Bonds Say Chances of U.S. Recession at 60%

Soon before each of the seven recessions since 1970, short-term interest rates on Treasuries crossed above longer-term rates (i.e., rates "inverted"). Based on where rates stand today, adjusted for the Fed's policy of near zero target rates for overnight loans, Bloomberg reports the economy has a 60% chance of recession in the next 12 months.

Currently, two-year Treasury notes are yielding about 80 basis points (0.8%) less than five-year notes, but according to Bank of America research, the adjusted rates only show two-year Treasuries yielding 20 basis points less than the five-year. An approx. 80-point difference marks the chances of recession at 15%, whereas the 20-point adjusted difference marks the chances at 60%.

"The adjusted curve is giving a powerful signal for an upcoming U.S. recession," Ruslan Bikbov, a fixed-income strategist at Bank of America, told Bloomberg. "If that happens, the Fed's target rate could remain near zero beyond 2014," he said in an interview on Oct. 3.

Worried about a recession's possible impact on your portfolio?

To help protect you from such a scenario, we looked back in time and identified a list of stocks that outperformed the market during each of the last three big market downturns over the last decade (between 10/01/2007-03/02/2009, 04/19/2010-06/28/2010, and 07/18/2011 to the present day).

For each stock we list the alpha, i.e., outperformance, relative to the S&P500 index, a benchmark for our analysis.

In addition, all of these stocks appear to be undervalued relative to Benjamin Graham's valuation equation.

And finally, all of these companies have proven themselves to be more profitable than their competitors over the trailing 12 months (TTM).

Considering their track record during market downturns, and their superior profit margins, do you think these undervalued stocks are worth a closer look?

Use this list as a starting point for your own analysis. (Click here to access free, interactive tools to analyze these ideas.)

List compiled by Eben Esterhuizen, CFA:

1. Duke Energy (NYSE: DUK  ) : Operates as an energy company in the Americas. Between 10/01/2007 and 03/02/2009: Price changed from $15.26 to $11.19, a price return of -26.67% (alpha of 28.03%). Between 04/19/2010 to 06/28/2010: Price changed from $14.81 to $15.27, a price return of 3.11% (alpha of 13.37%). Between 07/18/2011 and 09/18/2011: Price changed from $18.37 to $19.57, a price return of 6.53% (alpha of 13.38%). [Average Alpha: 18.26%]

TTM gross margin at 34.78% vs. industry average at 27.31%. TTM operating margin at 22.55% vs. industry average at 18.89%. TTM pre-tax margin at 20.7% vs. industry average at 14.44%.

Diluted TTM earnings per share at 1.54, and a MRQ book value per share value at 16.95, implies a Graham Number fair value = sqrt(22.5*1.54*16.95) = $24.23. Based on the stock's price at $20.15, this implies a potential upside of 20.27% from current levels.

2. Bank of Marin Bancorp (Nasdaq: BMRC  ) : Operates as the bank holding company for Bank of Marin that offers a range of commercial and retail banking products and services in California. Between 10/01/2007 and 03/02/2009: Price changed from $29.61 to $17.17, a price return of -42.01% (alpha of 12.69%). Between 04/19/2010 to 06/28/2010: Price changed from $32.83 to $32.34, a price return of -1.49% (alpha of 8.77%). Between 07/18/2011 and 09/18/2011: Price changed from $35.1 to $33.96, a price return of -3.25% (alpha of 3.6%). [Average Alpha: 8.35%]

TTM gross margin at 83.61% vs. industry average at 71.27%. TTM operating margin at 49.87% vs. industry average at 39.28%. TTM pre-tax margin at 34.19% vs. industry average at 22.71%.

Diluted TTM earnings per share at 2.84, and a MRQ book value per share value at 24.35, implies a Graham Number fair value = sqrt(22.5*2.84*24.35) = $39.45. Based on the stock's price at $34.15, this implies a potential upside of 15.51% from current levels.

3. TrustCo Bank Corp. (Nasdaq: TRST  ) : Operates as the holding company for Trustco Bank that provides various banking products and services to individuals, partnerships, and corporations. Between 10/01/2007 and 03/02/2009: Price changed from $9.25 to $5.08, a price return of -45.08% (alpha of 9.62%). Between 04/19/2010 to 06/28/2010: Price changed from $5.98 to $5.76, a price return of -3.68% (alpha of 6.59%). Between 07/18/2011 and 09/18/2011: Price changed from $4.75 to $4.57, a price return of -3.79% (alpha of 3.06%). [Average Alpha: 6.42%]

TTM gross margin at 71.5% vs. industry average at 61.37%. TTM operating margin at 41.85% vs. industry average at 32.96%. TTM pre-tax margin at 25.43% vs. industry average at 14.12%.

Diluted TTM earnings per share at 0.39, and a MRQ book value per share value at 3.48, implies a Graham Number fair value = sqrt(22.5*0.39*3.48) = $5.53. Based on the stock's price at $4.49, this implies a potential upside of 23.07% from current levels.

4. AT&T (NYSE: T  ) : Provides telecommunication services to consumers, businesses, and other service providers worldwide. Between 10/01/2007 and 03/02/2009: Price changed from $33.76 to $19.78, a price return of -41.41% (alpha of 13.29%). Between 04/19/2010 to 06/28/2010: Price changed from $24.5 to $23.17, a price return of -5.43% (alpha of 4.84%). Between 07/18/2011 and 09/18/2011: Price changed from $30.12 to $28.94, a price return of -3.92% (alpha of 2.93%). [Average Alpha: 7.02%]

TTM gross margin at 56.91% vs. industry average at 50.34%. TTM operating margin at 15.51% vs. industry average at 15.41%. TTM pre-tax margin at 13.85% vs. industry average at 13.7%.

Diluted TTM earnings per share at 3.44, and a MRQ book value per share value at 19.21, implies a Graham Number fair value = sqrt(22.5*3.44*19.21) = $38.56. Based on the stock's price at $28.94, this implies a potential upside of 33.24% from current levels.

5. Entergy (NYSE: ETR  ) : Operates as an integrated energy company in the United States. Between 10/01/2007 and 03/02/2009: Price changed from $94.37 to $58.63, a price return of -37.87% (alpha of 16.83%). Between 04/19/2010 to 06/28/2010: Price changed from $75.1 to $69.69, a price return of -7.2% (alpha of 3.06%). Between 07/18/2011 and 09/18/2011: Price changed from $66.28 to $65.6, a price return of -1.03% (alpha of 5.82%). [Average Alpha: 8.57%]

TTM gross margin at 31.07% vs. industry average at 27.31%. TTM operating margin at 19.54% vs. industry average at 18.89%. TTM pre-tax margin at 16.83% vs. industry average at 14.44%.

Diluted TTM earnings per share at 7.06, and a MRQ book value per share value at 48.62, implies a Graham Number fair value = sqrt(22.5*7.06*48.62) = $87.88. Based on the stock's price at $66.39, this implies a potential upside of 32.37% from current levels.

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.


Kapitall's Eben Esterhuizen and Alexander Crawford do not own any of the shares mentioned above. Profitability data sourced from Fidelity; price, BVPS, and EPS data sourced from Yahoo! Finance.

The Motley Fool owns shares of Bank of America. Motley Fool newsletter services have recommended buying shares of AT&T. 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.


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