Why I added Amgen and Celgene to my portfolio

Over the month of January, the S&P 500 Index (SPX) dropped by 3.46%. In my opinion, the market correction was caused by the concern about the viability of the global economic recovery following the market sell-off in emerging markets.

Argentina has been hit particularly hard. The government has devalued the peso by 15% against the dollar to slow down a decline in foreign currency reserves and close a gap with the burgeoning black market for dollars. That’s the peso’s lowest level since 2002.

The significant depreciation of Argentinian peso was partly matched by the 8% decline of the Turkish lira versus the dollar compared to the previous month. To defend the currency, the Turkish Central Bank dramatically increased interest rates.

The turmoil in these markets was particularly aggravated by the Fed’s decision of tapering quantitative easing by another $10 billion, hence, reducing the monthly asset purchases to $65 billion.

Fed’s decision of cutting the pace of monetary stimulus for a second time was taken on the back of a steadily improving US economy. U.S. gross domestic product expanded 3.2% in the last quarter of 2013, in line with economists’ estimates. Despite stagnating incomes, consumer spending increased more than forecast indicating that the economic recovery is well-founded.

In Europe, the UK economy expanded 0.7% in 2013 Q4 compared with 2013 Q3, with an estimated GDP growth of 1.9% for the year 2013. With rising house prices and business confidence, the prospects for the British economy are looking particularly good.

Although the US economic recovery is undeniable, mixed company earnings in the fourth quarter indicate that the recovery is somewhat fragile and not universal across firms. Another disturbing fact is that, given the uncertainty with regard to global recovery, US companies are not spending on capital as much as they should.

Instead, dividends and share buybacks are used to keep shareholders happy. In my opinion, for a sustainable economic recovery, earnings should be channeled into investment. Sluggish investment today implies lower productivity and earnings growth in the future.

Since the end of 2011, the US capacity utilization index seems to be hovering around 78% indicating chronic excess capacity. Although the index rose to 79% in the last quarter of 2013, this is relatively low by historical standards, a bigger increase needs to be reported for sustained increases in capital spending. The silver lining of an increasing output gap is that the US inflation is expected to remain low throughout 2014.

In January, Apple’s (APPL) stock tumbled after the company announced its fiscal first-quarter results. Despite the iPhones sales reaching a quarterly record, it slightly missed the analysts’ estimates. That fact, together with a softer guidance for the current quarter, triggered a massive market overreaction in my opinion.

As a long-horizon investor, I take this market reaction in stride and will hold on to this stock. I also expect Apple’s agreement with China Mobile to generate healthy earnings in the future, irrespective of the company’s product pipeline.

On the positive side, another portfolio holding, Facebook (FB), came out with stellar fourth-quarter results with more than half of total ad revenues coming from mobile ads. I personally disagree with analysts who argue that FB’s P/E multiple looks too rich.

Facebook has experienced 63% sales growth, compared with the previous year’s quarter. That’s very impressive and the company’s margin expansion has led to strong growth in free cash flow, which gives the company room to acquire new companies for further growth.

I believe that FB with its 1.23 billion users worldwide is just starting to exploit its growth potential which may be considered as unprecedented and should not be judged on the basis of its P/E value.

In my opinion, the correction in the stock market is a buying opportunity. Based on that belief, I made some additions to my Long Only Sector Rotation portfolio in January. In order to increase the sector diversification of the portfolio, we chose to buy some biotech stocks.

The biotech sector had quite a good run last year and usually tends to outperform in times of economic expansion. I bought Amgen (AMGN) and Celgene (CELG). In my opinion, these biotech stocks have the potential for medium- to long-term outperformance.

AMGN is the world’s biggest biotech company and produces medicines for diseases such as cancer, kidney disease, and rheumatoid arthritis. The company is cheap from the valuation point of view. Its current P/E of about 17 (as of Feb. 7) is lower than the industry average and its sales growth and profit margins are comparable to the other companies in the sector.

Furthermore, as the company is involved in ‘biologics’, (drugs that generally exhibit high molecular complexity) it is pretty difficult for generics to copy them purely on the basis of the patent law related to ‘biosimilars’.

Celgene specialises in therapies for cancer and immune-inflammatory diseases. The company has a P/E ratio of 43 (as of Feb. 7) and a strong sales and net income growth.

Although the company’s earnings results for 2013 Q4 slightly missed the market estimate, the earnings are still solid. CELG’s fourth quarter revenue and net income rose by 21% and 13%.

In January, I made various changes to our portfolio. After the earnings announcement, which beat the market estimates, I sold TD Ameritrade Holding (AMTD).

According to my stock selection method, AMTD indicated no further upward potential. I also took profits and sold the chip equipment supplier Lam Research (LRCX), which also is fairly valued in my opinion.

I added Google (GOOG) to our portfolio. We see GOOG’s selling Motorola Mobility to Lenovo as a positive development. From a valuation point of view, the company’s P/E ratio of 33 is still below its industry average of 48, and my personal stock valuation model based on fundamentals currently gives a buy signal for this stock.

DISCLAIMER: The investments discussed are held in client accounts as of January 31, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.