Everyone who read YCharts Research’s recent Competitive Snapshot Report on the Diversified Industrials industry knows that the secret to GE’s industry-beating profitability lies in its financing arm.
Source: Company Statements, YCharts Research
However, the higher margins of a financing business compared to an industrial one is just part—and arguably not the most important part—of GE Capital’s effect on the firm’s overall profitability.
The latest upward revision in second quarter GDP growth tips the balance even more toward a hike in the Federal Funds rate sooner than later. While there’s some debate whether the Federal Reserve starts its march toward rate normalization in the first or second quarter of 2015, the time to adapt your fixed income portfolio is now. As Anthony Valeri, Investment Strategist at LPL Financial recently pointed out, the bond market has a habit of sending yields up about four to six months ahead of the first Fed Funds hike.
Some history in a few charts, starting with the 1994 rate hike. Coming out of the early 1990s recession the Federal Reserve pushed its Federal Funds rate to around 3% where it stayed through 1993.
In early 1994 the Federal Reserve began to ratchet up the Federal Funds rate, but as seen in this chart, the 10-year Treasury had already had a move up of more than 50 basis points before the Federal Reserve kicked into tightening mode.
The bull case articles in Barron’s – it being a sober and well-reported publication – often suggest an upside of 20% or 30% on well-known stocks the weekly has decided are undervalued. Big increases but nothing wild. And the magazine has an enviable record in identifying long and short candidates.
This past week’s issue, however, appeared to go out on a limb more than usual in suggesting Pepsico (PEP) shares have 50% or more upside. That’s a lot for a $140 billion market cap stock, one that’s up 17% since a February low spot, and that trades at a not-cheap forward PE ratio of 20. Not to mention it’s in the slow-or-no-growth soda pop business, where it plays second banana to Coca-Cola (KO).
The potential boost for the stock, of course, would be a split-up of Pepsico, separating the beverage business from the Frito-Lay snack operation, which grows faster. Nelson Peltz, a big shareholder, is agitating for such a split. CEO Indra Nooyi resists. But feeling the pressure, she has an aggressive cost-cutting program underway.
AlianceBernstein recently made the case that preferred stock might be just the ticket for frustrated yield seekers. Trailing 12 month yields more than double the recent payout for the 10-year Treasury sure look enticing, as seen in this chart of the $10.5 billion iShares S&P US Preferred Stock Index (PFF).
Of course, when we’re talking preferreds, we’re pretty much talking about banks. (Using YCharts’ expanded ETF data, you can examine the components of any ETF.) And banks' ability to make good on the coupon payments. Given that these are subordinate to bonds that’s not a given. We only have to refresh our memories back to the financial crisis to see how high-income seekers owning preferreds made out:
With economic growth picking up a smidge, and seemingly stable enough for the Federal Reserve to get serious about a potential rate rise in the first half of next year, there’s little to suggest any need to get your inner bear on. But at the same time, with valuations anything but cheap, getting a bit more smart/defensive in your stock allocation seems like a reasonable pursuit.
Enter, the Schwab U.S. Dividend Equity ETF (SCHD). Its got the sort of high-quality large cap issues -- Johnson & Johnson (JNJ), Microsoft (MSFT) and Chevron (CVX) -- that participate plenty on the upside, but also have the nice habit of holding on better when the markets correct. And as Morningstar Analyst Abby Woodham recently noted in Morningstar magazine, about two-thirds of the portfolio is invested in stocks that have been designated by Morningstar to have a wide moat. That compares to less than 50% of the S&P 500.
For income investors, the Schwab US Dividend ETF does indeed provide a dividend yield premium to the SPDR S&P 500 ETF:
The projected yield for the Schwab portfolio is an even more compelling 3.1%. (You can now find an ETF’s prospective yield on its main quote page, under the Fundamentals section on the right side of the page.)
Based on ETF asset flows you’d think patriotism was some sort of magical investment strategy. The two biggest ETFs, SPDR S&P 500 (SPY) and iShares Core S&P 500 ETF (IVV) have combined assets of more than $225 billion. The next two largest ETFs, the iShares MSCI EAFE (EFA) and the Vanguard FTSE Emerging Markets ETF (VWO) have a combined asset base of $100 billion. That near 70/30 split between U.S. and foreign stocks is a tad out of whack. The Vanguard Total World Stock ETF (VT), a market cap weighted global portfolio that includes developed and emerging markets has about 50% in the U.S.
Performance chasing is no doubt at play here.
Yes, Europe’s economies are back in stall mode. Japan had a rough second quarter as well. And China is still working its way through its massive debt migraine. But let’s remember that markets move ahead of economic data.
The cyclically-adjusted price-to-earnings ratio or CAPE has been inching up recently. The PE10, as it is also known, is now reading around 26.0, close to the 2007 pre-crash value and well above the historical average value of 16.6. Market pundits use the following logic to call for a crash...
But financial ratios are not physical constants, so simply because the present value of a ratio is higher or lower than its historical average actually doesn’t have much predictive power.
While pundits’ logic is faulty, the CAPE does have an interesting story to tell.
The fastest growing large cap industrial stock is $13.5B market capitalization Pentair (see image below for ticker PNR)!
Whether you have a vested interest in the health of General Electric (GE) or simply like to look to the Industrials sector as a bellwether for the economy, you will like YCharts Research's most recently published Competitor Snapshot Report on the Diversified Industrials industry.
This report, published to subscribers to the YCharts Research List last week, cuts through the clutter of data overload to offer a reader a clear, cogent look at the Industrials sector in general and the Diversified Industrials industry in particular.
This Competitor Snapshot Report precedes a detailed Focus Report and valuation for General Electric, which will be published next week. Companies mentioned in the report include General Electric, 3M Co. (MMM), Honeywell Int'l (HON), Danaher (DHR), ABB (ABB), Emerson Electric (EMR), Illinois Tool Works (ITW), and many more.
To download this report and put yourself on the YCharts Research distribution list so you can receive future sector and company reports ahead of the crowd, click the link below!
Let’s just say the rate prognosticators would love a mulligan. The standard expectation at the beginning of the year was that the 10-year Treasury, which sat at 3%, had left its lows behind and was if anything, headed higher. Yet nearly nine months in, the Treasury note yield is now below 2.5%.
Even if the current thinking turns out to finally have the timing right, and rates do head higher, the consensus is that we’re likely to only see the 10-year Treasury make it back to 3% by year end. And that’s a maybe.
That once again retrains the spotlight on dividend paying stocks as a potential bond-beating source of income. (Of course, that also comes with guaranteed bond-beating volatility.) Looking at the trailing 12-month dividend yield for two of the largest dividend-focused ETFs, iShares Dow Jones Select Dividend (DVY) and Vanguard High Yield Dividend ETF (VYM) you might think the the iShares portfolio is the better option for income seekers looking for something with more juice than the 10-year Treasury.
On the same day that Wal-Mart (WMT) ratcheted down its year-end earnings target, along came news that Berkshire Hathaway (BRK.B) had once again added to its Wal-Mart stake during the second quarter. Granted, Berkshire wasn’t jumping in with a two-fisted grab; the addition was basically to keep the lagging Wal-Mart stock at about 4% of the $107.5 billion investment portfolio.
While Warren Buffett’s big four holdings -- Wells Fargo (WFC), Coca-Cola (KO), American Express (AXP) and IBM (IBM) -- account for more than 60% of the portfolio, Wal-Mart is in fact the fifth largest position in the portfolio. The fact that Buffett still clearly wants to maintain its 4% weight is not for nothing. (Among the Big Four, only IBM was added to in the second quarter. In late June, YCharts chief of research Erik Kobayashi-Solomon took a detailed look at IBM stock and concluded that around $240 a share represented a median outlook for fair value. That’s a near 30% premium to where IBM recently traded. Remember, too, Bank of America (BAC), when Buffett converts those BofA preferred shares he bought during the financial crisis, will join the Big Four as a Big Fifth of common stock holdings.)
Interestingly some other pretty impressive value investors were also adding to their Wal-Mart stakes in the second quarter. Multiple Dodge & Cox funds along with Oakmark and Vanguard Wellington added to their positions. Wal-Mart, a wide moat stock in the eyes of Morningstar (MORN), currently trades at a near 8% discount to the research firm’s estimate of fair value. Not a huge margin of safety, but a slight relative value when held up against all wide moat stocks and the consumer defensive sector, both of which trade at fair value. (Full disclosure: Morningstar is an investor in YCharts.)
That slight discount is in large part a function of a stock price that has gone nowhere of late. While the broad market has been making repeated new highs over the past year, Wal-Mart shares continue to trade well below their 52-week high and not too far above the 52-week low.
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