So far in 2014, investing in stock market indexes such as the S&P 500, the Nasdaq 100, or the Russell 2000 hasn’t worked out. The ETFs that track these three indexes — the SPDR S&P 500 ETF (NYSEARCA:SPY), the Powershares QQQ Trust (NASDAQ:QQQ), and the iShares Russel 2000 ETF (NYSEARCA:IWM) — are up 0.8 percent, down 2.4 percent, and down 2.1 percent respectively.
While this performance certainly isn’t terrible, it draws attention to the fact that in 2012-13 stocks simply ran too far too fast. Now that there is tapering of quantitative easing, a larger tax burden thanks to “Obamacare,” and signs of global economic weakness this underperformance shouldn’t be surprising.
But if these assets aren’t performing well this year what is? Also, will this year’s winners continue to outperform?
The answer to the first question is “safe haven assets.” These assets are making you money, and furthermore, there is no evidence that they will stop making you money any time soon. With the aforementioned economic concerns impacting first quarter earnings results I think the relative weakness in more economically sensitive assets is set to continue, and investors should consider adding one or more of the following “safe haven assets” to their portfolios.
1. Treasury bonds
At the beginning of the year every investor hated U. S. Treasuries, which closed 2013 at a multi-year low. As a result this was one of the best contrarian trades to start the year, and so far it has worked extremely well. The iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT) is up a whopping 9 percemt for the year, and the uptrend appears to be continuing. This is counterintuitive. Everywhere we are reading that China is selling Treasury Bonds, and that Russia could sell out of its position as well. Also because of tapering the Federal Reserve is buying fewer Treasury bonds.
However there are sources of demand. For starters since nearly every analyst was bearish of Treasuries last year chances are several of them held short positions. These positions need to be covered at some point, and this creates demand for Treasuries. Also, while demand from the well-known foreign sources for Treasuries has fallen there is surprisingly demand from Belgium.
Now that Treasury bonds are rising again, this can draw in momentum traders and speculators, who will put further pressure on the short sellers to cover. Also, if tensions continue to develop between the U. S. and Russia, we could see additional demand from safe haven investors.
Gold has been one of the best performing assets this year, with the SPDR Gold Trust (NYSEARCA:GLD) rising 8 percent for the year. Like Treasury bonds, gold ended 2013 at a low point. It seemed as if every analyst was bearish of gold despite the fact that mining companies couldn’t make any money mining it and despite the fact that the Chinese and Indians were buying a lot of it.
The fact remains that gold is in a long term bull market. In 2011 gold needed to correct after having risen relentlessly every single year — including 2008 — since the beginning of the 21st century. Now it seems as if the correction is over, and the rebound is coming in a market environment where there are several reasons to own gold, such as a rising money supply, rising global demand from both individual investors and large institutional investors, and rising geopolitical tensions. In all likelihood, gold will continue to perform well in the foreseeable future as investors realize that the substantial rise in the U. S. money supply will ultimately lead to high inflation.
3. Utility stocks
Utility stocks were left in the dust by more economically sensitive stocks in 2013, but they are coming back with a vengeance in 2014. So far the SPDR Utilities ETF (NYSEARCA:XLU) is up over 13 percent for the year, making it the best performing of the safe haven assets. Furthermore, it closed out Friday’s trade at a fifty-two-week high, and not a penny lower despite a sharp fall in the broader equities market. Utility companies aren’t the most glamorous investments, but they provide customers with a continuing necessary service. They also pay nice dividends — the XLU pays a 3.4 percent dividend versus the S&P 500 which pays less than 2 percent. This gives Utilities a bond-like quality, and they consequently outperform in troubling market environments.
While the XLU is in need of a pullback I suspect that the uptrend isn’t over. People want the profit potential offered by stocks and the safety provided by bonds, and utilities provide a little of both. As growth stocks turn lower investors will flock to utilities and other defensive stocks, and they should continue to outperform.
Of course, there are some basic tips to keep in mind while looking for new investing opportunities. Last week, we discussed three general rules for picking growth stocks that are likely to be winners down the road. The following three rules may not have a 100 percent success rate, but they will certainly give any investor an edge. Here’s a recap:
1. Valuation Matters
There is a false dichotomy in Wall Street lingo that there are “growth stocks” and then there are “value stocks.” This is rubbish — you should only buy a stock that offers good value regardless of its growth. The distinction that is being made refers to stocks that trade at high p/e multiples in virtue of their growth rates, and stocks that trade at low p/e multiples without any growth but which generate regular profits and income.
How, then, do we determine whether a growth stock offers good value? A good rule of thumb is to look at its “PEG” ratio, where the “PE” stands for the p/e ratio and the “G” stands for the growth rate. Specifically, you divide a company’s p/e ratio by its projected growth rate. Generally, a growth stock is going to be a solid investment if its PEG ratio is 1 or less, meaning its p/e ratio is equal to or below its growth rate. The same stock is not worth buying if its PEG ratio is anywhere greater than 1.5, and it is worth selling, no matter how much you like the company, at a PEG ratio of 2.
So, for instance, MasterCard has an historical growth rate of about 20 percent. Since its growth is decelerating, and since its primary competitor — Visa — released earnings figures that suggest decelerating growth, we can conservatively project that MasterCard’s growth rate is about 18 percent. MasterCard trades at 24.4 times 2014 earnings estimates, giving it a PEG ratio of 1.36. This means that the stock offers good value, even though it trades with a relatively high p/e multiple. I wouldn’t buy the stock just yet, although if I owned shares I wouldn’t sell them either.
2. Pick Growth Stocks With Secular Tailwinds
While valuation is a major factor in picking a growth stock, there are some growth stocks I simply don’t want to own even if they offer good value. The reason is that they are growing in an industry that isn’t, or one that is extremely competitive. Take Chipotle Mexican Grill as an example. This company is growing rapidly, but it is doing so in the fast-food restaurant industry. While the industry is growing, it isn’t growing very rapidly. Furthermore, there are hundreds of fast-food chains all over the country vying for your business. While Chipotle is succeeding now, how do I know that it will continue to do so?
On the other hand, take the example of MasterCard again, which is in a growing industry — cashless payment solutions. Not only is this industry growing, but it isn’t very competitive. MasterCard’s only competition comes from American Express, Visa, and Discover Financial. Given that the cashless payment industry is growing, and given that there is very little competition, I am confident in MasterCard’s future growth.
The bottom line is that you need to make sure that you are buying growth stocks in industries in which it is easy for best of breed companies to grow.
3. Invest in Best of Breed Companies
Once you’ve discovered a growth industry you want to invest in, you shouldn’t indiscriminately buy all or several of the stocks in that industry group. If you take the time to go through the companies one by one, you will find one or two that stand out as “best of breed” companies. You should own these.
Take, for example, the additive manufacturing industry (or, 3D printing.) There is little doubt that this is a growth industry, and I think investors who want to own growth stocks should familiarize themselves with it. But if you start reading through company reports you’ll find that they are all citing the growth potential of the industry as reasons to invest. Find the companies that have outperformed, that have been able to innovate and take that innovation to the point of sales and profit growth.
In other words, make sure it is really growing. I know that sounds redundant, but consider that there are companies in the additive manufacturing space that aren’t growing their revenues and profits such as Organovo — a company that has no sales. Instead, invest in a company such as Stratasys, which is growing sales and building a business that is focusing on benefitting from every aspect of the industry. Note how Stratasys shares are down with the rest of the industry, yet not nearly as much — the stock is off 26 percent for the year versus Organovo, which is off 50 percent. While the downtrend in these stocks may not be over, the market is telling you which are the winners and which are the losers.
If you follow these three tips, you won’t always pick winning growth stocks. But I think most of the time you will.
One more point that I want to make is that each of these three pieces of advice is supposed to be exclusionary — it is meant to help you eliminate potential candidates for your portfolio. Remember that you are building a portfolio of just a handful of stocks out of thousands of possibilities, and that your time is best spend finding reasons not to own a stock than to own it. This is especially true of growth stocks, which have tremendous outward appeal but which also come with significant risk. As long as you can identify and focus on the latter, you will be successful at picking the best growth stocks the market has to offer.
Disclosure: Ben Kramer-Miller has no position in any of the ETFs mentioned in this article. He is long Visa and Stratasys.