Markets essentially just do two things. They either follow trends, or they don’t.
In 2016, stocks followed their post-financial crisis upward trend. The S&P 500 gained about 10 percent. The Dow gained about 12 percent. Both gains are above the historic average return of 8 percent per year. Most of those gains occurred within the space of the final two months of the year.
So far, the trend is intact. Stocks are still the best game in town for investors as we head into a new year. But they’re still pricey as well. The S&P 500 trades close to 24 times earnings. The only two times stocks have been more expensive on average, we were entering the housing bubble 10 years ago and the Internet bubble 20 years ago.
The funny thing is, stocks could go a lot higher. Between high amounts of cash on the sidelines by wary investors and a lack of mania, we’re not at the psychological point where the trend is likely to break. And even, then, alternatives to stocks didn’t fare too well either.
Bonds dropped modestly, assisted by another rate hike by the Federal Reserve at the end of 2016. But do you really want to lock in a measly 2.62 percent return on a 10-year government bond when inflation is 1.7 percent but ticking up. Even if you do manage to make a gain after inflation, taxes will take most of that away. Sorry, but bonds are still a “hot potato” investment at these levels. You might make some money owning them, but a sustained rise in interest rates, or even some good old market fear, will crush returns. Better buying opportunities will emerge.
The trend in gold still seems broken. While metal surged 30 percent higher in the first six months of 2016, it gave up most of those gains in the second half of the year. We’ll see if things turn around on that front. I expect that the worst is in and we’ll gradually trend higher. If that’s the case, there’s an argument that the downtrend is broken. But we probably won’t get past $1,300 or so, where the metal struggled to pass in 2016.
With the broad trends still in place for these various assets, the real opportunities in 2017 appear to be in individual places, not sector-wide. That means finding companies that are unloved, out of favor, and ideally ones that missed the market’s end-of-year rally.
Fortunately, there are always such opportunities. Let’s look at a few:
Nike (NKE). The athletic apparel and footwear manufacturer posted a dismal return in 2016, with shares sliding 15 percent. Compared to the overall market’s gain, that’s a relative underperformance of 25 percent. While shares look pricy on an earnings basis (23 times), the company’s valuation is starting to look appealing on an historical basis (about 33 time earnings). The company’s strong brand has long commanded a premium.
What’s created this relative value? A 13 percent decline in sneaker sales. Unlike other athletic apparel, Nike dominates the competition in this space with about 90 percent of the market share in the U.S. And while sales were down overall, the most recent quarterly numbers showed a rebound in sales, as well as improving sales of its shoes in China.
The most interesting trend for Nike is the sales growth in e-commerce. Admittedly, Nike is a little late to the party, but they’re quickly making up for lost time. The company is bypassing stores and selling direct to consumers. Nike.com saw sales grow by 46 percent. With traditional, brick-and-mortar retail venues still struggling, it’s clear that Nike is still getting its products into the hands of consumers one way or another.
Nike pays a modest dividend of 1.4 percent, but has a long history of growing payouts. And, over longer periods, the stock has done exceptionally well. Over the past 30 years, it’s been one of the best performing stocks in the S&P 500 and the Dow. Now’s the perfect time to take advantage of its out-of-favor status.
Gilead Sciences (GILD). This pharmaceutical firm got taken to the proverbial woodshed in 2016. Shares dropped 24 percent in the year. The fear is that the company’s top Hepatitis drug, which is losing its patent, will fall by the wayside and that there isn’t a big replacement.
That’s always a fear with the pharma companies. If there isn’t a promising drug—or several—in the development pipeline that can jump to quick profits, fear sets in.
But the big drop in shares seems overdone. The company sports a fantastic profit margin of 47 percent. Return on equity is over 80 percent. The company generates $23 per share in revenue, meaning the company trades at about 3 times revenue at current prices. Even if there’s a drop from the loss of one of its top drugs, the company has other drugs that it relies on in the meantime. It will develop or buy a new one to replace the aging ones, as the Big Pharma names always do.
This is another dividend-growth play as well with a 2.6 percent yield at current prices. With a payout ratio of just 16 percent, however, the company has room to continue increasing the dividend far into the future, even if future earnings remain flat.
Wal-Mart (WMT). On Star Trek, some of the pipes on the star ship Enterprise were labelled GNDN. That was an inside joke for “goes nowhere; does nothing.” That’s how I feel about Wal-Mart’s share performance. Although shares were up in 2016, share prices remain about 25 percent below the highs set in early 2015.
The retailer is a nice combination of safety, value, and growth at these prices. Shares trade at 15 times earnings, below that of other retailer competitors like Target (TGT) or Amazon (AMZN). Although earnings have been on a downtrend for most of the past year, the most recent quarter showed improvement and even some modest revenue growth.
While the value in Wal-Mart will likely persist given the competitiveness of the retail environment, the real value will come about over the long haul. The company’s dividend yield stands at 2.89 percent currently, but given the company’s history of raising the dividend, buying shares today could pay far better in the future.
These are just three large-cap stocks that look like relative bargains as we start the year. We’ll see how things unfold. Welcome to 2017!
Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and is managing editor of Financial Intelligence Report.
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