A pullback is unlikely to sink a strong bull market in equities, yet it could offer investors an ideal opportunity to increase exposure to a sector of the market that has lagged in the recent rally. MoneyLetter columnist John Stephenson picks three global healthcare stocks to buy on a market pullback.
A red-hot reception for the Snap initial public offering and week after week of record-breaking markets for equities are not the only signs that investor optimism is running wild. Junk bond spreads, the premium investors demand to hold bonds over Treasury yields, are heading towards post-crisis lows. Another key indicator, the cyclically adjusted price-to-earnings ratio (CAPE measure) has also risen to a level not seen since the Internet boom, further suggesting a high degree of investor complacency.
Commodity prices are enjoying their best run in years, fresh evidence that investors are betting on a pickup in the global economy after years of sluggish growth and scant inflation. The S&P GSCI Index, which tracks commodity futures, rose 28 per cent last year in its biggest gain since 2009. Many commodities have continued to rally this year. Oil and natural gas prices have soared more than 50 per cent over the past 12-months. Precious metals like silver and materials like lumber have scored big gains in recent weeks.
A sustained rally in commodities would likely signal healthy consumer and business demand. It could also be a boon for the many emerging-market countries that rely on commodity exports, such as Russia, South Africa and Malaysia. A Brazil exchange-traded fund doubled in price over the past year, in part boosted by the powerful gains in commodities.
The U.S. consumer price index increased in January by 0.6 per cent, the biggest monthly gain in almost four years. Europe’s inflation measure rose to the highest in four years last month. Recent Chinese data also show expansion in manufacturing and increasing consumer confidence, easing investor concerns that China’s growth would continue.
Not all markets are sending bullish signals for growth, however. Yields on 10-year U.S. Treasury debt recently fell to their lowest level since November, a warning that riskier assets may be overvalued. Gold has also staged a comeback this year, as buyers have sought insurance against economic and political risk.
The economic indicators are looking promising, as is Mr. Trump’s ambitious policy agenda, which includes a market-friendly triad of top priorities in rolling back regulations on businesses, overhauling corporate taxes and spending $1 trillion in infrastructure projects.
A difficult market ahead
But the big ‘if’ for the markets is the question of whether the policies come to pass as they have been described. The stock market is expecting a best-case scenario for policy implementation and many savvy investors have begun to hedge their bets. Stocks are up 5 per cent since President Trump took office six weeks ago, and with the president boasting about the markets ascent, perhaps things are starting to look a little ‘toppy’.
Elevated valuation for the market, coupled with the rapid pace of market momentum and complacent investor sentiment, suggest a more difficult, but not necessarily cataclysmic, market environment in the months ahead.
Some money managers have even started looking at online betting websites that allow participants to place wagers—offbeat as it may be—on whether Mr. Trump will be impeached before the end of his current term, a possible indicator of popular perception that could depress stocks in the coming months or years.
Ladbrokes, a British gambling company, offers a market for bets that the president will resign or be impeached before the end of his first term. Recently that market implied that the chance of such an outcome was 55 percent.
While this may be a bit extreme, it would be wise to be a little cautious on markets over the next month or so, till we see if some of the most ballyhooed policies of the Trump administration will come to pass.
What I Recommend
The persistent grind higher by U.S. stocks has resulted in the S&P 500 trading at a price/earnings ratio now above 20 times. The VIX Index, or the so-called Wall Street fear index, has drifted downward at the same time that stocks have drifted higher. As a consequence, markets are priced for perfection.
The likelihood that the Trump administration will be able to implement their ambitious agenda in the time-frame expected by the market looks increasingly unlikely. That would leave the heavy lifting for justifying the market multiple to corporate earnings, which may be a tall order indeed.
The catalyst that sends stocks lower could come from abroad, as British lawmakers just removed the final hurdle for Prime Minister Theresa May to trigger Article 50, the legal mechanism to start the two-year Brexit negotiation process with the European Union. The French and German elections later this year could also be a catalyst for lower stock prices, suggesting now might be a time to adopt a more defensive stance in your portfolio.
A position in three global healthcare stocks
The healthcare sector has struggled to keep pace with the broad market, suggesting that the time may be right for building a core position on market pullbacks.
One stock that I really like is Amgen Inc. (NASDAQ—AMGN), a global biotechnology stock focused primarily on cancer, nephrology, inflammatory diseases and cardiovascular diseases. Despite pioneering the use of recombinant DNA and having produced several blockbuster biotech drugs, Amgen has the lowest expectations amongst its biotech peers. As well, there is room for dividend growth toward 2-3 per cent, as well as a re-instituted share buyback program. I have a ‘buy’ rating and a twelve-month price target of USD $210 per share for Amgen Inc.
Celgene Corp. (NASDAQ—CELG) is a global bio-pharmaceutical stock focused primarily on the hematology/oncology markets. The company has a growing inflammation and immunology franchise, and has developed drugs for psoriasis; it has also acquired a number of other drugs for multiple sclerosis and ulcerative colitis. Celgene has more than 25 partnerships with emerging biotechnology companies around the globe. The company has the best pipeline of new drugs of any biotechnology company globally. I have a ‘buy’ rating and a twelve-month price target of $145 per share for Celgene Corp.
Another name that I really like is Teva Pharmaceuticals (NYSE—TEVA), a global pharmaceutical company headquartered in Israel and engaged in the R&D and manufacture of pharmaceuticals. Fifty-three per cent of its revenue comes from the United States. The company has grown rapidly over the years through aggressive M&A, acquiring well-known companies such as IVAX, Barr Labs and Cephalon, among many others. Teva is stabilizing effectively after years of rapid growth by restructuring its cost base. I have a ‘buy’ rating and a twelve-month price target of $44 per share on Teva Pharmaceuticals.
The market will likely be higher by year end, yet there appears to be increasing cause for concern, particularly given the strength of the market in the aftermath of the U.S. election. A pullback is unlikely to sink a strong bull market in equities, yet it could offer investors an ideal opportunity to increase equity exposure to some sectors of the market that have lagged in the recent rally.
John Stephenson is an award-winning portfolio manager and the President and CEO of Stephenson & Company Capital Management Inc. in Toronto. He is the author of “The Little Book of Commodity Investing” and “Shell Shocked: How Canadians Can Invest After the Collapse.” He is also the publisher of Strategic Investor (www.StephensonFiles.com). He can be reached at (647) 775-8360 or (844) 208-8817, or email@example.com.
This is an edited version of an article that was originally published for subscribers in the March 2017/Second Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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