Usually at this time of the year a fat man in a red suit makes his way down a list.
He’s figuring out who gets presents and who gets coal.
This year, Santa’s delivering coal.
Just look at what happened overnight.
The S&P 500 (largest 500 US stocks) is down 1.5%. The US tech index, the NASDAQ, was smacked down 2.2%.
Both were in response to a decision by US central bank, the US Federal Reserve. The Fed rose the US Federal Funds rate by 0.25%. The benchmark policy rate should now move to 2.25–2.5%.
Why is the rate rise bad for stocks?
Why is this bad for stocks? I’ll touch on that in a minute.
I’ve had another think about it all. And now I think differently.
Santa is not giving us coal, with the 8.3% drop in the All Ordinaries this year.
We’re all getting gifts.
Santa has set us all up for a wonderful 2019. Or at least, next year has the potential to be wonderful.
That’s because we’re going to kick the new year off with much lower prices.
Today, I want to show you where to potentially find bargains.
That way, you can get the most out of Santa’s gift.
Trade slowdown being felt already
We got it done just in time.
Today we published a video that touches on key points in this article. You can go watch that video here. Alternatively, you can continue reading…
What a year. The 500 largest Aussie stocks (the All Ordinaries) are down 8% this year and 13% off their 52-week high.
Here are a couple of the winners and losers for the year:
Source: the Bloomberg
Some of these stocks deserve to be down. They have eroding businesses. Some had terrible prospects to begin with.
But others are down for no reason at all. Investors just don’t like the state of the world. And because of that they don’t want to hold stocks.
You’ll remember there were two ongoing events this year that pushed stocks lower.
The first is US interest rates. The second is the US-China trade tensions.
Towards the start of the year everyone was optimistic. We thought 2018 was going to be more of the same. We had just come off the back of two good years for stock investors.
But that optimism quickly turned to mixed emotions when the US central bank, the US Federal Reserve, continued to increase interest rates.
Higher interest rates make stocks less desirable.
With higher interest rates come higher discount rates that analysts plug into their excel models. And with higher discount assumptions, these models spit out lower than expected stock prices.
Higher interest rates also put upwards pressure on bond yields. The yield of a bond is the return you’d expect to receive holding it until maturity.
Because investors are generally risk adverse and want an additional return to compensate for risk, stocks usually have higher expected returns than bond yields.
And so with bond yields on the rise, stocks needed to up their expected returns fast.
The easiest way to do that is for prices to drop, suddenly. And that’s exactly what they did in February.
The first graph is the All Ordinaries. The second is the yield on a US 10-year government bond.
Source: the Bloomberg
Global growth is in question
Now as we head into 2019, global growth is in question.
The US-China trade war is doing nothing to downplay fears. We’ve had tariffs for just a few months. And already businesses are feeling the effects.
One of those businesses is US delivery service, FedEx Corporation [NYSE:FDX]. The US courier dropped 6% overnight as they told investors earnings would be lower.
‘Global trade has slowed in recent months and leading indicators point to ongoing deceleration in global trade near-term,’ FedEx CFO Alan Graf Jr said.
FedEx also said they won’t meet their target for operating profit either…
‘While the U.S. economy remains solid, our international business weakened during the quarter, especially in Europe. We are taking action to mitigate the impact of this trend through new cost-reduction initiatives.’
And this trouble in Europe is what could be the next source of problems as we head into 2019.
The pollies in the UK are prepared.
They’ve got less than 100 days to go until they leave the European Union. Yet parliament still doesn’t agree on an exit plan.
It’s why they’ve got 3,500 troops on standby. If riots kick off like they have throughout Europe, these troops are ready to subdue civilians.
It’s not just the UK with problems though. France, Italy, Brussels, even Germany. They’ve all got problems.
The latter is not only scared about global trade (something the Germans depend on). They’re also worried of a world where the European Central Bank turns off the easy money machine.
From the Australian Financial Review:
‘Uncertainty over the economy is growing just as the European Central Bank last week confirmed it will end its €2.6 billion stimulus program conducted through bond purchases.
‘The ECB says the economy is strong enough to halt the stimulus, but is keeping other support measures such as record low interest rates in place.
‘The ECB has indicated rates will not rise before fall 2019, and has indicated it could delay any first hikes in case of unexpected economic trouble.’
And as we roll into 2019, I believe a potential breakup of the EU will push stocks every which way. Much like US interest rates and US-China trade did during this year.
Again, these are all gifts — from Santa to you.
With lower stocks prices, potential returns go way up. Stocks that weren’t clear buys before are now worth considering.
But where should you look specifically?
Where should you look for these mispriced opportunities?
Some stocks are just so disgusting that most investors don’t want to touch them. These are the stocks you want to be looking at.
There are hundreds of thousands of analysts looking at Amazon.com, Inc [NASDAQ:AMZN], Apple Inc [NASDAQ:AAPL] and Alphabet Inc [NASDAQ:GOOG].
What makes you think you know something they don’t?
But there might not be any analysts looking at a $50 million company in an industry no one wants to touch. And this is where your advantage lies — in the small, ugly, unknown part of the market.
With a bit of reading, you’ll probably find a few bargains.
They might not be the next Amazon or Apple. But a lot of these stocks are mispriced. And it’s because no one is looking at them.
So, where are these stocks today?
I’d suggest you look at small service companies that depend on trade. Global trade is something everyone hates right now.
If things get worse for global trade then businesses like FedEx will likely dip further into the red. But it will also drag down the ugly, small logistics companies that dominates their local market.
And if that’s the case, then it’s probably worth finding out how much that small, ugly stock is worth.
What I’m trying to say is that these are all temporary events in the long run. And you know what else is temporary?
That tiny, ugly logistics stock and its beaten down price.
So start digging and set yourself up for 2019.
Editor, Money Morning
PS: In this just released report, Matt Hibbard shows you his top five dividend picks for 2019. Click here to claim your copy today.