The “Tom Brady” Of Stock Markets

If you have watched any American sports on television, you will have heard these familiar adages about the importance of a solid defense:

“The best offense is a good defense.”

And…

“Offense sells tickets, but defense wins championships.”

I can tell you that these aren’t just catchy things for sportscasters to say. This advice also applies to the stock market.

Now more than ever…

The Case For Strengthening Up Your Defense Is A Strong One

While I am not sounding the alarm on a market crash anytime soon, you need to be aware that we are currently enjoying both the second longest economic expansion and stock market run in American history. And on August 22nd, the bull market is poised to become the longest in history.

No doubt the good times have been rolling for a long time, but all great markets must come to an end, which is why I want you to be prepared.

To stick with my original sports theme, let me put it another way. The New England Patriots’ Tom Brady is still an incredible quarterback, but I don’t think it would be crazy of me to suggest that at age 41 the vast majority of his good years are behind him.

The stock market of today is very much like handsome Tom. Things are still going great and don’t appear to be slowing down, but the reality is that the end to this great run is likely coming sooner rather than later.

That is OK for us as investors. We do not need to panic.

However, we do need to make sure that our portfolios are prepared to play defense for what is coming.

Now The Good News — Defensive Stocks Have Rarely Been More Attractively Priced

While the S&P 500 is still trading near its all-time highs, the gains in recent months have been concentrated in shockingly few large, popular and expensive stocks.

You know the companies that I’m talking about. Amazon, Apple, Microsoft and Netflix alone combined for 84 percent of the S&P 500’s gain in the first half of the year.[1]

Not to be a pessimist again, but this is typical of what we usually see late in the cycle. Momentum driven buyers of stocks keep pushing the most popular names higher while the rest of the market runs out of gas.

Today, as an investor you shouldn’t want any part of those high-flying offensive stocks.

Fortunately, there has never been a better time to get defensive — defensive stocks that is!

Defensive, boring businesses that churn out low growth but extremely reliable cash flows are currently incredibly attractively priced relative to the rest of the market.

In particular, consumer staples (the ultimate defensive sector) are now at an all-time low as a percent of total market capitalization. As a group, these companies have never been so out of favor.

Consumer staples are non-cyclical stocks. They are considered defensive because they outperform during stock market corrections and recessions because their businesses continue to perform.

Examples of a consumer staple company would be makers of things like cereal, milk or diapers. These are the essentials that are purchased no matter what the economy is doing.

When the market inevitably cracks, investors who have stashed billions and billions of dollars into the currently popular momentum stocks are going to sell those and buy defensive stocks like consumer staples.

As JP Morgan shows in the graph below, the relative strength of consumer staples hasn’t been this low since March 2000. In fact, while it isn’t shown in this particular graph, the sector hasn’t been this relatively cheap since the all-time low hit in November of 1980.

chart

Not surprisingly, both March 2000 and November 1980 were great times to be buying consumer staples.

I would suggest that today is a great buying opportunity in consumer staples as well.

One of those dirt-cheap, cash gushing consumer staples is McKesson Corporation (MCK). This is exactly the kind of business that investors rush into when bull markets end.

McKesson is the largest and oldest healthcare company in the United States. McKesson’s core business is providing distribution services between manufacturers of healthcare products, doctors, pharmacists and patients. The company serves more than 50 percent of the hospitals in the country, delivering one-third of all medications used daily in North America.

I can hear you falling asleep!  But remember, boring is good today!

McKesson’s stock has been cut in half as the exciting big tech names have roared higher.

Today, this company is cheap. In each of the past two years, McKesson generated $4 billion in free cash flow. Against a market capitalization of $25 million, that means it is generating a free cash flow yield of 16 percent (free cash flow divided by market cap).

For a different perspective, consider that the company could use its free cash flow to repurchase 100 percent of its outstanding shares in six years at the current share price.

Those are the kinds of defensive numbers around which an investing championship is built!

Here’s to looking through the windshield,

Zach Scheidt

Jody Chudley
Financial Analyst, The Daily Edge

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