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Even as the stock market surged on Thursday, Neil Hennessy, chairman and chief investment officer of the Hennessy Funds, continues to hold a cautious outlook for stocks and the economy.

The Dow Jones Industrial Average jumped 340 points Thursday, or 2.9%, to 12209, while the S&P 500 soared 43 points, or 3.4%, to 1285 after bondholders of European debt were browbeaten by politicians into accepting at 50% write-down to their Greek debt.

While the bondholders’ new Greek haircut removes one black cloud hanging over the markets, Hennessy believes there’s enough negativity in the U.S. economy to remain wary of the near future.

On Tuesday, Hennessy announced the rebalancing of his portfolio for his Focus 30 Fund. He screens for five variables, market cap between $1 billion and $10 billion, no foreign stocks, price-to-sales ratio below 1.5, growth in annual earnings, and stock price appreciation over last six months. This strategy has given the fund a 21.7% annualized return over the past three years, beating the S&P 500’s 17.4%. But over the past year the fund underperformed the index by 50 basis points to 10.37%, as of Oct. 27.

A closer look at the portfolio changes gives an idea of what Hennessy thinks will be the growth sectors next year. The biggest changes were consumer discretionary fell from 50% of the portfolio to 30%, while utilities jumped from 0% to 30%, and consumer staples from 0% to 10%. Meanwhile, financials, health care, and materials all fell to zero. With consumer discretionary down and utilities and consumer staples up this long-term growth mutual fund is so defensive it looks like they’ve battened down the hatches for a big storm.

Much like when I spoke with Hennessy a year ago, he continues to feel one of the biggest problems for business is the lack of leadership in Washington.

One of the biggest issues is that the Dodd-Frank regulations remain mostly unwritten. Without a clear understanding of what the government plans to do about new regulations, taxes, or the new healthcare plan, Hennessy says few companies are willing to hire. And with the presidential campaign picking up steam, he has little hope of clarity before the election.

With unemployment high, economic growth remains low, he added. Highlighting his sentiment is U.S. consumer confidence fell in August to its lowest level since March 2009. Also in August, investors pulled the most money out of mutual funds since October 2008, right after the Lehman Brothers bankruptcy.

With the yield on the Dow Jones Industrial Average at 2.9%, Hennessy says, just like last year, companies will focus on dividends, either initiating or increasing existing ones, as a way to drive their stock prices higher. Meanwhile, the Dogs of the Dow, the ten highest-yielding stocks in the Dow industrials, currently yield 4.1%, or 30% higher than the 3.2% yield on the 30-year U.S. Treasury Bond. The Hennessy Total Return Fund is a mutual fund that tracks the Dogs of the Dow strategy.

Hennessy says stocks are cheap because market fundamentals, such as price-to-sales, price-to-book, price-to-cash-flow and price-to-earnings, are significantly below their 5-year and 10-year averages. The market’s P/E ratio is currently a multiple of 13, compared to its 5-year average of 16.

If you want to focus on the two main sectors of the Focus 30 Fund check out the Utilities Select Sector SPDR ETF (XLU) or the Consumer Staple Select Sector SPDR ETF (XLP).

Five good ETFs for dividend investing:

  • SPDR S&P Dividend ETF (SDY)
  • WisdomTree Emerging Markets Equity Income Fund (DEM)
  • iShares S&P U.S. Preferred Stock Index Fund (PFF)
  • First Trust DJ Global Select Dividend Index Fund (FGD)
  • Guggenheim Multi-Asset Income ETF (CVY)

For my full analysis of these five ETFs go to Kiplinger.com.

Source: Hennessy Continues Cautious View On Economy