BlackRock: Stocks Iffy, But Not These Pockets

BlackRock (BLK) profit rose 11% in the second quarter as total assets under management ticked up to an astounding $4.59 trillion. As much as BlackRock is benefitting from the extended bull market, BlackRock’s chief investment strategist Russ Koesterich recently sounded a small warning signal on “stretched valuations” in the stock market, echoing the same Yellen-esque caution about small caps, social media and biotech stocks.

Though he pegs stocks in general as “vulnerable,” Koesterich fingers two market segments offering decent relative value: Mega cap stocks and value stocks.

A bundled approach to those two themes can be had in the Vanguard Mega Cap Value Index ETF (MGV). According to Morningstar (MORN), the portfolio of 150 or so stocks trades at 14.5 times estimated 2014 earnings. That’s a steep discount to the 19.7x for the Vanguard Mega Cap Growth Index ETF (MGK) and the 17.4x for the S&P 500 index.

To be clear, in a bull market dominated by small cap stocks, the mega caps have been decided laggards. Both the SPDR S&P 500 ETF (SPY) and the Vanguard Mega Cap ETF (MGC) have been smoked by the SPDR S&P 600 Small Cap ETF (SLY) since the March 2009 low:

MGC Total Return Price Chart

MGC Total Return Price data by YCharts

But that’s a bit of a virtue at this point. Beyond the valuation argument there’s the fact that this bull, though it may continue to run for a while, is long overdue for a correction. In that scenario, mega caps offer more portfolio ballast than small caps. And year-to-date, mega caps have reasserted themselves relative to small caps, outperforming by more than six percentage points.

The top five holdings in the Vanguard Mega Cap Value ETF are Exxon Mobil (XOM), Microsoft (MSFT), Johnson & Johnson (JNJ), Wells Fargo (WFC) and General Electric (GE). JPMorgan Chase (JPM), Chevron (CVX), Berkshire Hathaway (BRK.B), Procter & Gamble (PG) and Pfizer (PFE) complete the top 10.

As noted in an earlier YCharts article, Fidelity’s standout mega cap fund manager was recently adding to JPMorgan, Microsoft, General Electric and Chevron, providing some interesting overlap for those interested in further research on mega caps.

Among the financial stocks, while Wells Fargo is the largest position in the Vanguard MegaCap Value ETF, its recent run makes it less compelling for fresh money than JPMorgan, Bank of America (BAC) and Citigroup (C) when viewed through the price-to-book value prism:

WFC Price to Book Value Chart

WFC Price to Book Value data by YCharts

But with a trailing PE ratio still below 13, it’s not as if Wells Fargo will be confused for a growth stock. It will be interesting to see in Berkshire Hathaway’s second quarter filing (out in August) if Warren Buffett added to the company’s Wells Fargo position, which at more than 20% is the largest holding in the $106 billion investment portfolio. Berkshire Hathaway hasn’t substantively added to the Wells Fargo stake since the second quarter of 2013.

Bank of America and Citigroup are also in the Vanguard ETF; along with JP Morgan they account for about 6.5% of fund assets. If you’re into trend spotting, the active value pros at Oakmark Select mutual fund have been pounding the pavement for financials at this juncture, and the funds own Bank of America, JP Morgan and Citigroup.

Energy stocks present a potentially nice two-fer. On valuation, the likes of Exxon Mobil and Chevron remain cheap not just in relative terms – with the S&P 500 trading at 16.5x trailing earnings -- but on an absolute basis as well, as their 12 month trailing PE ratios remain well below their longer term norm:

XOM PE Ratio (TTM) Chart

XOM PE Ratio (TTM) data by YCharts

Of course, a whole lot of capital expenditures amid a global pause in demand explain not just the low valuation, but the poor relative performance over the past few years.

But with expectations that the U.S. economy is picking up some momentum and emerging markets are solidifying as well (okay Europe is a big question mark) we’re potentially moving into a more friendly environment for the big integrateds. And keep in mind that historically, energy leads the pack in a bull market’s late stages.

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.

Read more articles about: Investing Ideas  ETFs   mega-caps   value investing   

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