Volatility Is Back
After stock market averages set record highs in mid-August, stocks sagged, interrupting the market’s recently re-established uptrend. The buoyant markets of the last couple of years must have spoiled investors; financial media featured predictions of doom even though the averages only declined 3% to 4% before the recent (brief) rally.
Market technicians define a “correction” as a drop of 10% or more. We haven’t had one of those for three years, a streak that some attribute to the accommodative low interest rate policies of the Federal Reserve. Its latest announcement that disappointing growth in the Euro area and an increasingly strong dollar add reasons for it to continue its policies, keep rates low even while the economy continues to grow.
A strong dollar allows U.S. consumers to buy imports more cheaply but weakens the competitive positions of exporting companies. As oil and many other commodities are priced in dollars, a strengthening dollar tends to push commodity prices lower. Crude oil prices are also under pressure from the impacts of weaker-than-anticipated growth in Europe and China combined with the oil production surge in this country.
As a result of the shale oil boom, the U.S. now rivals Saudi Arabia and Russia in oil output. While the U.S. is still a modest exporter, its domestic output pushes overseas oil producers out of the American market. Crude oil prices are at their lowest levels since 2012, good for American consumers but very detrimental to oil companies.
Energy stocks used to make up core positions in most stock portfolios but their potential growth is weakening. Dividends remain high on more established oil and gas companies, thus some remain suitable for retirement accounts. Better opportunities lie in other sectors, particularly advanced medical and technology stocks.
Activas PLC (ACT-$244), is the third largest developer of generic drugs, is a new buy recommendation. The company began in Corona, California with six employees, growing to a Dublin-based global firm with over $10 billion in sales. It acquired Warmer Chilcott, Swiss-based Activas, Forest Labs and is currently one of the bidders for Irvine-based Allergan.
Activas has a remarkable growth record with four years of consecutive earnings per share growth over 40%. It will announce its latest results on November 5 and estimates call for continued growth headed toward earnings for all of 2014 over $13.00 a share. With the markets currently turbulent, prudence suggests taking partial positions now.
Wobbling stock prices make merger arbitrage deals even more attractive. Abbvie (ABBV-$57 remains on track to acquire our positions in Shire plc (SHPG-$257). The deal should close in three months or so with Shire shareholders receiving 24.44 pounds (currently $39.39) and 0.8960 shares of the combined company. The combined value is $96.84, which, multiplied by the ADR conversion ratio of three comes to $290.52.
That equals a spread over 12% today, an unusually attractive arbitrage weighed down by hysteria brought on by the clamor about “tax inversions” and new Treasury rules. These new rules do not appear to block this buyout, leaving it up to Congress, which is out of session until after the elections. It is highly unlikely that Congress can muster an effort, even if desired by the newly elected House, before the deal closes. If the deal fails for tax reasons, Abbvie is committed to pay Shire a substantial breakup fee.
In technology, my newest recommendation is Palo Alto Networks (PANW-$101), a leading company in cybersecurity. It protects the networks of more than 19,000 companies in over 120 countries, including more than 75 of the Fortune 500. Recent security breaches at Target, Home Depot and JP Morgan Chase are accelerating demand for Palo Alto products and services. Both sales and earnings have sizzling 60% growth rates and I suggest taking initial positions before its next reporting date on November 24.
Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1995. [email protected] 949.494.1376/800.697.2622