The U.S. stock market will post gains of 7% to 10% next year. Out-of-favor sectors including banking and commercial real estate will be among the best performers. Small- and mid-cap companies will continue to fare best. Value will outperform growth.
It’s safe to own stocks with solid dividend yields because interest rates won’t rise enough to hurt them, despite the expected pickup in growth and inflation. Ten stocks, below, should be among the best performers.
Those are the 2021 predictions of three of my favorite stock letter writers, who I check in with each year for an annual forecast and a short list of favorite stocks.
Investment letter writers are the unsung heroes of the market. They don’t get the attention showered on sell-side analysts and pop-star fund managers. But their thinking can be just as good, or even better.
Of course, I have a bias. I also have a stock letter called Brush Up on Stocks. (See the link in my bio below.) But rankings that these letter writers pay the Hulbert Financial Digest to calculate confirm their long-term records.
Here’s a closer look at what they think lies ahead, and
some of their favorite stocks for 2021.
Prudent Speculator: 10% gains, led by value
Citing the vaccine rollouts, editor John Buckingham expects life to start returning to normal in 2021, driving gains of around 10% for the S&P 500
He disputes claims that investors are euphoric, citing the $4.3 trillion parked in money market funds, and the $18 trillion in bonds yielding virtually nothing or worse (negative yields). He predicts value will outperform growth because it typically does better as economies improve.
As for individual names, citing just a few goes against Buckingham’s practice of diversifying to reduce risk. But he plays along. Buckingham likes companies that have decent business prospects over the next several years, look cheap and pay generous dividend yields.
For example, Cisco Systems
has a trailing price-to-earnings ratio of around 14, below its historical range of 15-18. But he thinks it will benefit from the rollout of 5G by AT&T
Buckingham believes consumers will go for 5G to better view entertainment from content kings like Viacom
and Walt Disney
Cisco’s network switching equipment will play a big role. It pays a 3.2% yield.
Next, he likes CVS Health
as a contrarian play on exaggerated fears that Amazon.com
will move into the pharmacy business. Shares trade at just 10 times earnings, and CVS pays a 3% yield.
Also consider General Dynamics
It gets about 70% of its sales from defense contracting, but there is a private sector kicker in the mix, in Gulfstream business jets. General Dynamics looks relatively safe given its $81.5 billion backlog. It pays a 3% yield.
In banking, Buckingham suggests J.P. Morgan Chase
which he describes as a quality bank that merits a premium valuation. The bank will benefit as the yield curve turns more upward sloping because the economy will strengthen. Meanwhile, it is well-reserved with a strong balance sheet. This leaves a lot of room for buybacks and dividend hikes. It pays a 2.9% yield.
He also singles out ManpowerGroup
a play on a European rebound since it gets about two-thirds of its revenue there. Staffing companies also tend to do well as economies recover. Buckingham thinks earnings will double by 2022. It pays a 2.6% yield.
Investment Quality Trends: Rising rates pose no risk to dividend stocks
Editor Kelley Wright is skeptical of predictions of fast economic growth for 2021 because unemployment remains elevated. “But if there is acceptance of the vaccine and the virus gets under control, it will be a tremendous positive, especially for consumer sentiment,” he says. “I think the S&P 500 will figure out a way to produce the usual 8% to 10% gains.”
That wouldn’t match this year’s gains of 15.6% for the
S&P 500. But it would be a healthy advance nevertheless.
Wright specializes in companies that pay decent dividends, so it’s worth pointing out he doubts that the higher interest rates and inflation that might come with solid growth would be a negative. “I think it would be good, because it would confirm we have some growth,” he says.
Wright searches for discounted names among financially
sound companies with long histories of paying increasing dividends. In his
system, stocks look cheap when their dividend yields return to the repetitive
highs of the past. Yields rise when stock prices decline. So this can be an
effective way to identify possible bottoms for stocks.
His undervalued category currently has around 55 stocks,
and the majority of them are financials. This suggests banks still look
attractive despite their recent strength.
One he singles out for us is Comerica
which has a big presence in Southern states like Texas, Arizona and Florida, but also California and Michigan. The historic, repetitive high yield here is 4.1%, which suggests the stock looks cheap at $66, or below. Comerica currently sports a 4.8% yield, with the stock at $56. The bank trades just above tangible book value. It only pays out 30% of earnings. This suggests plenty of room to increase its dividend. Comerica has hiked its dividend by at least 10% annually for the past 12 years, says Wright.
Next, he suggests Tyson Foods
Here, the repetitive high yield suggesting value is 2.7%. Tyson has fallen enough to ring the value bell — it now has a 2.7% yield. The Covid-19 epidemic severely hurt China’s chicken and beef production. Tyson has signed multi-year contracts to supply Chinese distributors, sourcing product from Thailand, which is safer because this country has lower flu risk, says Wright. This business should begin kicking in during the first and second quarters. Tyson has a 12-year history of raising dividends, so it is likely to do so again in 2021.
Among real estate investment trusts (REITs), Wright likes Simon Property Group
Its 6% yield is above the 5.4% repetitive high yield, suggesting good value. The REIT runs shopping mall properties. Hence the stock weakness. But Simon Property Group seems to have a workable plan. It’s in the process of converting empty Sears and J.C. Penney stores to Amazon.com distribution hubs. That’s a smart move, says Wright, because it makes Amazon.com more competitive with Walmart
Otherwise, the REIT is turning malls into “playgrounds for adults,” with high-end theaters and arcade-restaurant combos offering games that appeal to this crowd.
Cabot Turnaround Letter: Much of the expected growth is already priced in
Editor Bruce Kaser predicts a more modest 7% gain for the S&P 500 in 2021, citing rich market valuations. Economic growth will be solid, and S&P 500 earnings will advance 11% compared to 2019. For stocks, Kaser likes out-of-favor, discounted companies with potential catalysts.
In banking, he likes Wells Fargo
a turnaround under the leadership of its relatively new CEO Charles Scharf, who was a protégé of J.P. Morgan Chase CEO Jamie Dimon. Kaser say Wells Fargo looks cheap, trading below tangible book value. Meanwhile, the bank continues to reduce costs and clean up its corporate culture following a long string of scandals. Wells Fargo stock is also held back by concerns about exposure to commercial real estate loans. But Kaser thinks the bank is adequately reserved.
Kaser also suggests the troubled consumer products company Newell Brands
Its stock trades where it did in the early 1990s. But Kaser expects progress because of the presence of activist investor Carl Icahn. Icahn helped select the relatively new CEO, Ravi Saligram, who joined in late 2019. “It looks like the company is turning the corner,” says Kaser. “Profit margins are improving and it is paying down debt. We think this turnaround is only now just starting, and investors under appreciate the changes and the earnings power.”
A note of caution
Given that these three letter writers are decisively part
of the bullish crowd, it’s worth noting that the crowd’s enthusiasm is nearing
a feverish pitch, by the sentiment measures I track. This makes the market more
vulnerable to pullbacks, in my view. So be ready for this psychologically, and
have some buying power. Avoid owning stocks on margin.
You might not realize this since the market has been in an extended upward arc. But, on average, stocks sustain 10% corrections at least once a year, and 5% corrections at least three times a year, points out Buckingham.
Michael Brush is a columnist for MarketWatch. At the time of publication, he had no positions in any stocks mentioned in this column. Brush has suggested T, GOOGL, DIS, AMZN, GD, JPM, WFC and NWL in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.