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Buy the Dip - 3 Reasons and 3 Stocks

Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The consensus believes that brown shoots are here and the economic train will derail for the third summer in a row.  The S&P 500 dropped 8% during the month of May in 2010.  In 2011, the month of May was the start of a near 20% correction in domestic equity markets.  And here we are again; the market is rolling over on softer U.S. economic data and European fears.  I think much of this hype is overdone and that whether the pullback in the S&P 500 is 5% or 15%, buying the dip makes sense.  There is clearly a distortion in the seasonal adjustments of many of the often followed data points.  The Great Recession and its occurrence in the calendar is clearly skewing the data to be better in the fall/winter and worse in the spring.  Throw in the warmest weather in a century, and you have a recipe for even more distortion. I wrote back in March that investors should put new purchases on hold.  Since then, the S&P 500 has fallen 4.5%. I don’t know where the ultimate bottom will be, but I don’t think it pierces 10%.  I will highlight three key macro reasons to expect a market correction to be temporary along with three stocks to add during this pullback.

Consumer Credit- The Best in Ten Years

The piece I penned earlier on revolving credit just showed a giant reversal in March.  How big of a reversal?  Well, total credit expansion of $21 billion was the largest in over ten years!  And revolving credit played a major part by surging 7.8% at an annual rate.  This is the kind of data that leads to green shoots on retail sales, confidence, and ultimately the stock market in the coming months. 

<img src="/media/images/user_36/ddpchart_large.png" />

 

Wyndham Worldwide (NYSE: WYN), which I have highlighted before, continues to make sense.  The company reported a beat on first quarter results thanks to higher than expected sales in their Vacation Ownership division.  Favorable credit dynamics in the economy should continue to boost segment sales. 

Wyndham Worldwide is the largest operator of timeshares and hotels.  Annual sales exceed $4 billion and EBITDA exceeds $1 billion.  The company has the number one position in each of its three divisions: the Vacation Ownership division accounts for 50% of EBITDA; the Exchange and Rental division, led by the RCI brand, accounts for 30% of EBITDA; and the Hotels division, led by Day’s Inn, Ramada, and Super 8, account for the remaining 20% of EBITDA and is based on the franchise model.

The company has historically gotten a knock for not being in the emerging markets of the world, but with 70% of sales derived from the U.S., it should be more of a blessing.  Limited exposure to Europe is helpful as is a lack of too much reliance on China and other Asian countries.  Take Wynn Resorts (NASDAQ: WYNN), which gets nearly 80% of its operating income from China, whose shares are down about 12% this month.  The company reported weakness in both Las Vegas and China. Macau property EBITDA was only up 6% compared to the 1Q 2011, in part due to lower gambling revenues from high-stakes players.  This is likely due to the high correlation of the Chinese housing market and the growth in total dollars wagered in the Macau region.  Wyndham Worldwide looks like a more immediate winner as a result of rising U.S. revolving credit.

Small Business Sales Best in Five Years

A key piece in the Index of Small Business Optimism, which rose 2 points in April to 94.5, is this excerpt….

"The net percent of all owners (seasonally adjusted) reporting higher

nominal sales over the past three months gained another 3 points to 4

percent, this after a surprising 8 point gain in March. This is the best

reading since April 2007 and equal to the average 4 percent reading in

2006.”

<img src="/media/images/user_36/nfib-sales_large.PNG" />


Here I would look to Cisco Systems (NASDAQ:CSCO), which I recently detailed.  As small business owners become more certain in their sales outlook, they will continue to turn to technology investments.  Also, the latest dip in productivity further supplants the notion that companies have cut labor to the bone and that technology investment dollars are necessary to drive productivity gains and earnings growth in the coming quarters.

Sell in May, Except During Presidential Election Years

 There really are so many different seasonal patterns that investors need to be aware that one exists to fit any investment argument.  Still, the historical seasonal pattern during the Presidential election year is quite remarkable.  The S&P 500 has only gone down double digits once (2008) during Presidential election years since 1940.  In contrast, it has produced double-digit total returns on SEVEN occasions!   And notice the chart from Bianco Research for the “sell in May” theory during election years. It doesn’t hold water and the summer is a boon to risk assets.

<img src="/media/images/user_36/seasonal-chart_large.PNG" />


Investors may want to consider Perrigo (NYSE: PRGO), which is suffering today after weak fiscal third quarter results.  Perrigo is the world’s largest store brand manufacturer of OTC pharmaceutical products and infant formulas.  They were a victim of the warm weather and reduced usage of cold medicines and lower flu incidents.  They lowered full-year sales guidance to 15%-18% from 17%-20%.  Still, Perrigo is a great story and investors have the chance to add to a best of breed with strong secular tail-winds.

Perrigo is the world’s largest store brand manufacturer of OTC pharmaceutical products and infant formulas.  The wind in their sail is the secular bull market in prescription usage combined with increasing market penetration of generic drugs.  On a manufacturing basis, with over $40 billion tablets produced annually, they are one of the ten largest drug companies in the world.  They consistently have more ANDA’s (Abbreviated New Drug Application) than any other drug company and stand poised to quickly become the market leader once a drug switches from Rx to OTC.  There are plenty of new drugs going generic in coming years to continue to bolster sales to the tune of 15%-20% for the better part of this decade.

Bottom line

The S&P 500, while showing weakness of late, will likely set a new high later in the year.  The spring brown shoots will vanish, similar to last couple of years, and investors should buy the dip.  Other trends in key economic data such as revolving consumer credit, small business sales, and favorable seasonal factors all point to the market hitting new highs later in the year.  Investors should focus on equity assets that can survive and thrive amid weak European growth and avoid those that are an all-in bet on Chinese growth.


 



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