In recent days, we’ve seen a pretty strong rally play out in the stock markets. The Dow Jones Industrial Average is 4.84% during the last week, alone. The S&P 500 is up 4.38% during the trailing 5 trading days. And, the Nasdaq is up 4.42%.
Now, there’s no way to know whether or not this is just a counter-trend bull rally in the midst of a larger bear market or if we’ve seen the bottom of 2022’s double digit pullback. Only time will tell in that regard. But, I do remain fairly cautious because when I look at the macro picture.
At a high level, I see a slew of potential significant headwinds on the horizon and therefore, while I’m not selling my blue chip stocks because of these concerns, I’m also allowing FOMO (the fear of missing out) to inspire me to hastily allocate capital into this rally.
If the rally continues, that’s fine…approximately 93% of my wealth is allocated towards equities and I’ll benefit in a major way. But, as always, I want to be prudent with my dry powder to ensure that I have the opportunity to buy into further weakness if it arrives.
Even after this recent rebound, the fact is, many individual companies still find themselves in bear markets. There are many high quality companies that I trade right now that are trading down 20%, 30%, 40%, 50%, etc, from their all-time highs. With that in mind, I still believe that there are buying opportunities in the market today. But, instead of talking about potential discounted stocks, in this week’s Durable Dividends article, I actually want to put a spotlight on names that are trading near their 2022 highs.
Why?
Well, because as much as I love highlighting blue chip value, I also think it’s important to take the time to reflect on what works in the market.
Doing so can provide confidence in one’s portfolio management strategy and sort of bolster good behavior over the long-term.
When looking at the stocks that are trading at/near recent highs across my portfolio and watchlist I see a common theme…
The recent top performers were formerly unloved stocks.
Some of these companies have been out of favor for years now, leading to incredibly cheap valuations. And, in today’s market environment, these former pariahs have transformed into market darlings.
Throughout much of the last 6 months or so, we’ve seen a sharp reversal in market sentiment, with a “risk-off” mindset amongst investors inspiring them to rotate out of more speculative, growth oriented stocks and into the beaten down, value oriented, cash cows.
This trend has accelerated throughout 2022, driven by the flight to safety inspired by current geopolitical uncertainties and the Federal Reserve’s hawkish stance when it comes to interest rate normalization.
While it’s true that rumors of productive peace talks have inspired short-term rallies in recent days, I think it’s still entirely too early to attempt to predict the ultimate outcome of the war in Ukraine.
I suspect that this crisis will contribute to higher energy prices and ongoing global supply chain issues for the foreseeable future. It’s clear that the war will weigh negatively on global growth. And, with no clear end in sight, I think the risk-off posture that we’ve seen the market adopt in recent weeks makes sense.
But, barring a major escalation which turns the war between Ukraine and Russia into World War III (which is a possibility – however slight – and therefore, a risk that investors ought to consider when thinking about asset allocation), I don’t believe that this geopolitical situation is the biggest headwind facing equity markets in the short-term…
That crown goes to the Federal Reserve and its ability to taper quantitative easing, reduce the size of its balance sheet, and raise interest rates in a way that will help to tamp down inflation and provide policy makers with future flexibility to deal with economic downturns without creating a recession by doing so.
Frankly, this is a very difficult needle to thread and therefore, once again, I think it makes total sense for investors to adopt a more defensive posture when it comes to their portfolios in an environment when the Fed is tightening.
But, when saying this, I also think there is one very important fact that investors need to acknowledge: the economy remains very strong in the United States, the job market looks great, wages are rising, and collectively, the consumer’s balance sheet remains strong.
Therefore, I think calls for a recession in the very near-term are likely overdone; though, I will be monitoring the yield curve closely over the coming quarters to see how the Fed’s decision making impacts the bond markets (which, historically, have served as a fairly accurate barometer when it comes to predicting economic slowdowns).
While we don’t know how successful the Fed will be at living in the Goldilocks Zone which allows it to normalize while not causing a recession, what we do know is that rates are going to rise.
This week, the Fed raises rates (25 basis points) for the first time in 3 years. And, the Fed is calling for another 6 increases during 2022 alone.
All of this was expected and it’s the reason that high multiple stocks are selling off.
Simply put, as the risk-free yields attached to fixed income rise, the demand for equities (risk assets) is going to fall.
Therefore, multiple contraction across the major averages (and especially in the very risky areas of the market) is a logical response to the normalization process.
However…if a company’s earnings multiples were already compressed to irrationally low levels, then it doesn’t make sense for them to head lower.
On the contrary, during this risk-off sentiment shift, it has made sense for investors to pile into beaten down blue chips, finally, after years in some cases, allowing these coiled springs to pop.
A couple of examples that are at the forefront of my mind right now – with regard to this trend – are AbbVie (ABBV) and Bristol-Myers Squibb (BMY).
I’ve written dozens of articles, made a handful of YouTube videos, and made hundreds of bullish comments about these two blue chip bio-pharma names in recent years.
I’ve put my money where my mouth is as well, building up overweight positions in both stocks.
Why?
Well, because to me, these stocks had gotten entirely too cheap during their recent periods of weakness.
Both ABBV and BMY traded with single digit price-to-earnings ratios for much of the last 2-3 years. However, both companies posted strong earnings growth during their downtrodden periods. Therefore, a wide divergence between operational performance and the premiums that the market placed on shares formed. To me, this represented a fantastic buying opportunity.
Bristol-Myers has posted positive EPS growth for 8 consecutive years. During 5 out of these 8 years, BMY’s annual EPS growth was in the double digits. And yet, if you go look at a long-term stock chart here, the market has essentially hated BMY since the middle of 2016.
AbbVie, too, has posted positive EPS growth for 8 consecutive years. In AbbVie’s case, the company has posted double digit year-over-year EPS growth during 7 out of the last 8 years. And yet, from 2019-2022, the stock traded with a single digit P/E ratio.
For someone like me who loves buying mature, cash cow companies who produce reliable growth and are trading at irrationally cheap prices, it was easy to accumulate large positions in these two stocks.
But, throughout the process, there were plenty of naysayers, calling the companies “dogs” and saying that all of the investment dollars flowing into ABBV or BMY shares were going to amount to “dead money”…or worse.
That’s the typical reaction of someone who allows fear to dictate their decision making, instead of paying attention to fundamentals. And in my opinion, that is the exact type of noise that fundamental value investors should be tuning out.
For years, it was clear to me (and many others who bought the dip) that both ABBV and BMY were primed for a rebound because the multiples attached to shares were simply too low.
And finally, it appears that 2022 is proving us right.
This piece certainly isn’t meant to be vindictive to any of the ABBV or BMY bears out there. No one has a crystal ball, no one is right 100% of the time, and therefore, I don’t think it makes much sense for an investor to brag about trades, or worse, ridicule others with opposing opinions. Instead…this piece was meant to show that patience pays off in the market.
Far too many times, I’ve seen investors lose sight of their logical, rational, fundamentally driven theses and allow fear to cause them to make a mistake in the market. And I hope, with so much macro uncertainty and so many scary headlines swirling around, that the recent rallies of stocks like AbbVie and Bristol-Myers will provide solace to disciplined value investors.
The market is fluid. Sentiment is constantly ebbing and flowing, into and out of various sectors and industries, resulting in unpredictable bullish and bearish times. But, during periods of volatility I believe that investors can use underlying fundamentals (past, present, and future estimates) to serve as a buoy, or an anchor, against the fearful storm. This is especially the case when the companies in question pay a dividend.
Reliably increasing fundamentals tend to result in reliably increasing passive income, which is exactly what I want to see from the companies that I invest in. And therefore, not only can a strict focus on fundamentals, (especially those related to profits and dividend safety metrics) result in peace of mind and a safe (and rising) passive income stream in the present, but it can result in fabulous returns over longer periods of time, just as patient AbbVie and Bristol-Myers Squibb investors are well aware of after their recent rallies.
Disclosure: Nicholas Ward is long ABBV and BMY.
This article is intended to provide information to interested parties. As we have no knowledge of individual circumstances, goals and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended. It does not guarantee that securities mentioned in this newsletter will produce profits or that they will equal past performance. Additionally, we are not an investment advisor and do not offer securities or tax advice. Although all content is derived from data believed to be reliable, accuracy cannot be guaranteed. Nicholas Ward, contributors and staff members of Wide Moat Research may hold positions in some or all of the stocks listed.
Nicholas Ward is a research analyst who currently writes for Seeking Alpha, The Dividend Kings, iREIT, and Forbes Real Estate Investor. Before that, he was Founder and Editor-in-Chief of The Dividend Growth Club, as well as the Income Minded Millennial. Nicholas has also contributed to Sure Dividend, Investing Daily, and The Street, where he covered stocks in Jim Cramer's Action Alerts PLUS Portfolio.
Nicholas holds a bachelor of arts from The University of Virginia, where he studied English and studio art. Prior to transitioning into the financial industry, he managed a vineyard in the foothills of the Blue Ridge Mountains.
