How stock sell-off can be good for the savvy investor
Volatility has returned to Wall Street.
The stock market ended a rollicking week with a strong rebound on Friday, which wiped out most of the week’s losses but still left the Standard & Poor’s 500 index 6.2 percent below its record close Sept. 18.
Analysts give lots of reasons for the sell-off, but none are particularly new or convincing
There are more signs of a slowdown in Europe, which could hurt U.S. multinationals, but Europe has been weak for years.
There’s fighting in the Middle East (when isn’t there?) and in Ukraine (that’s been going on since February).
The dollar is rising (which is bad for U.S. exporters, but good for buyers of imported goods).
Oil prices are plummeting (which hurts the nation’s booming shale oil sector but helps consumers).
Ebola has killed one person in the United States (but has been ravaging West Africa for six months).
What really happened is that stocks were overdue for a pullback. The last time the S&P 500 fell more than 10 percent — considered a correction — was in mid-2011, when it tumbled 19.4 percent over about five months. (It got close, falling 9.9 percent, in
mid-2012.)
Sometimes, there is a reason. In 2011, S&P downgraded U.S. Treasury debt, sending shock waves through the global financial community.
But sometimes, “it’s difficult to identify the exact reason why a selloff happens,” says David Samra, lead manager of the Artisan International Value Fund. “It gets to the point where someone pushes a button, other people push buttons, it snowballs.”
John Allen, chief investment officer with wealth management firm Aspiriant, said his firm has been telling clients all year to “expect less from their investment portfolios.” Low interest rates, engineered by central bankers, “have led to overvaluation of stocks and fixed income across the planet,” he said. Even with the pullback, “We are still in a globally overvalued world.”
Howard Simons, president of Rosewood Trading, also thinks stocks are still overvalued. “This is not a 2008 type of situation,” he said. “We are not going into a major recession. We are not going to be living in caves and eating bugs anytime soon.”
But, “a lot of this excess cash growth around the world that has been flowing into financial markets” is going to be shut off and stocks need to be repriced to reflect that. “You can take your dreams of 20 percent returns from now until the end of time and put them in your closet with the bowling balls.”
Other money managers saw last week as a buying opportunity. “We had been having trouble finding things to buy,” said Jerome Dodson, who manages the Parnassus funds. We had new money coming into the funds. I was looking for things. Then suddenly boom, things go 5, 10, 15 percent below” where they had been.
Stock picks
I asked Dodson and other pros which stocks they would recommend for investors who see the dip as a chance to buy.
Although he can’t disclose what he was buying, Dodson said he likes Wells Fargo and Charles Schwab because they should benefit when interest rates rise. Wells, the nation’s largest housing lender, could charge more for loans and it “doesn’t have a lot of the exposure money-center banks have with trading and investment banking,” he said.
Schwab is even more sensitive to interest rates. It has been waiving fees on its money market funds to prevent their yields from falling below zero. If short-term rates rise, it could lift those waivers and also charge more on margin loans.
Samra would buy Samsung. The South Korean company is best known for its phone handsets, but it’s also the world’s largest manufacturer of semiconductors and flat-panel displays, and a large player in home appliances. It has nearly $40 billion in cash and virtually no debt.
Samsung stock “has been aggressively sold down as a result of competition in its handset business,” Samra said. At the high end, it competes with Apple, whose new models will likely take some market share. At the low end, it is getting squeezed by lowcost Chinese manufacturers.
The real reason to buy Samsung is its semiconductor business. Two pure-play semiconductor companies, SK Hynix and Micron Technology, trade for roughly 10 time earnings. If you applied the same ratio to Samsung’s semiconductor business, it would be worth about $85 billion.
The market is valuing the entire company at about $155 billion. If you subtract $85 billion for semiconductors, $40 billion in cash, $30 billion for displays and appliances, “you get the handset business for free,” Samra said. Samsung stock does not trade on a U.S. exchange but some brokerage firms can buy it for clients.
More semis
Michelle Stevens, manager of the Baird Small-Cap Value fund, also likes semiconductors, which got slammed the week before last but recovered some of those losses. She especially likes Triquint Semiconductor, which is merging with RF Micro Devices, and Skyworks Solutions. All three make radio frequency chips used in mobile applications, especially smartphones. “We see this huge opportunity (for these companies) to participate in the move to 4G networks,” Stevens said.
She said a 3G phone has about 20 to 30 cents worth of RF chips, and a 4G phone has $3 to $5 worth. Although the United States has largely transitioned to 4G, China “is just gearing up.” The chip companies sell to Apple and Samsung, so “you can play the trend without having to pick the right (handset) pro- vider.”
If she had to pick one of the three it would be Skyworks, which has “the best operating margins, conservative management, and is the market leader.” It’s trading about 14 percent below its recent high.
Shark bait
John Osterweis, manager of the Osterweis Fund, likes eBay because he also likes PayPal. When the two companies split, “We think each of the two pieces will take out some costs, be able to grow and be attractive stand-alone businesses.” PayPal “is showing accelerating growth. It’s not going to be put out of business by the new Apple payment system,” he said.
“People are worried (the eBay portion) is going to be put out of business by Amazon or whoever. We don’t think that’s the case. It’s a really strong franchise. It’s a big free cash flow generator.”
The stock is trading around $48. He think it’s worth in the high $50s or more. “You have the added kicker: Once the company is split in two, one or both of those pieces may be a good fit with some other company,” Osterweis said. In other words, “shark bait.”
Two funds
Karl Mills of Jurika, Mills & Keifer said innovative, well-capitalized tech companies have been oversold, but rather than pick one he recommends the T. Rowe Price Media and Telecommunications fund for diversification.
“Technological innovation is going to accelerate. I want to be invested in high-quality companies that are leading that rather than being disintermediated by it. And I want skilled managers picking those kind of stocks,” Mills said.
Emerging markets have also been hard hit, but here again he would choose a fund, such as Matthews Pacific Tiger. “I think the emerging world is going to continue to emerge. I want to be in the way of that. And it’s cheap relative to the U.S. market.”
Mills said he would put those funds in a virtual vault “and imagine you can’t touch it for five years.”