When a massive bubble in the bond market bursts, stock market leadership will shift dramatically, setting the stage for outperformance by quality, low-valuation financial and energy stocks during the resulting turmoil, according to Julian Emanuel, the chief equity and derivatives strategist at investment banking and securities trading firm BTIG. He believes that the bond market today may be "the greatest bubble ever," with prices at historic highs and yields at historic lows, per a detailed report in Business Insider.
Emanuel recommends 12 under-appreciated yet attractive energy and financial stocks that "could be expected to outperform if bond yields rise." Among those stocks are these 10: Occidental Petroleum Corp. (OXY), Capital One Financial Corp. (COF), Cimarex Energy Corp. (CEX), Principal Financial Group Inc. (PFG), Discover Financial Services (DFS), Comerica Inc. (CMA), SVB Financial Group (SIVB), Invesco Ltd. (IVZ), Lincoln National Corp. (LNC), and Prudential Financial Inc. (PRU).
Significance for Investors
"Investors' 'obsession with recession' appears to have topped as the Fed's rates cuts support inflation expectations," Emanuel wrote in a recent note to clients, as quoted by BI. As a result, despite the Fed's efforts, he expects bond yields to rise and bond prices to fall. "We expect further broad market upside to be led by the narrowing of the current valuation divergence--rotation--between cyclicals (Financials and Energy) and defensives/bond proxies (Utilities, Consumer Staples, Software)," he added.
Occidental Petroleum is trading at a forward P/E ratio slightly below the industry average, 15.56 versus 15.74, but its PEG ratio, which takes account of expected earnings growth, points to possible overvaluation, at 3.11 versus 2.11, per Zacks Equity Research. Based on these and other metrics, Zacks gives Occidental a sell rating. The stock is among the market laggards in 2019, down by 21.9% year-to-date. The consensus among analysts rates the stock a "hold," but with an average price target of $57.11, or 24.7% above the Sept. 19 close, per Yahoo Finance.
On the plus side, Occidental offers a hefty dividend yield of 7.1%. On the minus side, some investors and analysts believe that Occidental overpaid in acquiring Anadarko Petroleum, Barron's reports. Among those who disagree is Warren Buffett, who reportedly agreed to inject $10 billion into Occidental in order to facilitate the purchase.
Insurance, asset management, and retirement plan company Prudential yields 4.5%, and its stock price, based on adjusted close data, has advanced by 12.8% in 2019. “We believe in a very consistent and regular dividend that will be aligned with our earnings growth,” as Kenneth Tanji, the company's chief financial officer (CFO), told Barron’s, in a separate report. Indeed, the article notes, Prudential raised its quarterly dividend by 20% in 2018 and by an additional 11% earlier in 2019.
“It starts with the profitability of our businesses and the diversity of our businesses, [and] we are quite resilient in all kinds of environments,” Tanji told Barron's. He added that the Prudential's business units “are generating more cash flow than they need to grow,” providing funds that can be used for dividends, share repurchases, debt reduction, or acquisitions.
Emanuel's recommendation is based on some counter-intuitive notions. The first is that bond yields may rise despite the Fed's current program of cutting the federal funds rate. The second is that stocks with higher than average dividend yields, which normally appeal to income-oriented investors, can thrive as bond yields rise. Both remain to be seen.