While stocks hit all-time highs on Tuesday, the fact remains that there is a lot of uncertainty in the economy and in the market. The momentum stocks that led the market higher in 2013 are coming off their highs, and many of the assets that are performing are considered defensive, or they performed poorly in 2013 and are bouncing back. In all likelihood, these trends are going to continue. With that being the case, I think investors should consider adding the following assets on weakness to their portfolios.
1. Mosaic Co. (NYSE:MOS)
Mosaic shares are up over 6 percent for the year, although this is after a lousy 2013. The company suffered from a decline in fertilizer prices that has been a major headwind over the past couple of years. The stock plummeted last summer when the Eastern European potash cartel broke up, which threatened to hit potash prices.
However, Mosaic was prepared for the weakness. It held a lot of cash and it didn’t have a lot of debt. As a result, it was well positioned to buy back its own stock and depressed fertilizer assets on the cheap. At the beginning of 2014 it finalized its deal with CF Industries (NYSE:CF) to buy that company’s phosphate mine, and it also bought back $1.7 billion worth of stock.
Earnings have been weak on a year-over-year basis, but the company’s growth and fiscal discipline have substantially mitigated this weakness considering the decline in fertilizer prices. As a result, the company is extremely well positioned to benefit as agricultural commodity prices rise and as investors become interested in fertilizer stocks once again.
2. Altria Group (NYSE:MO)
Tobacco may not be as sexy as social media, but it is working this year. The nation’s leading producer of tobacco products, Altria Group, has risen 5 percent for the year. The company trades at just under 16 times earnings and it pays a 4.7 percent dividend. Both metrics make the stock extremely appealing relative to the S&P 500. The company should be able to provide investors with stable income for years to come, as it has universal brand recognition (Marlboro), and it has incredible pricing power — net profit margins topped 21 percent last quarter. Investors are looking for safety and they are looking for yield, and Altria Group provides both.
Investors who are concerned about a weakening dollar might want to consider Philip Morris (NYSE:PM) instead. The company sells products throughout the world, and so it is a good way to place a bet on a weakening dollar while collecting a nice dividend.
3. iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT)
Treasuries ended 2013 on a low point, and investors were absolutely convinced that interest rates had to rise. It didn’t matter what your outlook on the economy was. If you were bullish, then there was gong to be a great rotation out of bonds and into stocks. Also, a bullish stance meant that the Federal Reserve would stop buying bonds, which meant that demand would weaken. If you were bearish, then inflation was supposed to make bonds unattractive, particularly to our biggest foreign creditors, such as China and Japan.
Despite this, the bond market has been stair-stepping higher, and the TLT has risen 11 percent for the year excluding dividend payments. I suspect that this is going to continue as investors become more concerned about economically sensitive stocks. While they will still likely bid down the dollar and bid up commodity prices, this doesn’t necessitate that bond yields rise. The Federal Reserve is still buying a lot of bonds, and while Chinese buying has declined, the People’s Bank of China cannot simply sell all of its bonds in order to stockpile commodities, even if that is its long-term goal. With this being the case, Treasuries remain an excellent contrarian bet that will continue to work.
Want more analysis of the current highs and the state of the U.S. market? In an earlier article, we taked about how it seems as if U.S. stocks are the place to be. Here’s a recap:
Despite the turmoil in the Ukraine, weakening economic numbers coming out of China, and weak retail sales from many U.S. companies over the past few months, stocks are powering higher, and that’s a good sign — right? After all, if stocks can climb in this environment, then what happens when these problems start to clear up?
But before getting excited and jumping into stocks, keep in mind that the best time to buy stocks is when they are down, not up. When everybody was afraid of owning stocks in 2008-2009, the proverbial “smart money” was buying. Similarly, when things looked great in 2007, the proverbial “smart money” was selling. Inevitably, these investors did not time the market perfectly. You could have bought in December 2008 and seen your positions fall another 10-20 percent before the upswing occurred, but three years later, you were extremely happy.
In today’s market, I think that despite the strong performance of the major stock indexes that in many cases, the best approach is to either sell or wait to buy. Investors who look at the stocks that are driving the market higher might be a little concerned. For instance, if we look at the Dow, the stocks that are leading the way higher this year aren’t economically sensitive stocks or growth stocks such as JP Morgan (NYSE:JPM) or Visa (NYSE:V), but rather stocks such as Johnson & Johnson (NYSE:JNJ) and McDonald’s (NYSE:MCD).
These are companies that people buy for their recession-resistant cash flow streams and their generous policies of returning capital to shareholders. They are also the companies people buy when they are risk-averse — they are leading holdings of funds that focus on “value” and dividends, and not growth or momentum.
As a result, I think investors need to be concerned and extremely cautious. When choosing stocks, the best approach is to look for value and stocks that can generate cash flow even in an economic slowdown. For instance, some of the railroad stocks look intriguing.
The East Coast railroad companies Norfolk Southern (NYSE:NSC) and CSX (NYSE:CSX) both trade with 16 price-to-earnings multiples, and while their earnings are down year over year because of weakness in coal shipments, they have had years of growing their businesses and returning capital to shareholders through dividends and buybacks.
Another place to look is at the nitrogen fertilizer producer CF Industries (NYSE:CF). CF has seen its operating profits decline because of lower fertilizer prices, but it has been one of the best-run businesses in the market, with profits soaring over the past few years due to smart and aggressive expansionary moves such as the purchase of Terra Industries.
The company grew earnings from $4 per share to over $25 per share before the stock pulled back slightly, and all of a sudden investors became cautious as the company’s stellar growth came to a temporary halt. People need to eat, and rather than buying other “staples” companies that trade at 25 times earnings because of their bond-like consistency, you are probably better off buying something like this company.
However, you should probably be avoiding several sectors in the economy, such as retailers, which are overvalued and which have shown weak earnings growth and margin contraction that has led to profit declines even in some of the best retailers in the industry from Wal-Mart (NYSE:WMT) to Costco (NASDAQ:COST).
Financial companies as well are showing signs of weakness, and they are reporting reductions in revenues from their trading businesses and continued fallout from the financial crisis. If you must own a financial, make sure that it is not generating its earnings or earnings growth by taking capital out of its loss reserve portfolio.
Ultimately, when stocks are hitting all-time highs they seem like the place to be. But there are a lot of red flags out there, from valuation to leadership. Too many stocks are overvalued, and the wrong companies are leading the upswing for investors to become too confident in the market going forward. However, there are opportunities out there, and if you locate them, you can still make money in both the short and long term.
Disclosure: Ben Kramer-Miller is long shares of Mosaic Co., Visa, CSX, and CF Industries.