The market sold off sharply on Monday morning in reaction to fears over the Cyprus bailout situation, but was able to significantly pare losses before the end of the trading session. While some experts believe the concerns are overdone, others point out that widespread financial problems often start with tiny fissures. The broad market has been in the midst of a strong uptrend lately, helped in part by blind, unwavering support from the Federal Reserve. The dip may simply be a case of the market taking a much-needed breather, but given the run-up, a reversal would not be a huge surprise. Against this backdrop, Cisco Systems (CSCO -0.25%) may be the perfect stock to help insulate your portfolio from either possibility.
Global finance, or is it politics?
On Tuesday, the broad market slipped further as continuing concerns linger surrounding the potential bailout of the tiny nation of Cyprus. The country's banks remained close until Thursday while the government considers whether it will buckle to the demands of lenders to raid depositors' accounts to pay for defaulted debts. The threat has affected the entire European Union as it represents a dangerous precedent should such a move be approved.
While the news has caused some immediate-term consternation among investors, it should, in fact, prove to be of some ancillary benefit. Renewed fears over the debt situation in the eurozone mean that the U.S. dollar has strengthened and taken some pressure off the Fed. As Pimco CEO and Co-CIO Mohammed El-Erian recently explained: "The Fed is really engaged. The Fed cannot afford to see asset prices go down, and the economy is healing. But there will come a time when we have to make that transition from assisted growth to genuine growth and there's a big question as to when and how we're going to do that."
The extended period of artificially low rates and runaway bond buying has led to an expansion of the Fed's balance sheet by roughly $3 trillion. A strong dollar will help to keep inflation in check as U.S. imports, especially of energy commodities, will then account for a smaller percentage of the gross domestic product (GDP). The Fed has set up a situation where it must defend assets, and the only thing making that possible is low inflation.
Should the situation in Cyprus spread, however, the effects of such a contagion could put dramatic pressure on stocks. Recessionary pressures will be hard to keep in check as rates are already about as low as possible. At the current level of quantitative easing, the Fed is, to some extent, out of ammunition.
Why Cisco?
Over the past few quarters, there has been much debate over whether Cisco can still be properly be qualified as a growth stock. A central issue of this debate is the fact that the company has begun to pay an increasingly attractive dividend. The stock currently carries a dividend yield of 2.6%, despite the fact that the P/E has remained very attractive around 12. Still, the consensus analyst forecast is for earnings growth above 8% for the next five years -- not quite the growth of a highflier but certainly an attractive option.
On the cash front, Cisco is one of the most cash-rich companies on the street. The recent lawsuit between Apple (AAPL -2.00%) and hedge fund manager David Einhorn not only made Cupertino's hoarding of $137 billion front-page news, but it called attention to the cash situation that exists at many companies. While Einhorn was ultimately successful in his suit, it has not yet pushed Apple to begin dispersing cash. To put this in context, Moody's says that the top five technology companies, including Apple and Cisco, account for 24% of non-financial cash balances -- this is within the tech sector that itself accounts for 38%.
Cisco CEO John Chambers specifically said that his company's treatment of its large overseas cash balances would be dictated by U.S. tax policy, meaning that Cisco would not repatriate this money as long as the tax burden was so immense. In the longer run, however, this should allow the company to remain better globally diversified, which will be of particular importance if the stock market continues to reverse.
As Cisco continues to innovate -- it recently released a new router that has full application delivery ability -- its growth potential may be diminished, but it is not gone. The company pays a very respectable dividend and is sitting on a mountain of cash. These three attributes combine to make this a strong play in most market conditions, and a particularly nice one if the market reverses. The value angle will offer some protection in a market downturn, and the underlying growth potential should help the company to continue to deliver the solid results we have come to expect. Cisco looks very well positioned here and belongs in your portfolio.
