Uncertainties abound (shifting power in D.C., timing of rate cuts, health of the U.S. economy and geopolitical tensions to name a few), but we believe that our portfolios will provide handsome rewards versus other asset classes in the years to come.
With the presidential election now in the rearview mirror and President-elect Donald Trump putting together his administration, investment markets have started to pivot in anticipation of a new regime.
Though the history books dating back more than nine decades and covering 24 presidential terms show that stocks have favored a “D” vs. an “R” in the Oval Office (the results are far less heavily skewed in favor of the Democrats if the scoreboard starts after Herbert Hoover and the Great Depression), the major market averages reside near all-time highs.
We might argue that many are likely enthused about potentially lower (or at least not higher) tax rates, while reduced regulation could boost corporate profits. And a resurgence of animal spirits should bolster deal-making activity, which has helped propel Financials to the top of the sector performance table since Election Day.
We also note that Q3 results from Corporate America were healthy, while the U.S. economy remains on solid footing. The latest estimate for Q4 real (inflation-adjusted) GDP growth from the Atlanta Fed stood at a robust 3.3%, there were 227,000 net new nonfarm payrolls created in November and even the relatively weak factory sector just showed signs of improvement with a better-than-expected reading on the ISM Manufacturing Index.
What’s more, inflation is trending in the right direction, with the most recent projection from the Federal Reserve of a further easing of interest rates next year appearing intact. New York Fed President John Williams said on Dec. 2 that while the Personal Consumption Expenditure (PCE) gauges are still above the Federal Reserve’s 2.0% target, there are reasons to be confident that they will reach that level, thanks to a slowdown in inflation rates for goods and services excluding food, energy and housing.
There are plenty of reasons to be optimistic about the prospects for equities going forward, especially as a pessimistic view of stocks would defy the historical propensity for gains, on average, in any given year. This goes double (or is it triple?) for years that end in 5, as shown in Figure 1!
However, even as the historical evidence shows that Dividend Payers and Value Stocks, like those that we have long championed, have enjoyed average annualized returns of 12.6% and 13.9%, respectively, since the launch of The Prudent Speculator in March 1977, we always are braced for downside volatility. Indeed, selloffs, downturns, pullbacks, corrections and even Bear Markets are events that equity investors have always had to endure on their way to achieving terrific long-term returns.
Given our experience of Trump 45, we expect plenty of twists and turns in policy from a Trump 47 White House. After all, the President-elect said on his Truth Social platform, “On January 20th, as one of my many first Executive Orders, I will sign all necessary documents to charge Mexico and Canada a 25% Tariff on ALL products coming into the United States, and its ridiculous Open Borders. This Tariff will remain in effect until such time as Drugs, in particular Fentanyl, and all Illegal Aliens stop this Invasion of our Country!”
Tariffs could lead to higher inflation in the U.S. and hurt profits of more than a few American manufacturing companies, but many believe the threat is likely a strong negotiating tactic à la The Art of the Deal. Certainly, it would not be a surprise to see some tariffs implemented, but Mr. Trump arguably threw fans of free trade a bone by naming Scott Bessent as his Treasury secretary. Mr. Bessent could modify his views, but back in January he said, “The tariff gun will always be loaded and on the table but rarely discharged,” while in October he added, “A lot of what he’s doing is to escalate to de-escalate.”
As it is prediction season, our best guess for 2025 is a return in the 9% range for the S&P 500 index, with much-less-expensive Value Stocks advancing 15%.
Recent sales have freed up funds to go shopping for stocks that have yet to have their day in the sun, while we maintain exposure to companies that we think will continue to garner additional market affection.
IT’S A MARKET OF STOCKS
The major market averages were up handsomely in 2024, but the average stock did not fare anywhere near as well. In fact, through December 5, the average constituent of the broad-based Russell 3000 index had a return some 14 percentage points below that of the capitalization weighted benchmark.
Some investors may find it frustrating that the rising tide has failed to lift all boats, but we think the current dynamic has made it much easier to cash in chips on dearly priced stocks and reinvest the proceeds into undervalued names. After all, the objective of most investors is to sell high and buy low, and we have long preferred to buy stocks that have (temporarily, we believe) gone on sale.
Our broadly diversified portfolios benefited this year from names like accessories designer and marketer Tapestry (TPR), power equipment maker Eaton PLC (ETN), construction and mining equipment leader Caterpillar (CAT), specialty retailer Dicks Sporting Goods (DKS), social media king Meta Platforms (META), consumer electronics giant Apple (AAPL), software titans Microsoft (MSFT) and Oracle (ORCL), and semiconductor firms Broadcom (AVGO), Lam Research (LRCX), Micron (MU) and Qualcomm (QCOM).
Believe it or not, each of these was a value-priced bargain when we first made our initial purchase in year’s past and we have been pleased that others have bid up the share prices. True, some will argue that these names have moved more toward the Growth end of the classification spectrum, but we do not mind if others come to see the attractiveness of the businesses. Indeed, just because we are buying Value stocks does not mean that we do not expect sales and profits to grow and/or valuation metrics to move up toward historical norms.
That said, we remain attentive to price multiples and we took advantage of market enthusiasm for each of these holdings in 2024 by capturing some of our profits to move back toward a more normal position size. This has freed up funds to go shopping for stocks that have yet to have their day in the sun, while maintaining exposure to companies that we think will continue to garner additional market affection, all while leaving overall valuation metrics for our portfolios decidedly in the Value camp.
The shares of more than a few prominent companies have lost altitude this year and we recently picked up ownership in or added to names we found attractive like brewer Molson Coors (TAP), package carrier United Parcel Service (UPS) and appliance manufacturer Whirlpool (WHR).
There also are lesser-known names in the mark-down aisle these days, including refiner and service station operator HF Sinclair (DINO), chemical producer Celanese (CE), semiconductor testing equipment-maker Cohu (COHU), staffing firm ManpowerGroup (MAN), oil and gas concern Civitas Resources (CIVI) and office and labratory space REIT Alexandria Real Estate Equities (ARE).
We highlight these companies to underscore our commitment to a broadly diversified approach to portfolio management. Historically, our wining stocks have won far more than our losing stocks have lost and we are proud of our long-term performance record. To be sure, that does not mean we can’t improve on our methodology. We have incorporated additional metrics, such as Free Cash Flow Yield and Enterprise Value to EBITDA, alongside traditional analytics focused on earnings, sales and book value, but the factors that have driven our home runs have also led to the occasional strikeouts.
We also are very careful to believe that political views are best expressed at the polls and not in portfolios, and staying on an even keel emotionally generally has been good for our financial health (here, here and here). We endeavor to continue with that approach throughout this Special Report. Of course, there are several themes that are impacted by our present understanding of the new regime’s goals and ambitions, and we’ll note those impacts as they come up.
At the end of the day, near-term gyrations do little to upset our long-term orientation and conviction for our Value-based investment approach. Plus, we agree with Warren Buffett, who noted several years ago that he has “yet to see a time when it made sense to make a long-term bet against America.”
A PIVOT HOME
A go-to tool during his presidency, President-elect Trump made tariffs a key part of his campaign. His post-election nominations and comments have driven home the point that he is serious about bringing manufacturing back to the U.S. Earlier this year, he toyed with the idea of implementing across-the-board tariffs on imports, including a 10% to 20% duty on Chinese goods. Trump has already reported discussions with the leaders of Mexico, Canada and other nations, with our overall feeling that headlines about tariff plans are simply a starting point in a broader effort to make American-sourced goods more attractive.
Individual companies may uniquely experience potentially harmful treatment. At an event on Sept. 23, Trump said, “As you know, [ag equipment maker John Deere (DE)] announced a few days ago that they’re going to move a lot of their manufacturing business to Mexico. I’m just notifying John Deere right now, if you do that, we’re putting a 200% tariff on everything you want to sell into the United States.” Sounds ominous, until one remembers that manufacturing stocks like DE, construction and mining equipment titan Caterpillar (CAT) and electrical power equipment maker Eaton PLC (ETN) all enjoyed market-beating returns during the prior Trump years. And, for what it is worth, DE shares have gained 9% as of this writing, outperforming the overall market, since the Trump tariff threat.
We concede that sweeping, high-rate tariffs would likely punish many of our stocks, add to inflation and cause problems for the overall American economy. Such a shock is unlikely. Instead, we suspect we’ll see a slower and more-targeted rotation home, giving companies, supply chains and consumers plenty of time to adapt to what will eventually be more expensive imports.
A shift towards U.S.-sourced goods is likely to make a big splash for many of our Small Capitalization stocks. In June, we wrote an Investment Insight on the topic and found that 76% of revenue for the small-company Russell 2000 index came from North America, while the figure was 64% for the large-company Russell 1000 index. Certainly, each company is different and warrants further investigation into supply chain and sales dynamics, but at face value, exposure to U.S.-centric companies would seem to be of particular interest going forward.
We suspect we’ll see a slower and more-targeted rotation towards the U.S., giving companies, supply chains and consumers plenty of time to adapt to what will eventually be more expensive imports.
The pivot home started with Trump’s first presidency and gained steam in Biden’s presidency. We expect momentum to continue to build, even as the challenges can be larger than initially imagined. Intel (INTC) is a good example of this. In an effort to capture development and tax incentives, the company worked to build fabrication plants in Ohio and Arizona. Construction is far behind schedule and the yields trail those of Taiwanese plants, but progress is being made.
Speaking of Intel, the company recently parted ways with turnaround-CEO Pat Gelsinger. We would not be surprised to see new management split off the fabrication (manufacturing) segment from the chip design segment, effectively freeing up Intel’s fab business to take on customers who may have previously felt that a unified Intel was direct competition.
POWER & ENERGIZE THE U.S.
A key point in Trump’s election platform was to “make America the dominant energy producer in the world, by far!“ As we wrote in our election-related Special Report (here), this policy proposal was hardly surprising given that it was a key feature of his first presidency. U.S. crude oil production has steadily marched higher in recent years and we expect that to continue. Using data from the Energy Information Administration (EIA), Trump’s first year (2017) had 9.4 million barrels per day of crude production. Production reached 12.3 million in 2019 and 12.9 million in 2023. Despite the lagging returns for Energy stocks in 2024 (large-company energy stocks gained 11% through December 6; small-company energy stocks were down 4%), we think integrated giants like Chevron (CVX) and Exxon Mobil (XOM) can benefit from more U.S. energy production, as can others throughout the chain like global producer EOG Resources (EOG) and U.S.-centric E&P outfit Devon Energy (DVN).
We also note that the push to EVs will be decades in the making and more than half of U.S. oil production is not used to power motor vehicles. Of course, we have benefited from our exposure to industrial battery maker EnerSys (ENS).
Nuclear power has the lowest carbon footprint of all electricity sources, uses the smallest section of land and needs few materials, yet the generation technology has one of the worst reputations around the world — think Chernobyl, Three Mile Island and Fukushima. We’ll see if Trump embraces nuclear power generation, but as Europe found out after the war in Ukraine started, the value of stable energy sources is high and the newest versions of nuclear could power the U.S. well into the future, even as it will be a long time before fossil fuels go the way of the dinosaur.
Microsoft (MSFT) recently announced plans to buy 20 year’s worth of power from Constellation Energy’s Unit 1 of the Three Mile Island plant to power its A.I. data centers. Pinnacle West (PNW) operates three reactors, each with 1,300 megawatts of capacity, at the Palo Verde Generating Station outside Phoenix, Arizona, so there are ways to invest in this alternative energy source.
FOND OF FINANCIALS
In March 2023, the lightning-quick collapse of two prominent institutions in Silicon Valley Bank and Signature Bank after uninsured depositors fled en masse was followed by the demise of European financial behemoth Credit Suisse and prominent California-based lender First Republic. Even though the collapses began in the Regional Bank corner of the wider Financials sector, acute worries rippled through the entire system. Fortunately, the threatened mass exodus of depositors has failed to materialize and subsequent regulatory bank stress tests came and went without issue.
The ordeal’s impact on Financial sector stocks was uneven and returns have not yet converged. The KBW Regional Banking index was flat in 2023, while the S&P 500 Financials index gained 12%. A similar story persisted in 2024, with the Regional Banking gauge gaining 24% and the Financials benchmark climbing 36%. Interestingly, a large chunk of the year’s return came after Election Day. Concerns remain about the path of interest rates, status of net interest margins, commercial real estate default potential and shrinking loan volumes, but we think there should be much more enthusiasm for healthy Regional Banks offering superb risk-reward profiles with rich dividend yields.
Though one wouldn’t necessarily guess given the drubbing in 2023, we like PNC Financial (PNC) for its history of good risk management and it boasts a broadly diversified loan book, solid capital ratios and strong credit quality. We also like Cincinnati-based Fifth Third Bancorp (FITB) and its avoidance of held-to-maturity securities plus the diversity of its fee-generating businesses that includes payments, investment banking, wealth management and mortgages. And for those looking to move up the risk/return spectrum, Bank OZK (OZK) is still suffering from worries over its commercial real estate exposure, but CEO George Gleason & Co. have long utilized partnerships with strong developers, incorporating low leverage and defensive loan structures to embed a measure of safety into its loans. Capital ratios are strong and the dividend was just increased for the 57th consecutive quarter, pushing the yield to 3.7%, yet the forward price-to-earnings ratio is just 8.
Looking at bigger banks, it’s hard not to like JPMorgan Chase (JPM), as its fortress balance sheet provides a stable keel to go along with an ability to generate profits in varied environments. A statistically deeper bargain, trading at a huge discount to tangible book value, we are liking the turnaround efforts underway at globally diverse Citigroup (C) under CEO Jane Fraser. We also think Goldman Sachs (GS) stands out with its well-known financial prowess that has helped maintain immense profitability despite weathering multiple strategic shifts in recent years.
As interest rates have pulled back, non-performing loans have remained contained and risks to M&A are likely to dampen under the new administration, we expect to see banking activity and deal-making rise again.
MAKE AMERICA HEALTHY AGAIN?
On November 27, the Financial Times ran a story titled “Inside Robert Kennedy’s fractious battle to fix America’s health.” Robert F. Kennedy Jr. is Trump’s current pick to run the country’s health department. The Health Care sector is one of two sectors that has not gained since the election, in large part due to substantial uncertainty related to the plans of Mr. Kennedy and the health department.
If there’s one thing Wall Street doesn’t like it’s uncertainty, and it’s very unclear (to us) which direction Mr. Kennedy is going to head. One path would take aim at America’s enormous pharmaceutical industry, which could be politically challenging given that those who need to confirm him are often heavily supported by pharmaceutical companies. The other avenue would be to go after the country’s food industry, attempting to either tightly regulate or impose bans on inputs like artificial dyes, harmful pesticides and other chemicals similar to other developed nations. While we do not own them at present, the potential for trouble has already impacted share prices of “big food” companies like Kellanova and WK Kellogg (previously one company, Kellogg), General Mills and Kraft Heinz which are stuck in neutral or have tumbled since the election.
In any event, it’ll be an uphill battle for RFK Jr. given the power of the lobbies he is taking on, but we expect additional clarity to result in a share price recovery for many of the stocks that have been hit in fear of more draconian initiatives.
Still, for those looking for “healthier” picks, we like Fresh Del Monte (FDP), which grows fruits and vegetables and sports a 3% yield. Tyson Foods (TSN) could see an RFK Jr.-related bump as healthier proteins are likely to be preferred through rule changes over highly processed foods, but we must concede that one of TSN’s fastest-growing segments is its prepared foods business. Hip and knee orthopedic implant king Zimmer Biomet (ZBH) could also benefit from a more active and injury-prone America.
We feel inclined to reiterate that the secret to success in investing is not simply to select good stocks, but to not get scared out of them. Indeed, we have made money over the years from our stock holding as well as our stock picking!
The Health Care side of the equation is where we think substantial opportunity awaits those with long-term time horizons and strong stomachs. We believe that Big Pharma stocks like Bristol-Myers Squibb (BMY), Merck & Co. (MRK) and Pfizer (PFE), as well as biotech giants Amgen (AMGN) and Gilead Sciences (GILD), are likely to withstand even the heaviest of government reform efforts. These companies produce and develop critical medicines and therapies for folks around the world. A web article headline indicating a wish to ban medicines in favor of green veggies will garner a tremendous number of clicks, but the reality is that such efforts have almost no chance of making it to policy.
Looking at the managed-care business, UnitedHealth’s disclosure that costs were on the rise due to an increase in pandemic-delayed surgeries among older adults as well as the tragic murder of CEO Brian Thompson has created stiff near-term headwinds. However, the industry has manged to consistently grow through thick and thin, with current disinterest in the group creating significant long-term upside potential in stocks like Elevance Health (ELV), formerly Anthem, and CVS Health (CVS), which owns Aetna, in addition to its namesake chain of pharmacies, each of which trades for significantly lower multiples of earnings than does UnitedHealth.
DRIVING US CRAZY
Outside of Tesla, investors at the Electric Vehicle party have held little to celebrate, with positioning which has generally resulted in negative returns and quite a bit of handwringing. We continue to believe that EVs offer significant benefits to most drivers, especially those in urban areas, but they are heavy and expensive. Adoption has been slow, but so too was the adoption of cars early in the 20th century when horses had been the preferred method of transportation for millennia. Of course, the transition isn’t quite as drastic, but infrastructure still lacks and Tesla head Elon Musk has been lobbying to drop the federal government’s $7,500 tax credit for hybrids and EVs (we suspect this is primarily because it would cause more pain for competitors than for Tesla).
When the cards are ultimately counted, we believe we’ll see a multi-propulsion marketplace, where a third of new cars are fully electric, a third are some type of hybrid and a third have highly efficient internal combustion engines. For manufacturers we favor like General Motors (GM) and Volkswagen (VWAPY), this means that their EV investments aren’t for naught, but they’ll have to better balance their capital expenditures to keep ICE and EV developments coming. And cars still need wheels, so we continue to ride with Goodyear Tire (GT).
Our foray into the EV space hasn’t all been awful. Lithium miner Albemarle (ALB) was a star in our portfolios between 2019 and 2022, but has struggled more recently as lithium demand finds its footing. Shares have slumped 30% in 2024, but have improved 40% from August’s low point. Longer term, we think EV and hybrid battery demand will surge through the end of the decade with data published by the International Energy Agency predicting that 350 million electric cars will be on the road by 2030, up from 26 million in 2023. For those looking for inexpensive EV exposure, we think ALB is a great choice, especially as we have seen interest from the major auto makers in entering into longer-term supply contracts and even taking ownership stakes in lithium producers.
INTELLIGENT WAYS TO PLAY A.I.
Artificial Intelligence (A.I.) has been all the rage for several years now. Though we are comfortable holding a normal position size going forward, we recently trimmed Lumentum (LITE) after shares of the optical and photonics products maker soared more than 80% year to date, while a renewed sense of enthusiasm has pushed the S&P 500 Information Technology index up nearly 40%, which is a positive for our portfolios, given our 20%+ portfolio exposure to the sector.
In many ways, we’ve found ourselves at the right place at the right time with some A.I. picks, thanks in large part to another theme for the last decade or so, cloud computing. We have long liked companies in this space like Microsoft (MSFT), Apple (AAPL), Alphabet (GOOG) and Meta Platforms (META), who are scaling up their A.I. offerings with plans to generate additional revenue. We believe smaller names like power management concern Eaton (ETN) and data center REIT Digital Realty (DLR) also stand to benefit from widespread A.I. adoption.
Chipmaking giant Intel (INTC) has been entirely left behind from the rise A.I. The company has struggled to keep up with competitors and now-dismissed CEO Pat Gelsinger did not implement enough change in his relatively short tenure to thrill the board. While we thought Mr. Gelsinger’s were generally good, it’s our estimate that the company’s board wanted grander ideas to right the ship. As we alluded to earlier in this Special Report, we would not be surprised to see Intel split off its fab business. This would not only allow Intel to focus on chipmaking, it’d free the fab business from the illusion (or perhaps reality) of competition. We wonder if Advanced Micro Devices or Nvidia stayed away from Intel’s fabrication services given that their chips compete with Intel’s chips. Indeed, it would be unpalatable for GM to manufacture cars for Tesla.
Speaking of manufacturing, we also like semiconductor capital equipment makers Lam Research (LRCX) and Kulicke & Soffa (KLIC). Both companies produce equipment that’s critical to semiconductor manufacturing, generate positive free cash flow, have strong cash flow characteristics and solid balance sheets.
With Artificial Intelligence technology still in its infancy, we think investors should continue to pay attention to valuations as we have seen heretofore can’t-miss industries littered with losses if the reality fails to live up to the hype. There is nothing wrong with taking a little money off the table, in our view, even as we continue to expect additional appreciation from our remaining holdings. There are deals to be had, even as monetization of the technology with consistency will come further down the road and there are likely to be bumps along the way, resulting in a strong preference to spread the exposure over several stocks, rather than larger stakes in one or two.
SMALL COMPANY, BIG POTENTIAL
Small capitalization stocks (defined by Russell/FTSE as the smallest 2,000 companies in the broad-market Russell 3000 index) of the Value variety outpaced their Growth counterparts by 12 percentage points in 2022, though the latter has won the performance derby over the last two years by a similar score. Though small-cap Value stocks got whacked particularly hard in the Bear Market that occurred at the beginning of the pandemic, they have outpaced Growth stocks by a wide margin (more than 40 percentage points from the low point on March 23, 2020). While some of the valuation disparity has gone away thanks to strong Value stock returns, we think significant appreciation potential still exists in this corner of the stock market.
Our all-cap Value flagship strategies include small and mid-cap names, but we also offer our asset management and wealth management clients a managed account strategy that specifically caters to Small-and-Mid-Cap Dividend (SMiD) stocks. The forward P/E ratio on the SMiD portfolio is near 13, compared with 26 for the Russell 1000 index and 20 for the reasonably priced Russell 1000 Value index.
Considering our SMiD strategy, several names we highlight for the next three-to-five years are regional bank Western Alliance (WAL), electrical component manufacturer Bel Fuse (BELFB), toy maker Hasbro (HAS), furniture maker Ethan Allen (ETD), streaming service provider Sirius XM (SIRI), insurance company Old Republic (ORI), construction machinery producer Terex (TEX), electronic manufacturing services provider Jabil (JBL) and drug-maker Organon (OGN).
CLOSING
Those that have been reading our Outlooks should not be surprised to see that our themes do not undergo massive changes between editions. After all, we are buying our undervalued stocks for their three-to-five-year or longer potential, with the intention of holding them through a business cycle or two. We think the market is offering those with long-term time horizons substantial opportunity as evidenced by the litany of names mentioned above, while most offer generous dividend payments, with that income helping investors better navigate the inevitable volatility of the share prices.
Of course, one must still construct a diversified portfolio of these stocks, so we offer the reminder that we have wealth and asset management services available. After all, we feel inclined to reiterate that the secret to success in investing is not simply to select good stocks, but to not get scared out of them. Indeed, we have made money over the years from our stock holding as well as our stock picking!
PARTNER WITH US
For more than 46 years, we have collaborated with our clients in their investment decision making process as they pursue their long-term financial goals. We are committed to keeping your goals, concerns and attitude about investing at the heart of your plan. If you’re ready to experience our personalized investment approach and exceptional client service, contact Jason R. Clark, CFA at 949.424.1013 or jclark@kovitz.com.
TPS Special Report: 2025 Stock Market Outlook
