The value in healthy cynicism
LOW-VOLATILITY MONEY FLOW AIDING UTILITIES, TELECOM AND REAL ESTATE
The flood of liquidity global central banks have provided to financial markets over the past five years has created an environment where excess capital is searching for a home.
Since the world still feels like a scary place for many i nvestors, that capital is seeking as much safety as possible.
That’s the case in the fixed income market: U.S. treasuries continue to be in high demand, as is sovereign European debt that pays negative yields.
Within the equity market, money has flowed into companies that have very low fundamental volatility, so their earnings don’t swing cyclically. That’s provided a big lift to sectors such as utilities, telecom, consumer staples and commercial real estate.
In the opinion of James Morrow, portfolio manager at Fidelity Investments, investors are looking for max safety and don’t care about the return.
“The market is kind of daring you to take a little bit of cyclical risk, or it is daring you to take a lot of valuation risk in safety,” he said. “The irony, I think, will be that because these names have been viewed as so safe and attractive, they’ve been bid up to the point where they may be the riskiest part of the market from a valuation standpoint.”
That’s a primary reason why Morrow has been rotating into more cyclically exposed areas of the dividendpaying universe for the Fidelity U.S. Dividend Fund.
Some of the names he believes have been shunned by the market are found in the financial sector — the portfolio’s largest weighting.
“I think financials are misunderstood in the U. S. market because there is a lot of muscle memory from the financial crisis, and investors are really concerned with downside protection,” Morrow said.
What he thinks the market is missing is that the sector has become a lot less risky in the past five years. U.S. financials have twice the levels of capital they had going into the crisis, and they’ve had enormous restrictions placed on them in terms of the kind of businesses they can participate in.
“I think financials are a lot less risky than they used to be, yet the market is pricing them like they are just as risky or more than they used to be,” Morrow said, noting that many financials are trading at or below tangible book value, something that has historically been a huge buy signal.
He highlighted big banks such as JPMorgan Chase & Co., Morgan Stanley and Bank of America Corp. as names with really cheap valuations and attractive yields.
“Even though they are not paying out a huge part of their earnings yet, the yields are pretty attractive,” Morrow said.
JPMorgan Chase & Co. ( JPM/ NYSE) has been a top 10 holding since the fund’s inception, and can be bought at roughly 11x earnings with a dividend yield around three per cent.
“They’ve done a great job at managing through the credit crisis and are in a really good position right now,” Morrow said. “And you don’t have to take a lot of valuation risk.”
Another sector that the portfolio manager believes has been l eft behind is energy.
One large holding is Williams Cos. Inc. ( WMB/ NYSE), a stock that has been hit hard in the past 12 months due to a failed merger, and concerns about high leverage for some of its biggest customers.
“It’s a huge opportunity to own an attractive and stable business that has been left out of the dividend trade,” Morrow said. “It’s a way to take a quality, lower-volatility approach to a sector that is inherently commodity- driven and volatile.”
U. S. consumer stocks are sort of the haves and havenots in terms of valuation.
Growth- oriented names, including those found in the social, Internet and e- commerce groups, have had an incredible run, and therefore look pretty expensive.
Meanwhile, traditional industrial and durable- type consumer names, such as autos and furniture/appliance sellers have been left out.
Morrow highlighted General Motors Co. ( GM/ NYSE) as an attractive opportunity, given that it has cleaned up a lot of its union issues, as well as its balance sheet post bankruptcy.
He also noted that the company has net cash, has done a good job of putting margins back into the business, and the stock trades at only about 5.5x earnings.
“People are really skeptical and it pays an almost five per cent dividend,” Morrow said. “Even if U. S. car sales can stick around this level for a few years, the company is going to generate an enormous amount of cash flow.”
THERE IS A LOT OF MUSCLE MEMORY FROM THE FINANCIAL CRISIS.