The S&P 500 officially swung into negative territory in late July and early August, erasing all the gains it had made in 2011. Consequently, market sentiment soured as investors dumped even low-risk investments in search of safe haven. Prior to Standard & Poor's downgrade of US credit, we spoke with Daniel Neiman, co-manager of Neiman Large-Cap Value (NEIMX, 877-385-2720), about corners of the market that remain attractively valued. Neiman also touched on a hedging strategy that provides his fund with downside protection.
Although Washington reached a deal on the debt ceiling, the possibility of a downgrade of US credit is still the 800-pound gorilla in the room. Should investors be worried about a downgrade?
I'm concerned that a downgrade would hurt our economy and create more volatility. The US economy is approaching the brink and the broad market has dropped off considerably. The economy has been unpredictable for the last year or two-the economy will appear to be stabilizing and then a raft of bad news will strike. Any downgrade of US Treasuries will only prolong this cycle.
Investors should be wary, but they need not be overly concerned if they've invested in large-cap names. Large-caps are global companies and would be somewhat insulated from a downgrade of US debt. But if the US economy falters, the rest of the world will suffer. Just as US large companies are tied to foreign economies, foreign large-caps are tied to the US economy. The effect of a downgrade would be felt across the globe and it would take decisive action to right the ship.
What investments should our readers avoid given the possibility of a downgrade?
Stick to solid, fundamentally strong companies. Even if an investor bets on a hot sector, it's quite possible that they will enter the sector too late. By rotating from sector to sector, investors are merely moving within the same economic circle. Investors are better of f in the long run following a tried-and-true strategy driven by fundamentals.
We also sell covered call options on a percentage of each of our holdings at different strike prices over the next three to six months. This allows us to buy into undervalued securities when the markets are down. We then sell the calls as the markets rise. If the market continues to improve, some of that stock is called away, which allows us to build in a sell discipline. We employ a bottom-up stock-picking strategy to find fundamentally strong companies that deliver profits in up or down markets. We capture better dividends as the market retreats and we capture option premiums as the market rises. That allows us to focus on solid companies without guessing what the next hot sector will be.
Please name several companies that you believe are fundamentally solid.
Gas and electric companies have changed the way they do business due to new regulations and some have adapted quite well to the new regulatory environment.
Among larger utilities, Southern Company ( SO ) has been a step ahead of the game, which is why the firm has been able to generate profits year after year. Southern Company is well protected from the competition in the retail space because it produces a high level of excess capacity. This means that Southern company rarely has to purchase power from its competitors. The firm's stock has gained 4 percent year to date and boats a dividend yield of 4.7 percent. Southern company has outperformed while providing investors with a solid dividend.
American Electric Power ( AEP ) has embraced recent advances in renewable energy sources such as solar, wind and hydroelectric power. This trend will help American Electric Power smooth volatile coasts associated with producing electric power while reducing future carbon emissions. The company's profits doubled year over year in the second quarter as American electric Power continues to boost sates to industrial and residential customers. The stock has risen 3 percent year to date with a yield of close to 5 percent. Its price-to-earnings ratio (P/E) is about 12 and the company's shares have a beta of 0.60-this correlation to the market will benefit the company's shares as the stock market declines.
Both of these utilities feature stable debt-to-equity ratios at 1-to-1 and a beta well below 1, which suggests that these stocks will hold up in declining markets. If stock prices continue to fall, yields for these stocks will increase. They will become even more undervalued.
Public Services Enterprise Group's ( PEG ) stock is down about 3 percent his year, but the company boasts solid earnings and its dividend yield stands at about 4 percent. Regardless of whether the market advances or retreats, investors will get paid and garner a solid, steady return. Utilities generally increase their dividends year over year. As stocks go down, yields rise. Given the continuing debate over the US deficit, and the possibility that credit rating agencies will downgrade US debt, it makes sense to invest in solid businesses that will weather the storm and continue to pay dividends.
We also hold some names in the oil and energy sector. Chevron Corp ( CVX ) has committed itself to alternative energy. Even though the stock has gained 8 percent this year, it's still fairly valued. These shares are extremely attractive now that Chevron's stock has recently dropped shapely from its 52-week high. The energy giant's debt levels are close to 10 percent of equity, return on equity is 22 times and its P/E is 8. The stock also yields more than 3 percent. Chevron's stock is a real value right now.
Insurers are also attractively valued and we like Chubb Corporation ( CB ) and Aetna (AET).
Why do you favor insurance names when many of these stocks have fallen out of favor?
We like stocks that have fallen out of favor but for which the underlying numbers haven't changed. Chubb's fundamentals remain solid and the stock carries a P/E of 9. Chubb has raised its dividend for 46 consecutive years. The firm continues to write premiums and build its cash position, so the dividend is extremely well covered.
Aetna is a very different type of insurer. The company's stock has fallen out of favor as many investors have struggled to assess how the company will be affected by President Obama's health care reform. There's still plenty of business to be done by health insurers. In fact, these companies will reap the rewards if the law mandating that all citizens carry health insurance is upheld.
Investors must filter out the noise and dig into a company's fundamentals to discover whether the firm is still performing well and capturing market share.
You also hold shares of select retailers. What are some of your favorites?
Many investors view retailers as cyclical investments, perhaps this means one should buy these shares loser to the holiday shopping season. But we've held some retailers such as V.F. Corp (VFC) for quite some time. The stock has been one of our top performers, with a 30 percent gain year to date. V.F. Corp is a high-end retailer, perhaps not as high-end as a company like Neiman Marcus, but V.F. Corp's brands include Seven Jeans, The North Face and Nautica. It's a conglomerate of different brands under one umbrella. The stock's P/E comes in at just less than 20 with a 2.25 percent dividend yield.
Costco Wholesale Corp (COST) is another retail stock our fund has held for some time. The company continues to open stores and expand globally. Every customer that leaves a Costco seems to push a shopping cart loaded with $400 worth of merchandise. Retailers such as Costco have faired well over the past year by offering better values, streamlining operations and facilitating online shopping. Select retailers in well-defined niches will continue to perform well in this uncertain economy.
Nike (NKE) is another consumer-oriented company in our portfolio. The stock has dropped off a bit after performing extremely well during the first half of the year. Nike produces niche products that are in high demands. The company also continues to capitalize on its strong brand.