- It is wise to have one's portfolio positioned for many different scenarios in 2021.
- In this article, I share 5 things I've prepared for my portfolio, given the backdrop of an uneven economic reopening around the world, and further stimulus in the US.
- I also review the 12 ideas I shared a few weeks ago, and share two more individual stock ideas in this article.
- I do much more than just articles at The Cyclical Investor’s Club: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »
After a great 2019 and 2020, 2021 has been off to a good start for my stock portfolio, but when I observe other investors and read other stock writers, I see a lot of blanket extremism. There are crypto extremists who think bitcoin is the greatest investment opportunity of our lifetime and that it can only go up; there are innovation extremists whose portfolios are full of the stocks of recent IPOs that have no earnings; then, there are extremists in the opposite direction who are holding excessive amounts of cash and long-term bonds; and there are also extremists of the indexing variety who buy index funds with no clue about the valuation of what they are buying.
While some of these investors will end up doing okay over the long-term, I think that over the course of the next economic cycle, I expect all of these investors will underperform investors who carefully select individual stocks of quality businesses while they are trading at reasonable prices and hold them until they become expensive or the business quality declines.
About three weeks ago, on February 11th, I published an article titled "There Are Bubbles But Cash Is Not The Place To Be, Here Are 10 Stocks To Buy Now," and in that article, I shared more than 10 ideas I thought were worth buying. The point of the article was that many parts of the market were at extremes, but there remained opportunities still worth buying for the medium and long-term. I want to take a moment here to examine the returns of those ideas and compare them with the returns of the market indices over the past few weeks.
Above are the returns of Invesco QQQ ETF (QQQ) and SPDR S&P 500 Trust ETF (SPY), along with the one non-stock idea I suggested in the article, Aberdeen Standard Physical Platinum Shares ETF (PPLT). As you can see, all of them traded down since the article was published, with PPLT trading down the most. I think PPLT was mostly trading down on temporary US dollar strength, and I'll come back to that discussion later in the article. Now let's look at the performance of the stock suggestions from that article.
Of the eleven stock ideas I shared in my last article that I thought were good buys, only Facebook (FB) is slightly negative, with a return of -2.26% (it's worth noting, though, that its most appropriate benchmark, the QQQ was down -7.74% over the same period). The other ten stock ideas were all positive, most significantly so. Including the PPLT decline, as a group, these 12 ideas that I shared about three weeks ago are up an average +10.21% compared to a -1.81% return from SPY.
It's worth noting that these ideas came from several different sectors and industries, but the main thing they had in common was that they were quality businesses trading at good valuations. So, even while the S&P 500 was down, and the Nasdaq was down even further, this basket produced double-digit returns. This was a unique situation where the markets moved fairly quickly, and I had no idea the market would move as quickly as it did, so I'm not suggesting every month will be like this one.
It is entirely possible these returns could have been spread out over an entire year instead. And that's fine. I'm not trying to precisely time anything when I buy a stock. Usually, I buy a stock and forget about it for a while, and wait for the market to change its mind about it over the next 2-3 years. But I also try to keep a relatively balanced portfolio and estimate roughly where we are in the economic cycle, and that is what most of this article will be about: What should investors be prepared to experience in 2021?
Expect Rotation and Reflation
This is one that has been obvious to me for a while, but for which a lot of investors seemed unaware until the recent market sell-off. We now have effective vaccines and COVID will effectively be a thing of the past by the end of summer 2021 in the US. The stocks that benefited from COVID will no longer have a tailwind, and since most of them are trading at very high valuations, their prices will come down. Meanwhile, those businesses that were hurt by COVID, but were not damaged seriously (i.e. didn't have to issue new shares or take on significant amounts of new debt) have been, and will continue to be, attractive investments.
These are stocks like the refiners I suggested in my last article, and the financials and industrials. There will be stocks like airlines and cruise lines and mall REITs that will clearly benefit from reopening, but most of those businesses were damaged too much the past year for them to be high enough quality for me, even if the stock prices will likely rally this year as well. I always buy stocks that are high enough quality that I would feel comfortable holding them if a recession occurred tomorrow.
For example, on October 22nd, 2019 I published an article titled "EOG Resources: I'm Buying The Dip." And I bought the stock around that time. Since then the energy sector has been hit by some of the worse headwinds since the 1980s, including a pandemic shutdown, a global recession, and oil briefly trading negative last May. But because EOG was high enough quality, I simply held the stock through the downturn and never considered selling it even though at one point last March it was down over -50% from the price I had paid for it.
Now, EOG stock has produced a positive return, even though it is still trailing the return of the S&P 500 over this time period. If EOG had been lower quality and had the potential to go to zero like AMC Entertainment (AMC) or Carnival (CCL) did, I may have been tempted to sell the stock near the bottom. And while I don't expect a recession this year or next year, black swans do happen, so stocks like AMC and CCL and others, while they will likely benefit from a reopening, are not high enough quality to attract me and remain too risky for me.
In fact, I think the danger of investors buying lower quality reopening stocks is one of the bigger landmines out there for medium and long-term investors right now, because while they might get the reopening theme right, and also get the short-term momentum right, eventually it's the earnings of the businesses that will drive the medium and long-term returns, and those factors still don't look great for some of the lower quality reopening stocks.
If we limit ourselves to higher quality reopening and reflation stocks that still have upside left, like T. Rowe Price (TROW) or BorgWarner (BWA), or Principal Financial Group (PFG), then I think they are relatively good bets over the next two years. However, we will want to take profits at some point before the next recession or industrial downcycle because usually, these types of stocks suffer a lot during downturns. In other words, they are good medium-term bets, but not necessarily buy-&-hold forever stocks if you are trying to maximize returns. (Even if they are high quality enough to hold during a downturn if we have to.)
The important part to remember about the rotation is that the overall market is not an indication of the potential returns an investor can get if they select stocks individually. This rotation will cause a huge deviation in the returns of stock investors who know what they are doing and indexers who do not. I think 20% returns are possible for good stock pickers this year even if the S&P 500 ends up being flat on the year.
Expect The Market To Rise +20%
I think it is entirely possible that with the reopening of the economy and the extra stimulus that is likely to be put into the US economy over the next month, that the overall market could rise another +20% this year. There could be enough retail money flowing into the market to completely reverse the minor tech sell-off we've seen the past month and for a stock like Tesla (TSLA) to go on and make new highs, as well as for new IPOs like Robinhood to rocket to the moon, and so on. So investors should be prepared for this. I'm a long-only investor so I don't short stocks, but long/short investors should be very careful with their short ideas over the next 6-12 months. I wouldn't be shorting anything no matter how expensive it gets or no matter how much the momentum shifted down the past month.
Additionally, I would not be holding excessive amounts of cash. I currently have roughly 15% cash equivalent and no bonds even though I think the market as a whole is very expensive right now. I won't hesitate to take profits in the stocks I own as they become overvalued this year, but I am not hiding in cash. There are still a few stocks worth buying.
Expect The Market To Fall -20%
If this appears to be incongruent with my last expectation, it is not. The market can both fall -20% and rise +20% in the same year, and investors should be prepared for both possibilities. I think investors should have enough cash on hand so that they could put most of it to work if the market falls -20%, but probably not much more cash than that. The value stocks that I am currently watching and waiting to buy, actually haven't fallen nearly as much as the wider market, so I'm unlikely to have many buying opportunities, even in a shallow bear market, and that's why I'm not holding lots of cash.
I only have an amount that I think I have a realistic possibility to buy stocks with over the next year or two. Any more than that will likely just be a drag on returns. However, we shouldn't expect that the stimulus-fueled market we've had in 2020 and 2021 will continue much beyond 2022, and it's likely the market will start looking forward to 2022 at some point in 2021, so, a sell-off can basically happen at any time. Investors should be prepared to buy that dip if values become available.
At this point, I think it should be fairly obvious that we are going to get inflation of one kind or another over the next year or two, and potentially it could be more than expected as stimulus gets spent over the next two years and as economies reopen. This is another reason not to sit on more cash than you can invest during a correction, and why long-term bonds are unattractive. It's also why I think some precious metals exposure like gold (GLD) is a reasonable alternative to holding too much cash (though I prefer owning stocks).
Expect An Uneven Reopening
While the US mostly failed to contain the pandemic in 2020, because of vaccine development and distribution and new economic stimulus along with continued support from the Federal Reserve, the US stands to have one of the fastest and strongest economic reopenings in the world in 2021. For the next six months, this should be very bullish for the US stock market and for the US dollar. We've seen signs this past week that despite massive amounts of money being pumped into the US economy, the dollar strengthened. I expect that because of the early and very strong economic recovery in the US that the dollar will remain relatively strong for a decent part of 2021, but that it will eventually weaken as the rest of the world is vaccinated and reopens as well.
If this happens along with a rising US stock market, it is likely that I'll steadily take profits in some of my big cyclical winners and shift that money internationally. I don't have any specific international ideas today, but if the US market rises another 10% don't think there will be many attractive ideas left in the US at that time, and it will probably be a good time to look for value overseas.
Right now, I'm finding an idea or two still in the US market, and next, I'll briefly share two ideas I bought from the S&P 500 index since my last public article. These won't be full analyses because I'm very busy and don't have time to write those this month, but much like my last article, they should at least provide some ideas for you to consider researching to see if they are right for you, and they illustrate that there are parts of the market worth buying, still.
After struggling with earnings growth for nearly 15 years, Merck has put together five straight years of earnings growth of about 8-9% per year. Meanwhile, the stock is trading at an 11.23 forward P/E. I estimate they trade at a PEG ratio of 1.33 while the wider market is trading at a PEG of around 3. Analysts expect them to continue to grow earnings at about this rate for the next few years.
This is a quality business trading at a fair price and I bought the stock a few weeks ago. (For individual stock purchases I usually take about a 1% portfolio weighted initial position.) While I don't typically focus much on dividends because I'm a total return investor, it also pays a respectable 3.56% dividend yield and it has a AA- credit rating from S&P. It's a stock that should do well over the medium and long-term no matter what the wider index does.
There are a couple of risks with Cigna that in a perfect world I would avoid. One of those is M&A risk. I tend to avoid stocks that have had significant and recent M&A activity because usually acquirers overpay and it takes a few years for them to admit it and for it to show up in the numbers. So Cigna's fairly recent Express Scripts M&A is something I would typically prefer to avoid, but as far as I can tell it looks to be going okay.
Additionally, there is some political risk as well if Democrats decide to make major healthcare reforms. I'm betting that major reforms don't happen with Washington being busy with COVID and the Senate currently split 50/50. When we toss in a very expensive overall stock market, it makes me more willing to dip my toes in a stock like Cigna if the price is right.
I estimate Cigna's earnings growth rate at about 13.22% since 2014 and that they currently have a forward P/E ratio of about 11.41. That produces a PEG ratio of 0.86 in a market where the average PEG is triple that. Analysts expect EPS to continue growing in the 10-13% range for the next three years and they have an A- credit rating from S&P. So, once again, while there are risks to the stock, we are getting a significant margin of safety and an exceptional value relative to the rest of the stock market. We took a position in the Cyclical Investor's Club last week, and while most of the market was selling off, Cigna was rising.
I think the stock still remains an exceptional value with a good risk/reward, so I have a 1% portfolio weighted position in it as well.
It's time for investors to cast aside any mono-lithic or extremist macro views about the US market. 2020 was a stock-picker's market and 2021 will be a stock-picker's market as well. Extreme views of the market (i.e. too much cash, too much speculative growth, or too much blanket index buying) will not be rewarded as well as good stock picking over the next 12-24 months. Individual stock selection of quality businesses trading at reasonable prices, and an understanding that the economy is still early cycle and not close to a recession, will likely be rewarded handsomely.
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This article was written by
Cory Cramer is an award-winning political scientist and a long-only cyclical investor capitalizing on market cycles. He has been investing since the 1990s and still invests his own money in the companies he writes about.Cory leads the investing group The Cyclical Investor's Club where he shares his unique approach to estimating the fair value of stocks by capitalizing on downcycles for undervalued companies. He teaches 4 unique cyclical strategies, offers a master valuation spreadsheet, and is available to answer any questions via chat or direct message. Learn more.
Analyst’s Disclosure: I am/we are long EOG, MRK, CI, PPLT, VLO, HFC, PSX, BWA, PFG, TROW, FB, ANTM, GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
I recently took profits in PBCT after their buyout offer. I'm long all of my other suggestions.
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