How Will Fortune Magazine's 10 Stock Picks for 2009 Fare?

I expect 2009 to be another tough year for equities. That being said, the current bear market rally is likely to take markets up another 20% from here during the first half of the year, before stalling in the summer months and retesting the November lows later in the year. There is a good chance that these lows will not hold and new sustained deeper lows will be plumbed later in the year, as official unemployment shoots up above 8%, consumers tighten their belts further and credit card defaults accelerate to unprecedented levels across all consumer strata.

Banks’ risk control models will blow up and fly out of the window once again, incapable of dealing with extreme circumstances. The US Government will again attempt to step in, in order to prevent the evaporation of mass amounts of capital. With the Fed’s interest rate control mechanisms out of commission, the government will work to directly inject more $ into the system a la TARP and by funding infrastructure public works projects.

But where will all this money come from? It is highly unlikely that the US government will be able to sell more bonds at insanely low interest rates. Who will buy them? The Chinese and the Japanese, who have been these bonds’ primary buyers, have plenty of problems of their own these days. In their attempts to prop up their economies they will transform from net buyers of US Government bonds to sellers. By drastically increasing the supply of such bonds on the market, they will significantly drive down bond prices and thereby increase market yields. This will effectively pop the bubble in government bonds.

Any new US Government bonds that could be auctioned under such circumstances would be forced to pay much higher rates of interest, which would make such new issues too expensive and thus impractical. So, what’s the alternative? Of course, the answer, which has already been suggested by the Fed is in “quantitative easing.”

At this point, expansion in the supply of $US through printing appears unavoidable. Even if “helicopter Ben” resigns his post as the Chairman of the Board of Governors prior to the expiration of his term in 2010 and is replaced by the biggest fiscal conservative Democrats can fathom, the central bank will still print new money. This is inflationary and will also cause the value of $US to fall precipitously.

This will all happen in 2009. Of course, this is a dreadful almost worst case scenario, but, unfortunately, it is also the most likely one. I believe that it is much easier to avoid a personal financial disaster by conservatively preparing and bracing for the worst. Thus, in looking at Fortune Magazine’s list of top 10 selections for 2009, I kept in mind the recessionary economic backdrop I just described.

Now, here are my mini visions for Fortune Magazine’s top 10 stock picks for 2009:

1. Altria (MO) – This stock is definitely a defensive recessionary play. When things get really tough, people increasingly turn to their vices for satisfaction. And what better way to do that than by smoking a cigarette? At under $5 a pack, this is definitely an affordable luxury many will turn to. But is Altria, the largest US cigarette maker, a good investment for 2009? I have serious doubts. In analyzing this company, please consider that it is not the same company it was less than 2 years ago, before it spun off its food divisions in the form of Kraft (KFT), followed by the spinoff of its international tobacco products division.

Now Altria is essentially a US-only tobacco products company. It is also in the process of acquiring a richly valued US smokeless tobacco products plus wine company for cash – cash that Altria is borrowing at considerable cost! Yes, the current 8+% yield is attractive and yes, the “Altria Earnings Protection Act,” which is likely to pass will make barriers to entry exceedingly high for new players, but Altria’s business is inherently a shrinking one, and for the foreseeable future, the company will continue to be mired in legal action related to the various cancers its products may cause. I say don’t be fooled by the incomparable comps with prior years and avoid Altria (and its products) this year.

2. Annaly (NLY) – This is a rerun from last year’s recommendation. Now that the federal government made the choice to stand behind Fannie (FNM) and Freddie's (FRE) mortgage guarantees, this stock is much safer than it was this time last year. It is also trading marginally lower and is paying a great dividend. At the current price level (over 50% above the 52 week low) I see it as fairly valued. I don’t expect it to appreciate considerably over the coming year, but it should do better than the overall market from here.

3. (DELL) – Now is a good entry point into Dell. The computer maker is certain to appreciate with the market over the next two months. However, I would not hold on to this stock for too long. Dell is in a very competitive commodity business on the low end. At the high end, Dell depends on corporate spending. Both sides of the business will be pressured through at least 2009, resulting in lower ship volumes and diminished profitability.

4. Devon Energy (DVN) – This US and Canada oil and gas exploration and production company’s fortunes are tied to prices of oil and gas. As I expect energy prices to recover from their December 2008 lows, I expect companies like Devon, EnCana (ECA) and Anadarko (APC) to appreciate alongside commodities. However, some of this expectation is already built into the current prices of these stocks and this should moderate your expectations for appreciation. I would rush to lock in a 20% gain from current levels.

5. Diamond Offshore (DO) – This energy play - a driller - is perhaps one of the more interesting stocks on the Fortune’s list. Once energy prices rebound strongly, DO will benefit more than its land based driller competitors. It makes sense to jump on this stock now, while it is trading at a very reasonable level. If you are looking for investment ideas in drillers, you should also not ignore Transocean Ltd (RIG), a Diamond Offshore competitor that may offer an even better appreciation potential from current levels.

6. Fluor (FLR) – I see this engineering and construction company as fairly valued at this point. Its strength in 2009 will come from gains in the public sector construction promised by the incoming administration. This strength has already been recognized by the market. Unexpected weakness is likely to come from waning demand from Oil and Gas customers, as they scale back development projects to maintain profitability. These customers have recently accounted for over 50% of all revenues and profits. If you are looking to invest in companies that may benefit from public works construction projects, you may want to look at some of the badly hurt raw materials suppliers like Cemex (CX) or Headwaters (HW), instead.

7. Johnson & Johnson (JNJ) – This is one of my perennial favorites. It is, perhaps, the most consistent long term performing publicly traded stock. The current dividend yield of 3% is attractive. The company significantly participates in the pharmaceutical, medical device and consumer products industries. Many of the products offered by JNJ are virtually recession-proof. JNJ has lots of cash and the stock is currently fairly priced, trading at a P/E of under 14 - the very bottom of its long term P/E range. Don’t expect to make a killing on this stock, but do expect price stability and a decent dividend – a winning combination in the current market.

8. Medco Health Solutions (MHS) – This 2003 pharmacy benefit manager spinoff from Merck (MRK) has done quite well for itself and its investors over the past 5 years. Pharmacy benefits managers like Medco basically make their money by negotiating discounts with drug makers for customers. Despite the success of the recent years, there are many problems with the middleman business model, including potential conflicts of interest resulting in breaches of fiduciary duty lawsuits, large clients’ desire to eliminate middlemen and, most threateningly to earnings, government’s propensity to regulate businesses that fall within current public policy interests. Medco shares are now trading at a very rich multiple, which discounts the potential problems, which are capable of halving this stock’s valuation.

9. Pfizer (PFE) – I like this pharmaceutical play – one of the better values among the big pharma. While the upside is relatively limited over the next year, so is the downside. In the meantime, the 7% dividend is reasonably safe and very attractive. Nice pipeline of new drugs should help maintain profits going forward. Licensed generics route may give a new life and revenue source to the expiring blockbusters.

10. Potash Corp. of Saskatchewan (POT) – In general, I like POT, no not the smoking kind – never tried that one, but POT, the Canadian company that produces potassium, phosphate and nitrogen based fertilizers. Of course, the company's crown jewels are the potash mines. It would be nearly impossible to supply the level of current world demand for potash without the mines in Saskatchewan and it would be impossible to grow crops without making potash available to them.

But how profitable are the Potash corporation’s businesses? Turns out that during Q3 of 2008, while the company enjoyed skyrocketing commodity prices, they were very profitable. However, as commodity prices quickly plunged, so should have POT’s profits – returning to their historic norm. I expect many commodities to rebound, some as much as 50% from their Q4 2008 lows in 2009, but that will still leave prices a far cry from last year’s peak. In the meantime, POT stock has already recovered more than 50% from its bottom, which leads me to believe that any further appreciation in this stock’s value will be short lived.

So, there you have it - my current view of the year ahead. You can certainly hope that history proves me wrong, but can you afford for me to be proven right?!

Disclosure: Long JNJ, HW, RIG.

Comments

[Vox Rationalis:]

"The Chinese and the Japanese, who have been these bonds’ primary buyers ..."

Utter nonsense. China recently supplanted Japan as the largest foreign holder of US debt, with a total at the end of October of $652.9 billion, or 6.17% of all US debt. Japan's total was $585.5 billion, or 5.54% (www.treas.gov/tic/mfh....).

"...[China and Japan] will transform from net buyers of US Government bonds to sellers. By drastically increasing the supply of such bonds on the market..."

You seem to ignore your own word - transform. IF China or Japan were to become a net seller of US debt (questionable), it would do so gradually. It's not like they would one day drop all of their securities onto the market.

"Any new US Government bonds that could be auctioned under such circumstances would be forced to pay much higher rates of interest, which would make such new issues too expensive and thus impractical."

First off, you make no prediction about what interest rates will be.
But US borrowing "too expensive and thus impractical"? Seriously? Has the going interest rate ever had any impact on the issuance of US debt? Did the government slow borrowing in 1981 when 3-month treasuries, which now yield close to zero, were yielding more than 14%? No, it INCREASED borrowing. So you think that in 2009 we'll see 3-month treasuries yielding at least double-digits, right?

But beyond that: you think the Fed will have no "interest rate control mechanisms" that aren't "out of commission." Sounds like you mean that the federal funds rate will remain near zero while short-term interest rates are double-digits.

Think about it, or take a look at a chart - federal funds is almost always very close to the 3-month rate, and when it's been out of whack fed funds has always been higher. You're trying to describe a world where a bank can borrow from the Fed at near-zero rates, then use that money to buy short-term US debt that yields 10+%. It's pure fantasy.

Jan 05 12:37 PM

[PharmBoy:]

How do you spell love? P-O-T. I bought it 10% under the peak, sold multiple contracts (OTM calls) against it all the way down and used the premiums to pick up more shares at 50 bucks, the steal of the year. This rally is just the beginning of some serious Elliott Wave action. And thanks to the buyer of 3 of my POT April 130 calls today for 4 bones apiece, that'll help with the bills!

Jan 05 07:19 PM

[Glenn McSpa...:]

I like POT and JNJ. Anything you buy in a grocery store or use to grow food makes the most sense now that most people are focusing more on their basic needs and crossing their fingers that they keep their jobs or get one if they've lost it...

Jan 06 10:33 AM

[Market Folly:]

POT is always interesting and could be a very solid play going forward if the current supply picture gets even bleaker as george soros and jim rogers have argued. we track hedge funds on our blog and have noted that soros has accumulated quite a large POT position lately: www.marketfolly.com/20...

also, we like RIG long term as well and some of our thoughts are here: www.marketfolly.com/20...

Jan 06 02:11 PM

[Cygnatra:]

I enjoy shorting stock picks from Forbes, Conde Nast Portfolio and Fortune magazine.......

Jan 06 02:20 PM

[anopenmind:]

As to....POT stock has already recovered more than 50% from its bottom, which leads me to believe that any further appreciation in this stock’s value will be short lived....."stock's value will be short lived"? Why? What is to keep it from going back to $200+ of last year, perhaps finally hitting the $400 Moningstar once predicted?

Jan 06 02:55 PM

[Chris B:]

"Of course, this is a dreadful almost worst case scenario, but, unfortunately, it is also the most likely one. I believe that it is much easier to avoid a personal financial disaster by conservatively preparing and bracing for the worst. "

If you're predicting a worst case scenario, with eye-popping inflation, you shouldn't be buying any stocks.

My ideas for '09?

Short Treasuries: TBT, PST
Long Oil: DXO, RIG
Long TIPs: TIP
Fertilizer/Energy Efficiency / low PE combo play: LXU
Foreign bargains: EWY, ERJ, CHL, AMX
Countercyclical REITs: EQR, SSS

Maybe pick up some temporary staffing companies like MAN, RHI, or SFN on the cheap for an explosive recovery rebound.

Jan 06 03:50 PM

[User 265729:]

How will Fortune Magazine fare given the condition of the publishing industry?

Jan 06 07:54 PM

[Brian Bober:]

Fortune's 10 stock picks for 2009 seem bullish for tech. Energy and commodities continue to be investors major theme. Dell is the only tech pick in the bunch and it is trading with a single digit P/E. Investors broadly appear disinterested in tech even though infrastructure stocks are gaining momentum due to numerous governments dumping money into infrastructure.

Technology is now part of infrastructure spending. In addition, last week China finally approved licenses for 3G creating massive demand for telecom infrastructure.

I agree with the author's opinion on Medco Health. It's middleman position appears precarious.

Jan 07 03:57 PM

[Jake Berzon:]

I have received the following email from Medco's VP of Corporate Communications, Lowell Weiner. I am posting it here with Lowell's permission. I hope that some of my readers will find it useful.


Dear Mr. Berzon:

I am responding to the comments in your article, "How Will Fortune Magazine's 10 Stock Picks for 2009 Fare" that recently appeared on the Seeking Alpha site.



I am compelled to respond to your recent characterization of our business as a "middleman" that primarily is engaged in negotiating discounts with pharmaceutical companies. That definition of our business is as outdated as referring to General Electric as "the light bulb company."

It is true that our clients expect us to help their employees, retirees and dependents obtain the prescription drugs they need at the lowest possible cost. But that is just part of what we do.

Medco is the world’s most advanced pharmacy, making a difference in the health of millions of Americans every day:

Ø Safely dispensing more than 100 million prescriptions in 2008 with Six Sigma dispensing quality.
Ø Monitoring prescriptions and sending millions of communications annually to physicians and patients, alerting them to the dangers of potentially harmful drug interactions.

Ø Encouraging patients to adhere to their prescribed therapy. Approximately 50 percent of patients with a chronic or complex medical condition who start on a new medicine abandon that therapy within the first year, risking more serious medical complications.

Ø Serving our patients with more than 2,000 specialist pharmacists who are trained in specific conditions such as diabetes, cardiovascular disease and asthma, among others, and are available to our patients at any time of the day or night.

Ø Managing the clinical care for patients under treatment for complex diseases and reliant on an array of medicines, including biotech agents, that often have extremely high costs and require advanced handling and administration. We provide pharmacy and nursing assistance.

Additionally, Medco is leading in the emerging field of personalized medicine – the use of genetic tests that guide a physician in selecting the medicine and dose unique to that patient’s need. We are working to develop and distribute new tests that improve physician prescribing and clinical outcomes.

Through these efforts we have grown our business and earned the trust and loyalty of our clients and patients. We were ranked by Fortune as America's Most Admired company in our industry, and outside of our industry we placed third only to Apple and Nike as Most Admired for Innovation across all companies.

We are proud that our clinical focus improves the health of so many Americans.

Sincerely,

Lowell Weiner
Vice President, Corporate Communications
Medco Health Solutions

Jan 09 01:43 PM

[donzelion:]

Excellent article, and Dent's demographics are seriously important. One other item typically neglected is legal structuring. Even if emerging markets offer the best development potential right now, investors won't benefit one bit from that potential unless firms in the emerging markets make the transition from family-oriented business models to ownership-oriented business models. Satyam is the tip of the ice berg - look at the family management lurking behind most major companies in each emerging market and you'll see similar stories to greater or lesser degrees.

The best indicator of a reliable company in the emerging markets would be (1) a healthy dividend payout ratio and (2) lower management compensation. That's why I like DEM long-term over EEM or VWO; market cap is easily gamed, but dividends speak loudly.

Jan 17 02:54 AM