The list below contains Signalee’s list of companies on the S&P 100 that I believe are trading at a reasonable value and are currently showing positive momentum. We use this list as a starting point for our covered call strategy for income.
The 21 names that make the cut this quarter have a heavy concentration in financials. Intuitively this makes sense as the economy is strong but there is uncertainty surrounding the future rate environment and the longevity of the current economic expansion. As a reminder: the steeper the yield curve the fatter a bank’s profits. The reason behind this is because a bank will take their short-term deposits and make long-term loans. When the yield curve flattens out it causes two things to happen:
- The spread between the cost of the short-term deposits and interest earned from the long-term loans narrows, which squeezes profit margins; and
- The yield curve is used by a lot of investors as an indicator of the strength of the economy. When the yield curve flattens it indicates expected economic weakness ahead. If the economy does weaken then loan growth slows and bad loans tick up, both of which impact the profitability of a bank and ultimately the short-term value of the stock.
The question investors are now asking themselves is how deep a recession will we face and what unknown risks are currently hiding on a bank’s balance sheet this time around.
The rest of the names on the list are on there due to the normal concerns about slowing growth and encroaching competition. Whether it’s the saturation of the cellphone, cable, and internet service markets (AT&T and Comcast), Amazon cutting into UPS’s market share, or what new drugs will replace existing drugs going off patent (Celgene and Allergan), these are all just run of the mill issues that companies periodically face. Whether the companies on the above list stay on the S&P 100 or fall off depends entirely on how their management team responds to the threats they’re currently facing.
Given the significant structural advantages the largest players enjoy, history has taught us to bet on them staying on the S&P 100 list a while longer.