Picks and Pans for the Pullback

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

The U.S. stock market is down around 6%, Treasuries are getting crushed, bond funds are down, and gold is down. Nearly every asset class has fallen on hard times after the Fed’s latest outline for the diminished path of QE going forward. Is now the time to panic? The likely answer is no and at this time there is no indication that the cyclical bull market has ended.

Did you know that the Dow Jones industrial average recently experienced 113 consecutive trading days without three straight down days? The streak ended on June 12. And did you know that this was the longest streak of all time? It was 20 days longer than the previous record that took place way back in 1935. The Dow would advance 31% in the ensuing year after its then-record run. It might be worth noting that 1935 was six years after the official start of the Great Depression. And ironically, it is now exactly six years since the start (December 2007) of the worst recession since the Great Depression.

Investors should not fear the current market happenings and instead maintain an overweight allocation to the equity space. Despite this, there will likely be continued declines in correlation of stocks as we progress into a rising interest-rate environment. This means it won’t just be about risk-on or risk-off, but that certain stocks will see substantially different return profiles due to divergent fundamentals and valuations. Interest-rate sensitive stocks still face viable headwinds, but some companies with strong competitive positions offer good entry points for long-term investors.

Interest-rate sensitive

The 10-year Treasury has exploded from 1.6% to more than 2.5% in less than two months. This is a massive move in a short period of time. The ramifications of this reach everywhere. Mortgage rates move higher, bond funds loss money, the U.S. dollar surges, foreign earnings are worth less, dividend yielding stocks are less compelling at the margin, and on and on. I highlighted potential landmines for a rising rate outcome recently and the thesis has played out.

Kinder Morgan (NYSE: KMI) has dropped more than 12%, twice that of the S&P 500, and the company still faces the same risks. Investors should continue to avoid this name and the MLP sector unless they have strong conviction that rates will stop rising. The S&P 500 utilities index has declined by 8% and REITs have collapsed 16% in the last month. It still remains too early to bottom fish in these sectors. A continuation in the 10-year toward and above 3% would lead to persistent under-performance from interest-rate sensitive names.

Biggest winners & biggest losers

In almost every market correction, the year’s biggest winners become the biggest losers during the pullback. This can happen for a couple reasons. First, the valuation has likely gotten a bit expensive and there is a fundamental case to be made for selling and taking profits. Second, when investors seek to reduce risk, they will usually do so by selling their winners first. This creates a bit of an opportunity for patient, long-term investors although they may have to encounter notable near-term pain if the selling continues.

One such example of this is Biogen Idec (NASDAQ: BIIB). Biogen previously had a market capitalization in excess of $50 billion after building the leading drug portfolio to fight multiple sclerosis (MS). It recently received FDA approval for a new oral version in its MS drug family that is expected to quickly grab market share. The company has seen positive results from hemophilia drugs that are helping shape a more diversified pipeline with still leading growth.

The stock’s price-to-earnings ratio has compressed 15%, but still sits at an elevated 31x. This is somewhat offset by fairly visible EPS growth that is expected to exceed 20% for at least the next two years. There may be an opportunity here for investors to add a growth name that likely has more earnings visibility than others that are more leveraged to Chinese GDP or global growth.

Another such name is BlackRock (NYSE: BLK), which also happened to be one of Barron’s 10 picks for 2013. The stock at one point was up more than 40% year-to-date before giving back 15% during the recent market fall. The company is the largest asset manager in the world by a wide margin with almost $4 trillion in assets. It has great diversity in products and most are of the ETF variety, which continues to gain acceptance over actively managed mutual funds.

I would give the firm wide-moat status as it has numerous ETFs with exceptional liquidity. Investors and traders demand this liquidity and thus they continue to seek out BlackRock's funds. Operating income advanced 12% in the first quarter compared to a year earlier. Long-term investors should favor these types of stocks during pullbacks.

The Foolish bottom line

There is limited evidence suggesting that the cyclical bull market in equities has ended. Long-term investors should continue to position their portfolios toward stocks with competitive advantages and sustainable growth that can be achieved regardless of the direction of interest rates. Investments that have relied on plummeting interest rates are vulnerable right now and best avoided for the time being.

It's easy to forget the necessity of midstream operators that seamlessly transport oil and gas throughout the United States. Kinder Morgan is one of these operators, and one that investors should commit to memory due to its sheer size – it's the fourth largest energy company in the U.S. – not to mention its enormous potential for profits. In The Motley Fool's premium research report on Kinder Morgan, we break down the company's growing opportunity – as well as the risks to watch out for – in order to uncover whether it's a buy or a sell. To determine whether this dividend giant is right for your portfolio, simply click here now to claim your copy of this invaluable investor's resource.

Justin Carley has no position in any stocks mentioned. The Motley Fool recommends BlackRock and Kinder Morgan. The Motley Fool owns shares of Kinder Morgan. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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