Ten-gallon stock tips

A strong Australian dollar adds to the attraction of investing in the US. Here are some top-10 lists.

PORTFOLIO POINT: With prospects for investing in US shares looking better and better from an Australian perspective, we examine three investment publications’ top-10 lists for 2012. Of these, three stocks stand out.

US stocks closed flat last night but the rally in the world's largest equities market since the beginning of the year has been unmistakable.

Late last year I wrote that the US would continue a mild economic recovery in 2012 (see Twelve predictions for 2012), and although I still believe that will be the case – whether or not the wheels fall off on China's fixed-asset investment bubble – others are questioning whether the recovery is real, not the least being Alan Kohler, due in part to continued uncertainty out of Greece's ongoing debt negotiations.

Yet as I wrote on Monday and the week before (see China's false dawn and Europe faces recession, not regression), market prices as they are still indicate more upside than downside for the developed world economies. While job seekers, home builders and fiscal-deficit hawks may have a tough time in Europe and America over the coming years, as far as equities investors are concerned there are a lot of good companies trading at very cheap multiples. Furthermore, strong technical indicators are also appearing in the price charts despite what, in my view, could still be a very volatile year for traders (notwithstanding low readings currently on the US VIX index).

This is especially true in the United States, which has so far been enjoying much stronger economic data than has been seen across the pond. Tonight's jobs report will be a key indicator to watch, but unemployment has so far held at a near three-year low of 8.5%. And while US companies are still releasing corporate earnings figures, of the half that have done so to date, 67% beat consensus analyst forecasts, according to Bloomberg. Blue-chip names such as MasterCard and Gap, for example, rallied almost 6% and 10% respectively this week on their surprise profit statements, while earlier in the earnings season, new economy bellwethers Intel, Microsoft and IBM all defied gloomier forecasts.

And with social media giant Facebook preparing for an initial public offering, investors are hoping for more of the same, although there are more than a few bears coming out of hibernation, including Bank of America-Merrill Lynch strategist Savita Subramanian, who last week described the latest quarterly results as constituting the weakest earnings season since Q4 2008 – at least based on the number of companies that had beaten both top and bottom-line (revenue and profit) expectations, not just one. Further, a lot of the disappointments have been from economically critical companies such as Citigroup and JPMorgan Chase.

Still, there are many others who are very excited, not least because of a “golden cross”, the technical indicator where a 50-day moving average crosses the 200-day moving average, on the S&P500 index (see chart below).

And while I'm as sceptical as any as to the validity of such soothsaying, in terms of building a self-fulfilling prophecy of bullishness, the golden cross is as good as it gets and, in the slightly facetious words of the Wall Street Journal, Wall Street's uptrend since October 2011 can now be "considered official”. I view it as a kind of vindication of my US versus China trade, when the S&P500 since that time is compared with the Shanghai All Ordinaries index.

With this in mind, and considering the Australian dollar’s relative strength to the Greenback (currently at $US1.07), now more than ever is the time to increase weightings to US equities from Australian equities, which I view as being far too exposed – by virtue of our currency and major source of trade – to the unpriced “black swan” of a Chinese economic correction. While China's latest headline GDP growth rate still appears strong, and its PMI is still above 50, I am disturbed by more coal-face indicators such as plummeting construction equipment sales and falling forex reserves considering that front-ended and debt-financed fixed-asset investment (or, more likely mal-investment still accounts for the lion's share of China's GDP.

Further, by increasing exposure to US stocks now that we’re more or less half-way through the American earnings season, investors can better judge the validity of price/earnings (P/E) multiples that are still, in many respects, as cheap as those in Australia if you believe, as I do, that profits for Australian companies will disappoint. Currently, the US S&P 500 has a median forward P/E of about 12.5 times, against an ASX 200 average of 11 times, but in Australian dollar terms, US stocks have a forward P/E of just 11.7 times.

What’s more, I believe the US dollar is still well-placed to appreciate against its major counterparts this year, including the Australian dollar. Not only do I continue to see the euro as likely to depreciate, due to the probability of a euro-wide recession and the inevitability of more accommodative monetary policy against the backdrop of misguided fiscal austerity, I see America’s monetary policy as a lot less accommodative going forward than does the consensus of market economists.

Presently, an emerging trade in the markets is that US dollars are again a sell, with investors looking at the Federal Reserve's recent statement on bond-buying as a kind of commitment towards another round of quantitative easing, or “QE3”. Yet as I've written numerous times before (see The sting in QE’s tail), the US Fed is not only unlikely to institute a policy that is no longer needed, now that inflation and employment are tracking back towards pre-crisis levels, but it is politically almost impossible for them to do so anyway.

Indeed, as the chart from RBC Capital Markets displays below, far from making a pledge to keep rates low until late 2014, as most in the media have reported, citing the relatively “dovish” Ben Bernanke, a significant portion of Federal Open Markets Committee (FOMC) policy makers actually appear to forecast the opposite: a series of interest rate rises during that year, which would logically signal a higher US dollar going forward.

Source: RBC Capital Markets via FT Alphaville

The question remains then, where in the US should you invest? First, I’m a fan of index investing for asset classes where you don’t have a clear line of sight and, thanks to ETFs investing in index products, has never been easier (see No looking back now: ETFs ready to take off). Despite the fact that Australian investors, due to the internet, have virtually as much information available on US stocks as do American investors, not being in the US we inevitably lack the situational and contextual advantages that allow the development of “gut feel”.

But if index investing is not for you, most Australian brokers make it relatively easy to purchase US stocks directly, albeit at slightly higher costs whether measured by dollar or percentage. While these costs could act as an impediment for short-term trading strategies (see The Ten Commandments of trading) unless you have a US broking account, for long-term investing, (see Buy and hold’s Ten Commandments) Wall Street holds many attractions.

And as for what those attractions are, three leading US publications have done their homework for you, each picking 10 stocks that they view as outperforming the market in 2012:

-Fortune magazine's top-10 picks
Code Company
Price
(USD)
12-mo. avg broker target
Diff
%
P/E (latest)
AAPL Apple
$455.12
$562.96
23.69%
12.95
CAT Caterpillar
$110.33
$128.06
16.07%
14.91
EEP Enbridge Energy Partners
$32.23
$33.71
4.59%
31.75
GT Goodyear Tire
$13.28
$19.21
44.65%
24.64
HAL Halliburton
$36.54
$51.00
39.57%
11.86
INTC Intel
$26.49
$27.17
2.57%
11.08
JCI Johnson Controls
$32.44
$39.83
22.78%
13.47
LMT Lockheed Martin
$83.17
$81.35
-2.19%
10.64
MSFT Microsoft
$29.95
$31.78
6.11%
10.86
RY Royal Bank of Canada
$52.86
$57.00
7.83%
16.55

Source: Fortune Magazine, Yahoo Finance. Prices as of close US trade, 02/02/2012.

-Barron's Top-10 Picks
Code Company
Price
(USD)
12-mo. avg broker target
Diff
%
P/E
(latest)
BRKB Berkshire Hathaway (B)*
$78.73
$85.00
7.96%
16.82
CMCSA Comcast Corporation
$26.69
$31.24
17.05%
19.2
DDAIF Daimler
$57.97
$53.50
-7.71%
9.44
FCX Freeport-McMoRan
$45.51
$54.61
20.00%
9.52
MET MetLife
$36.38
$46.69
28.34%
6.81
PG Procter & Gamble
$63.32
$71.12
12.32%
18.62
RDS-A Royal Dutch Shell
$71.74
N/A
41.06%**
7.12
SNY Sanofi-Aventis
$36.70
$40.80
11.17%
15.75
STX Seagate Technology
$25.75
$30.53
18.56%
23.51
VOD Vodafone Group
$27.23
$33.65
23.58%
12.61
* Berkshire Hathaway New Common Shares
** Based on difference between quoted and target price in Amsterdam

Source: Barron’s, Yahoo Finance. Prices as of close US trade, 02/02/2012

-WSJ Smart Money Top-10 Picks
Code Company
Price
(USD)
12-mo. avg broker target
Diff
%
P/E
(latest)
T AT&T
$29.79
$31.56
5.94%
45.14
BIDU Baidu, Inc
$130.79
$188.23
43.92%
50.19
CEO CNOOC
$213.17
$245.33
15.09%
8.92
EXC Exelon
$39.64
$42.38
6.91%
10.92
GOOG Google
$585.11
$702.03
19.98%
19.66
NGD New Gold
$12.31
$15.22
23.64%
17.46
NEM Newmont Mining
$62.29
$77.89
25.04%
14.19
POT Potash Corp
$47.26
$55.96
18.41%
13.46
SAP SAP AG
$61.92
$47.39
-23.47%
16.37
SI Siemens AG
$97.84
$119.03
21.66%
11.24

Source: Smart Money, Yahoo Finance. Prices as of close US trade, 02/02/2012

The first thing that stands out to me from these picks, however, is that not all of these companies are cheap. Fortune’s Enbridge Energy and Smart Money’s Baidu and AT&T look downright expensive on a P/E basis. And as for the difference between price and target, each of the magazines had picks from December that have already overshot the mark: Lockheed Martin, Daimler and SAP, the latter two being German companies that have dual listings on the NYSE.

The second thing that stands out is that not all these companies are American. Besides German giants Daimler and SAP, Siemens is also based in Europe, as are Royal Dutch Shell (Holland), Sanofi-Aventis (France) and Vodafone Group (Britain). Potash Corp, New Gold and Royal Bank of Canada are all located north of the border, and Baidu and CNOOC are Chinese. Of the 30 stocks above, only 19 are American.

Third, while all of stocks may be secure based on their balance sheets and revenue streams, some of them, such as Comcast (American cable TV and telephony), Exelon (nuclear power stations in Illinois, Pennsylvania and New Jersey) and Seagate (hard-drives in a world where data is moving to the cloud) aren’t exactly in growth industries. And as for the various gold stocks on the list – Freeport-McMoRan, New Gold and Newmont – although I don’t view a fall in the yellow metal as imminent I don’t view it as having much in the way of solid fundamentals at current prices.

And while I was surprised to see that no stock appeared on more than one list, it does go to demonstrate how much more diversified the US market is – both of American-based companies, and overseas equities listed in the US – and indeed, considering the small differences between share price and consensus broker target for a number of them, it also demonstrates how much more efficient the US market is in terms of price discovery.

And this makes my job easier for out of these 30 stocks, there are only three I really like: MetLife, Apple and Goodyear Tire.

Royal Bank of Canada, Potash Corp, Siemens, Vodafone and Royal Dutch Shell get honourable mentions as I like the outlook for Canadian banks (see Northern exposure and this fascinating comparison with Aussie lenders), fertiliser (see Food for thought and Phosphate’s promise), green technology (see The east is green) emerging market mobile telephony (see Under the radar: The new pay-phone for another example) and oil prices, but these are all foreign companies. I also like Google, Berkshire Hathaway and Procter & Gamble for their commanding positions in their chosen industries (of which Buffett’s Berkshire operates across many), but none excite me at current levels.

The difference then with MetLife, Goodyear and Apple is, respectively, a story of deep value, short-term challenges obscuring long-term opportunities and technological foresight. With MetLife, this New York-based insurance group may have traded for a century and a half but it was thrashed like a penny dreadful alongside other US financial stocks in 2008. Unlike its nearest rival – American Insurance Group – however, MetLife rode out the financial crisis using the period to acquire its rival's life insurance division for $US16.2 billion. MetLife is now the largest life insurer in the US and looks set to grow as more Americans, thanks to government pressure (and possibly mandate if Obama is re-elected) take life, dental and disability insurance policies. Trading at a P/E of just 6.8 times, MetLife trades for peanuts - just like the cartoon characters on its blimp.

Goodyear is another company known for its dirigible and suffering a sharemarket rout along with the beleaguered auto industry. And what’s worse for Goodyear is that in a great year, so far, for US stocks, its performance has been terrible, falling 10% in just one day after a Deutsche Bank analyst call revealed a weak short-term outlook for the company.

But while the rubber ain’t burning fast enough for sell-side analysts, I believe Goodyear is slowly transforming into a company that investors should watch over the coming years. After divesting itself of low-performing European and Latin American assets and rationalising its global supply chain in recent years, Goodyear is increasing its focus on places like China, where motorised transport is yet to take off. And while I’ve by now made myself known as a China bear as far as commodities and real estate are concerned, I’m very bullish on the long-term future of Chinese consumer markets, especially motor vehicles.

As can be seen in the chart below, if the history of America’s economic development is anything to go by, the story is already over for Chinese banking, steel production and electricity consumption (woe betide Australian exports of coal and iron ore!), but is yet to begin for air travel, dining out and passenger cars. And while this might not mean much to US car makers that can’t compete on price with Chinese equivalents, for specialist providers such as Goodyear – which competes on quality and reputation (it has one of the highest scores on this and corporate citizenship according to Forbes) – its market position is relatively defendable. What’s more, despite recent problems with flooding in Bangkok, where Goodyear makes tyres in the region, its current challenges have been more than been priced into analyst forecasts, which suggest a 44.65% upside in US dollar terms.

Source: US Global Investors, Credit Suisse

Finally, Apple is a well-known favourite but since the death of founder Steve Jobs my enthusiasm for the stock is less to do with new product development, of which Jobs was an undoubted driver, but for Apple’s decision to build its presence in cloud computing. For much the same reason I’m bearish on Seagate, I’m bullish on Apple: in the coming years people will interact with data less through standalone computers and more through personal devices such as netbooks, tablets and mobile phones, which access data remotely through increasingly ubiquitous wireless internet.

Apple launched its iCloud service for Australia in October and although it's still relatively less known than iPads, iPhones or iPods, I believe this will be the bigger business eventually as more and more people work, socialise, listen to music and watch television through the internet. And just as Gillette makes its money from blades rather than razors, Apple will continue to make money from apps and iTunes, rather than devices, yet only on a potentially much larger scale. Right now, it seems, every second or third person owns an iPhone. Imagine a time when every second or third person has their data not on a computer, CD rack, DVD collection or bookshelf, but on Apple’s balance sheet.

This is by no means a definitive list of US stocks or opportunities, but with American companies cash-rich but low-priced there’s never been a better time for Australian-based investors to start investigating this enormous asset class.

Follow Michael Feller on Twitter @MFellerEureka

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