurs will be less than the upside should it become business as usual. Demand remains strong for life-saving treatments, both here and increasingly abroad.
Our two picks in this sector are Teva (TEVA, Financial) and McKesson (MCK, Financial). Teva is the world’s largest generic drug company. We think generics will play a large role in making new compounds available to the masses and reining in spiraling health care costs.
Its nearly one-fifth market share of the generic market is poised to grow following the acquisition of a large generic portfolio from Allergan. Teva’s manufacturing prowess, legal resources and marketing expertise are unmatched. Teva’s stock is a relative bargain, trading at just half its price of 18 months ago, less than seven times earnings and with a near 4% dividend.
McKesson is one of three key distributors to pharmacies, hospitals and doctors’ offices. McKesson, Cardinal Health and AmerisourceBergen control 90% of this business. Its $200 billion of annual revenues is poised to rise as health care spending escalates. Although McKesson’s business is low margin, that helps keep potential competition at bay. The entry point is timely; despite MCK having grown EPS more than 15% annually for the last decade, the stock is down 40% from last year.
Energy
Much to the joy of contrarians, energy led the market in 2016. The laws of supply and demand kicked in. 2016’s low fossil fuel prices shut down surplus production, sent rigs home and curtailed credit for further development.
We think energy has further to go. Never before has there been a two-year decline in capital expenditures. Exxon (XOM, Financial) is our vehicle to profit. This is the highest quality energy company out there, with operations diversified globally, plus across all aspects of energy production, including exploration, transportation, refining and marketing. Its balance sheet is solid, and it has been historically a superior capital allocator. The stock is 15% below its all-time high and boasts an above-average 3.3% dividend. That payout has grown nearly 10% annually for the last decade.
Financials
Contrarians rejoiced, too, with the late 2016 surge in this group, giving it a second place finish in the sector sweepstakes. Financials are the only sector not to revisit their pre-2008 crisis highs, weighed down by low interest rates, heightened regulation, more onerous capital requirements and weak loan demand. Despite the post-election run up, we think financials have more room to run.
We recommend Travelers (TRV, Financial), a conservatively managed leader in commercial insurance. We like the company’s broad diversification of lines and customers; its growing international book provides more growth opportunities. Despite a leadership change, we expect its shareholder-friendly approach of returning nearly all free cash to its owners in the form of dividends and stock buybacks to continue.
Industrials
This sector is a natural beneficiary of an improving economy, whether due to the low interest rates worldwide or the hope for pro-growth fiscal policies. United Technologies (UTX, Financial) is our pick; it is a leader in the aerospace and building components businesses.
Although some analysts see bumps in the road for the wide body aircraft market, United Technologies focuses in on the narrow body market, which is poised for continued growth. Helpful, too, is that 44% of its business is supplies and service in the aftermarket, a less cyclical and more profitable segment.
A catalyst for 2017 is the recent sale of its Sikorsky helicopter business. That coupled with its conservative balance sheet further supports our optimism.
Consumer staples
This sector disappointed in 2016. A strong dollar weighed on its multinationals. During 2016’s second half, fears of higher interest rates spooked, as many of these names were viewed as bond surrogates.
We are finding better values overseas, as investors have bid up stocks stateside out of perceptions that the economy is far better here. That may be true, but many overseas companies compete here, too, while many U.S.-based staples companies transact significantly overseas.
Unilever (UL, Financial), based in London and the Netherlands, is a powerhouse in personal products (57%) and packaged foods (43%), marketing such brand names as Knorr soups, Hellmans and Lipton. Nearly 60% of sales are in fast-growing emerging markets. Its distribution scale makes it tough for competitors to dislodge.
Purchases now are timely as it is nearly 20% off its high. Its generous 3.5% dividend has grown 12.5% annually over the last 10 years.
An attractive domestic staples pick is Sanderson Farms (SAFM, Financial). It is the third-largest chicken producer, after Tyson and Pilgrims Pride. Founded in the 1940s, this family business has grown steadily over the years and is nearly debt-free. It trades cheaply at about 10 times earnings. You can’t rule out a takeover attempt.
Consumer cyclicals
While not particularly cyclical, Hanesbrands (HBI, Financial), a purveyor of inner and outer wear including the Hanes, Champion and Maidenform brands, has mightily rewarded shareholders over the long haul. It has returned 14.8% annually over the last decade, more than double the S&P. Optimism is due to this company’s strong track record of strategic acquisitions, superior margins, highly valued brands and solid distribution capabilities.
With the stock down by a third since 2015, this seems like an opportune time for a commitment. Based on recent stock buybacks by the company, it seems to agree.
Real estate
Real estate’s worth was acknowledged by the keepers of the S&P 500, as it created a new sector for real estate last summer. This did nothing for performance, however, as the sector has since declined, with investors wary of the group’s sensitivity to rising interest rates.
There has been good long-term growth, with revenues up 16.7% annually over the last 10 years. Debt is low, and its share price is a multiple of earnings. With the stock down about 40% from its 2015 high, this is an opportune moment to invest.
Emerging markets
Emerging market (EM) stocks are generally cheaper than the developed markets’. Yet the EMs often have superior growth potential, partly due to their younger and faster growing demographics.
In order to capitalize, we suggest investing in American Movil (AMX). Firmly under the control of the world’s richest man, Carlos Slim, it dominates Central and South America’s wireless communications with a 25% lead over its closest rival. It boasts a 70% market share in Mexico, 20% in Brazil and is the lead carrier in Columbia, Argentina, Equador, Puerto Rico and Nicaragua.
While the stock’s recent returns for U.S. investors have been hurt due to dollar strength, this company continues to grow and return money to shareholders. Over the last five years the business has grown by 50%, but the share count has shrunk by 20%. Dividends have grown 24% annually on average over the last decade.
