Following the market for the last few months has been an interesting study in patience. At the beginning of December, with the market at all-time highs, and market volatility as measured by the VIX consistently hovering (and holding firmly) at all-time lows below 10, a lot of people thought the good times might never end, and investing never seemed easier. Just buy a low-cost index fund and wait for the next high to roll around. After all, that approach worked wonders throughout 2017, since the index returned more than 20% from January through the end of the year.
What a difference just a few weeks can make! After hitting its latest all-time high on January 26, the market dropped around 15% in just a little over a week before finding a bottom in early February. And while the market has rebounded from that short-term low point, volatility has generally remained the “new normal” on a day-to-day basis, as swings of 1% or more during any given trading session since are becoming more and more commonplace. In fact, as of today the market is testing its low for the year, with the S&P 500 less than 100 points away from that point. This latest drop is being fueled by uncertainty and angst around tariffs imposed by the Trump administration, with a big new round of $50 billion in tariffs directed squarely at China. Clearly, there is a generalized concern, and even fear that a trade war at this point is unavoidable.
Interest rates, China, and Tariffs
One of the primary benchmarks analysts like to use to measure volatility in the market is the CBOE Volatility Index (VIX). The VIX is often referred to as “the fear index.” Based on the S&P 500, it measures options trading activity to determine market sentiment. When call option buying (a bullish bet) exceeds buying in put options (a bearish bet), the VIX goes down, indicating that traders are generally confident about the health of the market. On the other hand, when put option buying is greater than call option buying, the implication is that traders are expecting the market to go down, which usually means that investors are becoming more and more nervous about the current state of affairs.
The market’s initial plunge from a month and half ago forced the VIX to spike well above its benchmark level of 20 that a lot of analysts, myself included, like to use to signal a high level of market uncertainty. Levels of 20 or above generally coincide with mostly bearish conditions reflected in the S&P 500. Over the last few weeks, the VIX had been mostly hovering below 20, but over the last two days has spiked above 20 for the third time since the big selloff in early February (as of this writing, it’s a little above 25). Considering some of the economic and geopolitical concerns that are drawing headlines right now – rising interest rates, tariffs and the looming threat of a trade war, and whether or not the economy’s pattern of growth is sustainable, to name just a few – I don’t think this increase in volatility is all that surprising. The low-volatility environment we watched all through 2017 wasn’t an indication that everything was great; in fact, I saw it as confirmation of the market’s extremely overextended state and reflective of ever-increasing market risk. To me, the return to volatility, including the overall market weakness we’ve seen to this point in the year is actually a healthy thing.
I fall into line with a lot of economists right now that aren’t calling for a new bear market, or even a recession in the near term. In fact, I agree with most opinions that the economy should continue to be pretty healthy throughout 2018. I think that some of the benefits of the December tax-cut bill, on both a corporate and personal level will only begin to be seen in the next few months. I also believe that the Fed is going to continue to aim to manage the market as much as possible; I think that this week’s interest rate hike was indicative of that determination, not by the hike itself, but by new Chairman Jerome Powell’s statement, which certainly implies he and the rest of the members of the Board of Governors seem intent on maintaining the pace and schedule that had previously been outlined by previous chair Janet Yellen.
What about tariffs? The media is all abuzz about their implication and the threat of trade war with China, the second biggest import/export partner the U.S. has. The future is unknown, of course, and one of the biggest challenges for anybody right now – on any side of the political spectrum – is trying to guess what, exactly is on President Trump’s mind. My own opinion is that as happened with the first round of tariffs on steel and aluminum a couple of weeks ago, the actual implementation will be less than those announced. Before signing the China-targeted tariff bill, Trump also announced exemptions for the European Union, Argentina, Brazil, Australia and South Korea, in addition to previous exemptions for Canada and Mexico on steel and aluminum. I believe that the smart thing is to use that as a model for what Trump expects to come from this second round. He wants to bring China to the table to negotiate; but where career politicians prefer to be polite and diplomatic, he’s willing to bend a few noses to get them there. Conflict has always been a natural part of doing business for Donald Trump, and I believe that is how sees what is going on now.
What is the average investor supposed to do? The market’s increase in volatility so far this year is a strong confirmation of the market’s tendency to “sell the rumor,” which means that it usually assumes the worst, at least in the short term. That can put a lot of stress on individual stocks, and the truth is that a declining market makes it hard to find ways to make money on a practical, constructive basis. In the worst case, an all-out trade war could put price pressure on an ever-increasing range of goods and services, which would ultimately filter down to the consumer level, and could be the tipping point for a reversal of the economic strength and health that has so far pushed stocks into the ninth year of this current bull market.
One of the smart ways you can keep working with the stock market, but try to minimize the level of risk you take in it, is to focus on sectors and industries that have historically proven to be resilient when the economy struggles. Analysts like to call these types of stocks “non-cyclicals,” because they don’t tend to follow the normal cycles from high to low that usually accompanies economic turmoil. These are businesses that have sustainable income sources because they offer products or services that other businesses and consumers always need no matter whether the economy is good or bad. A couple of the first sectors that most economists tend to talk about that fit this description are utilities and commodities, including precious metals.
I actually don’t love utilities very much right now, even though it generally make sense that even when the economy struggles, people need to heat their houses and water, and keep their lights on. It’s also true that most utility stocks tend to be less volatile than stocks in most other sectors; but it seems like every utility company I evaluate right now has issues that make me hesitate. In particular, they all seem to be very highly leveraged, with debt/equity ratios at sometimes alarming levels, and cash flows so restricted that their ability to service their debt has to be questioned.
Precious metals are interesting, and if you invest directly in the metal itself, like gold, you can usually get a reverse correlation that works well when stocks actually move into bear market territory. Investing in companies that mine and process metals, however is generally pretty risky and so I don’t think they provide the same kind of conservative, and even defensive posture I’d prefer to work with under current conditions.
Other commodities, like food and personal care products, provide a more compelling argument to me right now. We aren’t going to stop feeding our families or taking care of our personal hygiene, and so even when economic struggles filter down to consumers, household food and care budgets generally stay pretty consistent. Grocery store stocks like The Kroger Company (KR) continue to be interesting, at least up to a point; however this is an industry that retains a somewhat higher level of risk exposure right now, especially since I think the industry is going to consolidate as companies continue to try to figure out how they will compete with Amazon’s moves in the space and Walmart’s continued dominance. A good example passed the headlines earlier today, as reports surfaced that Target Corporation (TGT) and Kroger (KR) are exploring a potential merger.
My interest is actually turning more to the companies that fill the shelves of grocery stores than the stores themselves. Consumer Staples is a sector that has come under quite a bit of pressure since the beginning of the year, and that has pushed an increasing number of food and personal care stocks to historical lows. Considering that the economy itself is still healthy, the decline in these stocks can provide a good opportunity to get in at a low price. If a downturn does come, either in the near-term or somewhere down the road, the fact these stocks are already at or near historical lows should also help provide a buffer that will help them hold up better than cyclical stocks generally do. When you add in the fact that many of these stocks also offer an annual dividend, the idea of holding onto shares for long-term period of time becomes even more attractive.
Here are five of the most undervalued, and fundamentally strongest stocks in this sector right now.
1. Kraft Heinz Company (KHC)
Current Price: $60.30
This is a company that just about everybody should recognize right away. If you check your refrigerator or pantry, there is an excellent chance that one or more of this company’s products are sitting on your shelves. This is a $73 billion company with brands that include Kraft, Heinz, Oscar Meyer, Philadelphia, Planters, Velveeta, Lunchables, Maxwell House, Capri-Sun, and Ore Ida.
KHC’s stock has only been trading publicly since July of 2015, when Kraft Foods Group and Heinz merged. Their ROE and ROA numbers aren’t as high as the other companies in this list, but are still healthy. They have adequate cash flow, and their balance sheet indicates that operating profits are more than sufficient to service their debt. The stock’s annual dividend yield is one of the highest in the industry as well as this list, at 4.13%.
One of the very remarkable aspects of this stock is its value proposition. While most of the stocks in this list are trading 4 or 5 times their Book Value (or even higher), KHC is only a little above its Book Value of $54.34. The stock hasn’t been trading long enough to establish a historical average, but the industry average in this case acts as a reasonable proxy. The industry average offers a long-term target price of nearly $120 per share, which gives this stock very possibly the biggest upside of all of the stocks in this list.
2. Kimberly-Clark Corp (KMB)
Current Price: $104.74
KMB is the maker of household care products ranging from Depend incontinence products for adults to Huggies and Pull-Up diapers for babies and Kotex feminine hygiene products for women; family care brands in the U.S. include Kleenex, Scott, & Viva paper products. Their operations extend across the globe, and the company’s market cap is more than $36 billion.
Fundamentally speaking, there is a lot to like about this company. Their Return on Equity (ROE) and Return on Assets (ROA) numbers place them in the category of a growth stock, and they have healthy free cash flow. Like most of the companies in this sector, they are highly leveraged, but their balance sheet indicates their operating profits, along with cash and liquid assets are more than sufficient to service their debt. Additionally, holding this stock offers an annual dividend of 3.72% at the stock’s current price, which is very attractive.
The most compelling reason to think about buying KMB right now is their value proposition. The stock is currently more than 23% below all-time highs reached in July of 2016. It is also trading more than 74% below its historical Price/Book average, and about 19% below its historical Price/Cash Flow average.
3. Campbell Soup Company (CPB)
Current Price: $42.27
Sometimes a name says it all, and that is certainly true for this stock. Soup is one of the ultimate comfort foods, after all, no matter whether you’re sick (hello, chicken noodle) or just need something warm to fill your belly on a rainy day. Campbell’s soup is an American classic that everybody recognizes immediately. This is a $12.7 billion company that doesn’t just make soup; other immediately recognizable products include Prego pasta sauce, V8 juices, and Pepperidge Farm cookies.
CPB’s ROE and ROA numbers are excellent, and they have healthy free cash flow. Their debt-equity ratio is also lower than most of their peers and indicates they should have an easier managing their debt burden. This stock’s annual dividend yield is 3.3%.
The value proposition for CPB is very attractive. The stock’s downward trend, like KMB began in July in 2016 from a high at around $68 – a level it hadn’t previously seen since 1999. The stock is currently trading at a 36.9% discount to its historical Price/Book average, and a 24.6% discount to its historical Price/Cash Flow average.
4. Unilever NV (UN)
Current Price: $53.27
Unilever, which is based in the UK and the Netherlands, may be the most diversified of all the stocks in this list. An $80 billion company with operations that span the globe, their products can be found in just about any section of a grocery store. Some of the more recognizable brand names for its products in the U.S. include Axe, Dove, Sun, Hellmann’s, Knorr, Lipton, Magnum, Ben & Jerry’s, Vaseline, Suave, and Zest.
Since UN is based outside the U.S., but listed on the New York Stock Exchange, they are required to file annual reports just as any publicly traded company; however many of the usual fundamental measurements for internationally-based companies tend to be harder to come by. As a result, ROE and ROA numbers aren’t readily available for UN. Analyzing their latest annual report indicates that while they are like many of their brethren in carrying a fairly high level of debt, they have more than adequate ability to service their debt, along with healthy free cash flow. The stock offers an annual dividend yield of 3.13%.
UN is also different from the rest of the stocks in this list, because while the stock has come down over the last six months, it is not actually trading at or near all-time lows. In fact, the stock’s all-time high was reached in October of 2017 at around $61 per share, putting the stock just a little under 13% below that high. All the same, the stock offers a nice value opportunity, because it is currently trading almost 25% below its historical Price/Book Value average.
5. General Mills, Inc. (GIS)
Current Price: $44.21
When I hear the name General Mills, I immediately think of the breakfast cereals I grew up on: Cheerios, Chex, Wheaties, Trix, and so on. This $25 billion company’s branded products extend well beyond the cereal aisle, though and include Pillsbury dough, Betty Crocker and Hamburger Helper, Annie’s, Progresso, Yoplait, all the way to the freezer section with Häagen-Dazs ice cream.
GIS has excellent ROE and ROA numbers that fit well into the growth category, with very healthy free cash flow and more than adequate ability to service their debt, which is among the lowest levels of all of the stocks in this list. Its fundamental profile is boosted even more by the fact it offers the highest dividend yield of all of the stocks listed here, with annual rate of 4.4%.
GIS has been following an extended downward trend since July of 2016 after reaching an all-time high in the $72 range. The real validation of the stock’s value opportunity is that it is currently trading 23% below its historical Price/Book Value average, and 34.5% below its historical Price/Cash Flow average. With those two elements considered together, using that all-time high as a long-term price target seems neither unreasonable nor unlikely.
Being wary of current economic conditions usually means it’s a good time to start thinking carefully and strategically about the ways you’re going to invest your money. The great thing about the market is that there are a lot of different ways you can put your money to work for you, no matter what the market is doing. If you’re willing to work with a long-term time frame, and spend some time doing a little research, it’s possible to uncover good opportunities in a lot of different segments of the market in any market condition. Using one or more of the stocks outlined here could be a good way to diversify your portfolio into a segment of the economy that should hold up well even if the economy turns sour. That can give you better peace of mind.