Every investor knows that government and the financial markets go hand in hand, for better or for worse. Washington, D.C. and Wall Street are often at odds with one another, although they do sometimes agree, and the stock market reflects that. Investors are happy when both Washington and Wall Street are happy.
Just take a look at what happened in early April, when the Federal Reserve released minutes from its March meeting that reaffirmed their dedication to future quantitative easing (stimulus) measures. In previous weeks, various Fed governors had hinted at pulling back QE if the economy showed further signs of improvement, and investors took a risk-off, cautious tone. But with the surprisingly "dovish" (leaning toward low interest rates) tone of these March minutes, the market took this reassurance and translated it into a substantial market rally.
For long-term investors, opportunities could arise in the months ahead to buy blue-chip stocks that might dip temporarily if the financial markets overreact again to events transpiring in Washington, DC on matters that have a huge economic impact such as the debt ceiling and budget debates coming up here in the second quarter.
While the full effects of the "fiscal cliff" (a series of $530 billion in tax increases and budget cuts at the federal level) in January have yet to be fully felt, there are more contentious issues on the way. Coming up soon is the federal budget debate and another debt ceiling crisis in May. If those are not settled in a manner viewed favorably by investors, the U.S. credit rating could take another hit and investors might be more motivated to take profits in stocks that have been on an incredible rally through the first quarter.
However, there may be some very interesting opportunities in the near term if a small correction or pullback occurs. Based on the performance of stocks before and after the fiscal cliff settlement, those with strong global consumer franchises such Coca-Cola (NYSE: KO), McDonald's (NYSE: MCD), Teva Pharmaceuticals (NYSE: TEV), and JP Morgan (NYSE: JPM) could fall again due to the gridlock in the nation's capital. However, each has proven that it can also rise after the issue has been resolved as the poor performance of the leadership in Washington, D.C. does not diminish the long-term appeal of these companies as investments.
As the charts below show, McDonald's, Coca-Cola, Teva Pharmaceuticals, and JP Morgan all fell before the fiscal cliff was to be crossed. From there, Wal-Mart, Coca-Cola, McDonald's and other stocks rallied as the Dow Jones Industrial Average rose by 308 points in trading after the fiscal cliff agreement was reached.
In this first chart, both McDonald's and Coca-Cola, declined as the fiscal cliff approaches. After an agreement was reached in late December, both rallied through the first quarter and outpaced the broad market averages. We would expect a similar scenario to play out after a potential April/May decline.
McDonalds (MCD, Red & Green) & Coca-Cola (KO, Black and White): Chart Courtesy of MetaStock Professional
For Teva Pharmaceuticals and JP Morgan, the chart below tells the same story for market action in late 2012 and early 2013. Both JPM and TEVA pulled back a little earlier than we might have expected as safe-haven sectors drove the rally late in the first quarter of 2013. However, we see this as a signal that the stocks and the sectors they belong to are already becoming oversold prior to a new post-May rally, which should put the odds a little further in their favor for above-average returns.
JPMorgan Chase (JPM, Red & Green) & Teva Pharm (TEVA, Black & White): Chart Courtesy of MetaStock Professional
The primary reason that each of these stocks plunged is the main factor for McDonald's, Coca-Cola, JP Morgan, and Teva Pharmaceuticals being such a compelling long-term buy. All of them sell to consumers around the world. If a recession or short correction hits, there will likely be a decline in revenues. But all rebounded as these companies are industry leaders with a global franchise that is protected by a broad "economic moat." Economic moats include factors such as brand name, advanced technology or regulatory standards that protect the business operations from competition:
*Coca-Cola is one of the most famous brands in the world. Its products are sold in every country except for North Korea and Cuba. Coca-Cola is the largest global beverage company that has been in business since 1886, and now sells more than 500 product brands in over 200 countries.
About the economic moat of Coca-Cola, legendary investor Warren Buffett once observed that, "If you gave me $100 billion and said, ‘Take away the soft-drink leadership of Coca-Cola in the world,' I'd give it back to you and say it can't be done."
*Widely considered to be one of the best managed banks, JPMorgan Chase (NYSE: JPM) is also the largest in the United States with over $2 trillion in assets. The robust consumer banking of JPMorgan in mortgage activities and credit card operations around the world creates a very wide economic moat. Overall, JPMorgan has operations in more than 60 countries.
*The golden arches of McDonald's announce its presence to consumers in about 120 nations. While the basic menu of McDonald's is the same, it has been adapted for different tastes in different countries. In restaurants in Asia, for example, McDonald's sells a Samuri Pork Burger and McRice, among other items crafted to please the indigenous palette. No matter which item is served by McDonald's in whatever country, the quality of the product is an important consideration and a huge part of its economic moat.
So critical is quality to the McDonald's brand that it created Hamburger University where managers could matriculate to study the golden arches way of doing business. Founded in 1961, more than 80,000 McDonald's managers have graduated from Hamburger U over the past half-century.
*Teva Pharmaceuticals is the largest generic drug company in the world. Based in Israel, Teva has a global presence that has contributed to very strong sales and earnings-per-share growth over the last five years, easily topping those for Merck (NYSE: MRK), Eli Lilly (NYSE: LLY), AstraZenaca (NYSE: AZN) and Bristol Myers Squibb (NYSE: BMY). This should continue as Teva Pharmaceuticals has an economic moat featuring 27 pharmaceutical products in late-stage development.
As the table below shows, McDonald's, Coca-Cola, JP Morgan, and Teva Pharmaceuticals are all more profitable then industry peers, with strong profit growth rates.
In addition to being more profitable, these companies also have a strong dividend framework. As legendary investor Jack Bogle, founder of the Vanguard group of mutual funds and creator of the first index fund, notes in his book, Enough, more than 40% of the historic total return of a stock has emanated from the dividend income component. For long-term investors, the dividend growth rate is important, as the income paid from these companies has a history of rising over time.
No matter what happens in Washington, D.C., global demographics are bullish for McDonald's, Coca-Cola, Teva Pharmaceuticals, and JP Morgan. According to studies by global consulting firm McKinsey & Co., by 2025 the world's consumer class is expected to expand to four billion, up from one billion in 1990. Consumer spending in emerging market nations is projected to reach $30 trillion by 2025, half the world's total. The market share for generic drugs is expected to increase by half by 2015, with 80% of the spending for pharmaceuticals in emerging market going for the cheaper, but just as effective, alternative to brand-name meds.
No matter how the financial markets respond to the actions (or inactions) of Congress and the White House, the long-term outlook for McDonald's, JP Morgan, Coca-Cola, and Teva Pharmaceuticals is too bullish for investors to ignore, particularly at a time when shares sell at a discount due to a short-term overreaction to political follies. In summary, we are not suggesting that these stocks or firms like them are necessarily a good buy now. Instead, we would look for last year's pattern to emerge again when stocks sell off prior to the upcoming May debt ceiling and budget debates. Buying at the dips could turn into the kinds of profits we saw this year and a great entry point for a longer term hold.
Even in this uncertain investing landscape, you can count on Washington politicians to wait until the very last minute to come to any kind of agreement on the upcoming debt ceiling debate. This will afford stocks plenty of time to falter before a deal is reached, giving us a natural entry point into discounted stocks that might have otherwise been out of the question for investors. Keep a look out for a dip in the prices of industry giants such as McDonald's, JP Morgan, Coca-Cola and Teva Pharmaceuticals, as a lack of effective leadership in Washington, D.C. could mean big profits for you when the bullish headline finally comes.
Have a great day trading.
Editor, SlingShot Trader