Want value and protection? 2 stocks, 2 ETFs
The market is overbought and very expensive, but some areas still offer potential growth.
By Dennis Hobein, Stock Traders Daily
The stock market is overbought and very expensive. In a recent letter to subscribers, Thomas Kee, the president of Stock Traders Daily, noted that the market is currently trading with an exorbitant price-to-earnings-to-growth (PEG) ratio of 5.5.
The PEG ratio is a valuation measure that takes an investment's price-to-earnings ratio and divides it by expected earnings-per-share growth. A widely used rule of thumb is that if a stock has a PEG above 1, it is thought to be priced at a premium, and vice versa.
So at 5.5, it's easy to see just how rich the market is right now. Further, Kee says that even if earnings were somehow to grow at a 40% clip, the PEG ratio would fall only to 4.0.
There are other tools and metrics that are pointing to a market that has become "irrationally exuberant." For instance, the current put-to-call ratio, as of Sept. 18, was 0.79, indicating that investors are feeling far more bullish than bearish, even in the face of poor economic and earnings data. Also, the iPath S&P 500 VIX Short Term Futures (VXX), a measure of fear in the market, is showing no signs of life.
In short, the combination of a grossly overvalued market, the lack of fear, and the possibility that the Federal Reserve may have just fired its last bullet creates a high-risk situation for investors and traders. Stock picking is becoming more challenging each day. With that in mind, I want to put a few ideas in front of you that I still like, despite my very cautious sentiment on the market overall.
Conditions ripe for fertilizer producers
It is difficult to imagine a scenario in which fertilizer and/or seed companies will not do well. This past July, the United Nations Food & Agriculture Organization released its monthly food price index, which showed a 6% jump in prices. Some of this is certainly due to the drought that afflicted the Midwest this summer, but there are broader trends at play as well.
Food and grain supplies are already low, and fast growing populations in countries such as China, have altered their diets to be more protein-heavy. This means they are purchasing more grains to feed livestocks. Furthermore, it is my contention that the worldwide spending spree on quantitative easing measures and the like will continue to debase currencies. This means higher prices for many commodities across the agriculture spectrum.
One company at the forefront of these trends is Monsanto (MON), a producer of seeds, herbicides, among other products. The stock has been on fire since late May, up 30% since then, and it is trading at its highest levels since 2009. MON is coming off a very impressive second quarter report from June 27, easily surpassing analyst estimates as earnings per share and revenue shot higher by 29% and 17%, respectively.
Additionally, MON presented at a Credit Suisse conference on September 12, commenting that the "drivers for global agriculture growth are real and ongoing." Then, on September 19, Goldman Sachs added MON to its "Conviction Buy List."
Dollar Store at a discount
Although Fed Chairman Ben Bernanke likes to say that quantitative easing programs are for "Main Street," since their proposed purpose is to create jobs, there is a compelling argument to be made that he is actually hurting the lower-middle class.
Gas and food prices have undeniably shot up, and the dollar has undeniably fallen in value. It is debatable whether QE programs are to blame, but, logic would suggest that it has played a roll.
As consumers purchasing power erodes, family budgets will continue to come under pressure. Therefore, it has been my contention that discount retail chains, such as Dollar General (DG) will benefit.
Further, this may be an ideal time to consider the stock as it has cooled off and consolidated after reaching all-time highs in July. Shares seem to be "basing" at the $50 level. Valuation also isn't much of a concern as it is trading with a 1-year forward price-to-earnings ratio of 15 and a trailing price-to-sales of about 1.
Add some protection
For investors looking to hedge their portfolios against inflation or stock market losses, there are a couple easy ways to do so. With the Fed going all in with QE-Infinity, and as other central banks around the world -- most recently the Bank of Japan -- continue to devalue their currencies, the obvious beneficiary will be gold. Therefore, I believe that the SPDR Gold Trust (GLD) will continue to perform well.
For those looking to protect themselves from a downward slide in the market, I would simply suggest keeping a higher allocation in cash than normal. With the QE catalyst out of the way, and with the market up some 16% this year, now may be an ideal time to move some cash to the sidelines. Or, another possibility would be to put some money in the ProShares UltraShort S&P500 (SDS).
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Try as the bears might, they couldn't break US stocks. But investors still face frothy prices and considerable headwinds.
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