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5 Value Picks to Beat an Overvalued Market


We are in one of the longest bull markets in history, so it’s not surprising that investment advisors and market watchers alike are pointing to signs that the bears are taking over. And this is a good thing because it helps curb bubble-like prices and avoid the plunge that follows.

After the depression in 2008-2009, companies have been conservative about increasing investments and have tried to supply to consumption. Investors too have jumped off stocks that appeared remotely risky. This has resulted in a conservative (and therefore, prolonged) rally.

But in life and especially in the stock market, anything good soon appears to be too good to be true and over the past month or so, experts have been pointing to some negative signs. So let’s take a quick look at what those are:

What Are the Negatives?

In the words of HSBC technical analyst Murray Gunn, "With the U.S. stock market selling off aggressively on October 11, we now issue a RED ALERT.” His reason? "The possibility of a severe fall in the stock market is now very high" because volatility continues to increase since the end of the summer.

Global equity strategist at HSBC, Ben Laidler says that high earnings expectations, economic-policy uncertainty, the upcoming U.S. election and the Italian referendum are a combination of risk factors for stocks.

Citi's Tom Fitzpatrick (as reported in Business Insider) sees great similarities between the current charts of the S&P 500 and the index in 1987 right before the crash. Other than the technical factors, concerns highlighted by him include:

1. Europe-related: the UK beginning legal proceedings to exit the EU by Mar 2017 and Deutsche Bank’s inability to lower the $14 billion fine by U.S. authorities.

2. Most polarizing U.S. election in modern times.

3. Reports that the central banks in Japan and Europe will be lowering their bond purchases, which can impact central bank policies worldwide.

4. Market factors: a 16% move in oil prices within a week; a 20-basis-point shift in U.S. 10-year yields in five days; and a $90 move in gold prices in nine days. Plus, the Chinese yuan and British pound have made massive moves in a short period of time.

HSBC’s Gunn is looking for a Dow Jones Industrial Average of 17,992 or S&P 500 average of 2,116. Citi’s Fitzpatrick is looking for a support level for the S&P 500 of 2,119. Below these numbers there will be greater volatility and continued declines in search of a new floor.

Jim Cramer, in conversation with technical analyst and colleague Rob Moreno uncovered that when the market punishes yesteryear darlings like General Electric, Under Armour, Disney and Starbucks, it is a sign of bearish sentiment. Stunned that biotech stocks, particularly Gilead could slump so much because of Clinton’s promise to control drug prices, Cramer is advocating investing in technology instead: primarily companies dominating in social, mobile, cloud, Internet of things (IoT), augmented reality (AR) or artificial intelligence (AI).

Charles Schwab in a Sep 2016 report mentioned several negative indicators: soft ISM readings at the beginning of September, some weaker-than-expected housing data for August (housing starts fell 5.8% and building permits dropped 2.3% according to the U.S. Census Bureau; existing home sales fell 0.9% according to the National Association of Realtors), some signs of weakening of the seemingly ever-growing auto market (percentage of banks tightening auto loan standards is 8% compared to negative in the first quarter according to Cornerstone Macro Research. Possible reason is the 17% year-over-year increase in the number of subprime loans that are now 60 days or more delinquent).

In addition, possibilities of a rate hike remain although the Fed has already scaled back on its plans for 2016. Still, the minutes of the Federal Open Market Committee (FOMC) meeting in September indicate that sentiments are moving in support of a rate hike in November although after the election in December. Of the ten voting members, three supported a rate hike while several others weren’t opposed to it.

Chairperson Janet Yellen has said that the Fed is looking for “evidence” of a stronger economy, jobs report, international trade factors, etc. Raising rates are a bit of a double-edged sword, since it will pull money out of the market while not raising them soon enough will lead to inflation (currently contained at under the targeted 2%). Jobs have increased steadily through the year but mostly because of new people entering the work stream (unemployment rate remains at around 5%, which is fine but the Fed may be waiting for this to go down further).

What Are the Positives?

Declining Initial Jobless Claims: Initial jobless claims in October have declined to the lowest level since Nov 1973, marking 84 consecutive weeks of initial claims below 300,000, the longest streak since 1970. The trend line shows a continued decline since Jan 2015 indicating the likelihood of a more or less stable unemployment rate going forward. Since the unemployment rate of 5% is considered full employment, this is a huge positive for the economy.

Rising Consumer Confidence: The U.S. Consumer Confidence Index (CCI)), i.e. the degree of optimism on the state of the economy that consumers are expressing through their activities of savings and spending, is rising. In Sep 2016, the Index jumped to 104.1 (1985=100), up from 101.8 in August. The Present Situation Index rose from 125.3 to 128.5, while the Expectations Index improved from 86.1 last month to 87.8 this month. This is its “highest level since the recession” according to Lynn Franco, Director of Economic Indicators at The Conference Board.

Earnings Picture: A look at the Zacks Earnings Trends Report dated Oct 12 shows that we are entering a stronger period. While quarter three estimates for S&P 500 stocks were adjusted after second quarter earnings reports, the expected decline of 2.9% in Q3 earnings on 1.2% higher revenue compares very favorably with expectations for a 6.2% earnings decline entering the Q2 earnings season. Actual earnings growth rates have come in better than pre-season expectations by about +2% to +3% in the last few quarters and there’s nothing to suggest that this quarter will be any different.

Moreover, excluding the energy sector, which is expected to decline 68.3% in Q3, total earnings for the S&P 500 would be up +0.3%. The stronger sectors are expected to be Construction (+6.3% earnings growth in Q3), Business Services (+7.1%), Retail (+4.4%), Utilities (+4.8%) and Finance (+4%). Tech earnings ex-Apple are expected to be up 3.0% on +0.5% higher revenues. Overall earnings growth for the S&P 500 is expected to be positive from the fourth quarter onward.

Excluding the Energy sector, total earnings for the S&P 500 would be modestly in positive territory, up +0.3%.

A Good Time for Value Stocks

When market sentiments are turning negative, you can take advantage of the lower prices by investing in stocks with strong long-term growth potential. Here’s a list of such stocks:

Boyd Gaming Corp BYD

Headquartered in Las Vegas, Boyd Gaming Corporation is a leading diversified owner and operator of 22 gaming entertainment properties located in Nevada, Illinois, Indiana, Iowa, Kansas, Louisiana, Mississippi and New Jersey.

Zacks Rank #2

Value Score A

PEG Ratio 0.64

Earnings growth for next year 58.50%

Earnings growth next 5 years 37.60% (industry 12.10%)

KLA-Tencor Corp KLAC

KLA-Tencor Corporation is one of the world's leading suppliers of process control and yield management solutions for the semiconductor and related microelectronics industries.

Zacks Rank #1

Value Score B

PEG Ratio 0.67

Earnings growth for next year 14.20%

Earnings growth next 5 years 21.20% (industry 14.10%)

Lithia Motors LAD

Lithia Motors sells new and used cars and light trucks and replacement parts, provides vehicle maintenance, warranty, paint and repair services, and arranges related financing and insurance for customers.

Zacks Rank #2

Value Score A

PEG Ratio 0.83

Earnings growth for next year 11.30%

Earnings growth next 5 years 15.30% (industry 12.80%)

Green Plains Partners LP GPP

Green Plains Partners LP provide ethanol and fuel storage, terminal and transportation services by owning, operating, developing and acquiring storage tanks, terminals, transportation assets and other related assets and businesses.

Zacks Rank #1

Value Score B

PEG Ratio 0.74

Earnings growth for next year 11.30%

Earnings growth next 5 years 15.30% (industry 12.80%)

First Bancorp FBP

Green Plains Partners LP provide ethanol and fuel storage, terminal and transportation services by owning, operating, developing and acquiring storage tanks, terminals, transportation assets and other related assets and businesses.

Zacks Rank #1

Value Score B

PEG Ratio 0.71

Earnings growth for next year 2.40%

Earnings growth next 5 years 18.10% (industry 10.10%)

Where Do Zacks' Investment Ideas Come From?

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