European Stocks
European stocks and US stocks typically move with a fairly high correlation but they’ve diverged quite a bit over the past 3 years as both the euro currency and British pound have depreciated significantly against the US dollar. I’m thinking we’ll likely see this gap close over the next year so I started building positions in the Euro Stoxx 50 ETF (FEZ) and iShares UK ETF (EWU) over the past 2 weeks. We’ve had virtually no exposure to European stocks over the last 2 years as I’ve been bearish on the euro currency and Eurozone economies (I remain bearish over the long term) but short- to intermediate term pressures are likely to create an outperformance of European equities over US in the next 6-12 months.
S&P 500 (black) vs iShares UK (EWU) – 20 years
International investments are as much of a play on currency changes as it is the underlying asset class. My view is that we’re at peak bullish rhetoric for the US dollar and bearish for the euro and pound, and so we’ll likely see both currencies gain ground on the dollar over the short term. The Fed has done little but talk for two years now, trying to influence the markets with forward guidance rather than taking action, and it was more of the same this past meeting. My guess is that we see either 0 or 1 rate increases in 2017, not the 3 they’re currently projecting, which should lead to a lower dollar and rates over the course of the year. Additionally, with the massive drop of the pound after Brexit, the UK is seeing much higher rates of inflation and economic growth. The pound is now looking like the cheapest developed market currency and the Bank of England will be facing pressure to raise rates so it’s time to start wading in.
Church & Dwight (CHD)
Church & Dwight has been a core holding for as long as my clients have been with me. The company is the epitome of consistency, generating double-digit growth and tons of free cash flow. They sell consumer brands like Arm & Hammer and OxiClean. I trimmed the position a good amount earlier this year as the stock traded up to a pricey valuation but a pullback of more than 15% is now allowing me to start buying it back. I boosted the position by 50% this week and would love to add another leg if the stock falls a further 8%-10%.
CHD – 5 years, weekly
Red Hat (RHT)
Red Hat was a new addition this year and I doubled down on the stock this week. The stock was hit last week following what was interpreted as a bad earnings release on top of the CFO leaving to become the CEO at another company. I disagree with the market. The CEO made it clear on the call that 2 large government deals that were supposed to close in the quarter were delayed, likely due to uncertainty over budgets with the presidential election, and will most likely close this quarter. With those billings, Red Hat would have posted the same high-teens growth rate that we’ve seen the last couple of years. Red Hat is the dominant player in Linux based open source software and is benefitting from the transition of everything online to the cloud. I think they have years of growth ahead. At less than 20x free cash flow with a $1 billion buyback in place I’d love to buy more if the stock continues lower. The chart makes me cautious in the short term but I’ll look to add more near the lower end of the 2-year channel.
RHT – 5 years, weekly
That’s it for this year. Thanks for following and Happy New Year to everyone!
-Nick