Proprietary investment strategy
401 Advisor, LLC specializes in building client portfolios using dividend paying stocks due to their long term history of providing superior returns over non dividend payers. I recently contributed to an article posted by U S News on their web site. The article highlights warning signs that a stock may be cutting their dividend in the future.
I recently had a conversation with a client about the strategy for his account in 2015. He indicated that since the market is at an all time high, he expects the market to crash by the end of summer as the Fed raises interest rates. And he would like to adjust his holdings accordingly.
Many of you are probably nodding your head in agreement with this sentiment.
However, please let me remind everyone, that if it was that simple and obvious to predict the economy, let alone the market with that much accuracy there would be many more rich people walking around than there are today! The only thing that is certain, is that what seems “certain” rarely is!
Case in point is a part of an email I received from Fuller Treacy Money, their comment of the day. For those who want the short version it is this: the article sites two economists from Harvard. They are very well known and respected economists. They have nearly opposite opinions.
The point I hope is obvious, if such esteemed economists with the same background, see the world so differently, how can any of us, without the resources and time to study these things as professionals do, be so sure that our opinions will be the ones that in fact pan out in the year ahead?
We just don’t know what the future holds and the best investment strategy is to listen to what the market tells us as we go along, use tried and true investment strategies, and always be aware…and have a strategy…for when things do change!
Below is the piece from Fuller Treacy.
A standing-room only crowd packed a hotel ballroom on Jan. 3 to hear…Professors Lawrence Summers of Harvard University and Robert Gordon of Northwestern University in Evanston, Illinois, defend their views.
“Just because we have 5 percent growth doesn’t mean we are out of the woods,” Summers, a former Treasury secretary and senior White House official, told the American Economic Association meeting in Boston, alluding to the U.S. economy’s pace of expansion in the third quarter.
He rattled off a variety of reasons for caution. Among them: the risk of financial bubbles, the difficulties the Federal Reserve may face in raising interest rates back to more normal levels, and continued excess capacity in Japan and Europe.
Summers also compared the euro area’s situation today with that of Japan in the late 1990s, before it slipped into a deflationary funk, and warned that the U.S. could be in for an extended period of a “dismal growth rate below 1-1/2 percent.”
Fellow Harvard professor Greg Mankiw took issue with that gloomy prognosis as far as the U.S. is concerned. In particular, he highlighted the improving labor market, where unemployment is at a six-year low and wages have begun to rise.
“We are returning to normalcy,” said Mankiw, who is also chairman of the economics department at Harvard in Cambridge, Massachusetts and a former chief White House economist.
In the real world study of schizophrenia known as the stock market some of you (ok probably about all of you with a life) may have missed this news over the weekend:
“This past weekend, China printed their September Import and Export data, and brother did it surprise everyone with how strong these two components were. September Exports rose 15.3% VS a year ago, and Imports rose 7% for the same time frame. The consensus was for 12% and -2 respectively, so not only did Exports and Imports kick some tail and take names later, they beat the forecasts! I think that this data is good proof in the pudding that China will show a recovery in the economy in the 3rd QTR, and really improve in the 4th QTR.” The Daily Pfennig
Why is this important enough to warrant a blog post? Because the “market” can’t decide whether to panic over the economy being too good – and the Fed raising interest rates soon, or whether to panic because the global economy is so bad that a slowdown will cross onto our shores and deflate our record high corporate earnings that have kept this market rally alive.
While Europe is still the big question, the prospect of a further slowdown of the Chinese economy has also spooked commodities and the industrial sectors. Maybe with some optimism that Chinese growth has bottomed we can put a floor on the market and end the current selloff.
As I have mentioned many times, it’s best to make your investment plans before events happen, taking the emotions away from decision making. I noted earlier that we began building our “arc” months ago. We have raised substantial amounts of cash in our Dividend and Growth managed portfolios – in the 35% range. And have about 20% cash in our Growth portfolios. Even if the markets turnaround from here, many stocks have seen fairly large selloffs and I have a shopping list of discounted equities that I am ready to buy.
On a side note, OPEC led by the Saudi’s, has continued to produce oil at their previous pace despite a global slowdown in demand. Normally you can count on the Saudi’s to cut production to prop up prices. This time however they have chosen to keep the pedal to the metal so to speak and maintain production. Why the change in strategy? Because they feel that by lowering the cost of a barrel of oil they will slow down the growth of U S and Canadian production which they see as a threat to their economy. What goes around…comes around…
Even more ironically, with gas prices dropping by about $.50 a gallon over the last year, the average driver is saving about $100 a month at the pump. By giving the U S consumer a little extra spending money, the Saudi’s have done what our own politicians are incapable of – creating a policy to help out us poor working stiffs in the middle class!
Here is a link to an article, Biotechnology ETFs Show Rebust Health In August I was quoted in posted at investors.com – the online publication of The Investor’s Business Daily (IBD). Short article focusing on two of the hottest market sectors, biotech and solar/green energy. My take is that it is mainly a consequence of a “risk on” market attitude that comes from global central banks jointly adding money into their respective economies. “Don’t fight the Fed” is particularly appropriate when multiple Fed’s are all pursuing the same easy money policy. Especially now that the ECB has decided to join the party.
Below is an excerpt from our Monday report from Sterne Agee, (emphasis added):
“Fed Chair Janet Yellen gave a balanced assessment of the labor market in her keynote speech at Jackson Hole last week, according to Standard and Poor’s Economics. She said there is no “simple recipe for appropriate policy.” She indicated that the economy is improving and that the FOMC now is questioning the degree of slack, and repeated that faster progress toward the employment and inflation goals could speed up rate hikes. She also reminded us that if progress is disappointing, then the accommodative stance could remain intact longer. In other words, the Fed remains data dependent.
What does all this mean for the timing of the exit from zero interest rates? We still think it is likely to come sometime in the second quarter of 2015.
During the next round of rate increases, investors appear to be fairly confident that equity prices will hold up, theorizing that an improving economy…should help support, if not boost, share prices. In addition, they point to two prior Fed tightening periods in which the S&P 500 held up remarkably well.”
Now let me translate. The consensus amongst Wall Streeters is that rates will increase in the second quarter of next year. This is a case where perception is far more important than reality as this could change if the economy progresses or regresses at a faster pace than anticipated. So “Data dependant” means that moderately bad economic news – the economy is growing, but at a slower pace than expected, will continue to be good news for the market as that would lessen the odds of a near term rate increase. But really bad news, as in recessionary news, or really good news (faster economy = faster rate increases) will be bad news for the stock market. In other words, we are in the bad news is good news market cycle.
Without extreme news, expect a continuation of the stock market rally from here into the end of the first quarter of 2015. The key to a rally continuation will come from first quarter 2015 earnings results. The question will be if an accelerating economy and theoretically rising sales can offset rising pressure on wages and rising costs from interest expenses.
401 Advisor, LLC’s position in our Dividend Income Plus strategy is currently 100% invested, with a rotation to what we deem to be higher quality issues. While the media focus is on the middle east and domestic turmoil, the real issues are Europe’s economy heading to recession, and China’s aggression in the far east. We’re invested…but nervous with the bailout plan in place.
The stock market is reaching new highs while the economy seems to be sputtering along. This has created an environment that has led Brian Nelson, CFA of Valuentum Securities appropriately using a baseball analogy during the baseball All Star Game and Home Run Derby to say, ” If there is an environment more difficult to hit a pitch out of the ball park, I don’t think I’ve seen one.”
My take is similar. The economy is improving and I don’t fear a rise in short term interest rates from the Fed. I’m in the camp that we need modestly higher interest rates to encourage banks to lend. On the other hand, while I don’t see any reason for a market correction, we are definitely due a routine 10% – 20% correction. What I am afraid of is that conditions exist such that an innocuous 10% correction could quickly become a full blown sell off – and very quickly.
And thus we have decided to start building our “arc.” My intent is to stay fully invested within the parameters of our investment models. However, we are definitely rotating our stock holdings into quality holdings. We’ve sold some of our higher yielding but lower quality investments and have sought out low cost, dividend growing cash flow kings that have proven they can weather a storm. We have backtested our holdings against several market scenarios and feel very comfortable should we get a surprise on the down side. At the same time, if the market continues its trek up, I think we will be well rewarded for holding low priced quality stocks.
This is when being “small” works to our advantage. With slim pickings in the markets for stocks that meet our stringent criteria, I am happy to hold 15 – 25 non-correlated stocks in a portfolio and not be forced to own hundreds of issues like a mutual fund.
I recently described my portfolio building process in an article for horsesmouth.com, a subscription site for financial advisors. A copy of the full article has been posted in the Library section of this web site.
The N Y Federal Reserve released the information in the chart below this week.
But if you look at the numbers, student loan debt is 125% of all auto loan debt. Considering that most Americans own a car, and only 33% of Americans age 25 to 29 have a college degree the debt per college grad is crippling, considering that cars and thus car loans, aren’t cheap.
What to watch for:
Before we talk bailouts and defaults watch for Wall Street to start bundling and selling pools of student loans to investors. The Government will say what a good idea this is, and investors will feel patriotic as their investments will help fuel more lending and more debt to unsuspecting future college grads. Then wait for the defaults and the billions of dollars retirees will lose out of their retirement accounts. Won’t happen? Just substitute “mortgage” for “student loan”. History really does repeat. (And just as a warning – student loans are already being bundled for secondary market, )
Are you just starting out? Saddled with debt? Trying to save, pay off debt and live a little all at the same time? If you need help, give me a call and we can get you started with a lifetime financial plan.
Heading into the weekend the markets have been a little shaky over soft economic news from China and apprehension over the Crimea vote this weekend.
Warren Buffet says – don’t sell stocks over either concern. For now I agree. Probably good advice to not look at your 401(k) statements next week, but anything negative should be short term.
Why does Crimea/Russia/Ukraine matter and why you should care? Despite the U. S. administration’s stance that military invasions are so 20th century and unbecoming of a 21st century leader, the reality is that there are many geographic hot spots in the world of today and tomorrow. Whether over oil or just as likely in the future; water there will very likely be other countries that will want to expand their territories. Letting one country (Russia) get away with it because no one is willing to intervene is an alarming precedent. I’m not saying there is a good solution, but I’m just hoping that allowing Russia to claim Crimea from a sovereign country (Ukraine) is not the first domino.
It’s been a busy year already planning for the year ahead. While 2013 saw a rotation in the stock market from the less risky sectors like utilities and into growth sectors like technology, with the likelihood of slow economic growth ahead I expect 2014 to reverse that trend.
Here is the link to where I discuss in more detail my outlook for the year ahead.
I was also interviewed for an article at wealthmanagement.com entitled “Advisors’ Top 10 Investment Ideas for 2014.” My ideas were picked for two of the “top ten ideas.”
For those of you that actually like my charts, below is a copy of an article that I wrote for horsesmouth.com
(Originally published at horsemouth.com on December 27, 2013)
The biggest worry heading into a New Year is that with the market at record highs, it certainly must be overvalued and due a correction.
While a correction might actually be welcome (the pause the refreshes), worrying about whether the market is too high is quite a relief compared to recent worries of the past – financial meltdown, Europe/Euro implosion, China hard landing, U.S. recession/depression… So while anything could happen in the short run, let’s look into the crystal ball and see what we can see.
Below is a Graph of SPY, the SPDR S&P 500 Index ETF since October of 2012. Highlighted by the vertical lines are the three recent time frames marked by our seasonal strategy – better known as the Halloween Effect. In short, global market history shows that most of a stock markets’ gains come from the period of November first ( the day after Halloween) through the end of April (when you will hear the phrase “Sell in May and go Away…”). While 2013 proved to be a good year to be in the market – for the entire year, you can see a marked difference in market performance. While the market went up during the entire period, between the second and third vertical lines, you can also see that it did so with more volatility than the period prior, and so far in the period after.
Figure 1 SPY October 2012 – December 2013
Technically the market is in a solid uptrend, and until it breaks out of this trend by going up through the top line of resistance, or down through the bottom line of support, we are in a bull market and investors should be taking advantage of it.
Looking at the bigger picture, Figure 2 looks at SPY using monthly returns since 1998. One of the debates about the market is whether we are still in a secular bear market that started in 2000. A secular bear is defined as a market that has reached a peak, declined and failed to rise above and stay above that peak. So in 2007 we breached the 2000 peak, but failed to stay above it. Today we are working on nine months of being above the 2000 and 2007 peaks. The question is can we stay there?
Figure 2 Spy 1998 – December 2013, Monthly Data
Bottom line – it will take a 17% decline to bring us down to the 2000 high. Given that we are in a seasonally strong period, it’s likely that it will take a full blown official correction of 20% or more to breach the 2000 high. While 20% corrections aren’t uncommon, more than that is, so barring a macro event as of yet unknown origin (the proverbial Black Swan) I believe we have exited the 2000 – 2013 secular bear and have entered into a new secular bull market.
What about the nearly “new daily highs?”
Below in Figure 3 is the classic secular Bull/Bear Markets graph from Crestmont Research (crestmontresearch.com/docs/Stock-Secular-Explained.pdf). Quite simply in a secular bull market, the market is supposed to record news highs! Note: the folks at Crestmont believe we are still in the middle of a secular bear market.
Is the market too high?
The common mistake our clients make is to think that price alone has any relevancy to whether the market, or a security is priced too high, or too low for that matter. While maybe not the best, the better and most common metric is Price to Earnings Ratio. While there are many variations on the “proper” P/E to use, I like to look at the earnings for the most recent quarter, annualize and use the current market price. Based on information from zacks.com third quarter earnings for 2013 should beat year ago earnings by about 4.9%, putting third quarter earnings at about $22.25 per share. Annualized that would be $89.00 a share. Based on the S&P 500 at 1842 we have a current P/E of 20.7. The good news is that the third quarter solidly beat expectations of only 1.10% earnings growth. Bad news is that earnings estimates for fourth quarter are coming down. Based on current estimates of 6.8% YoY growth, actual earnings will decline from third to fourth quarter 2013 – meaning P/E ratio goes up, not down.
This market really is getting expensive. Not to the eminent crash level, but to a level where it is hard to see huge market gains in 2014. Earnings absolutely have to catch up to current market prices and keep the current P/E at or under 20. Secular bear markets historically start with P/E’s in the mid 20’s so we could see a solid 25% gain from current market levels – and then seriously talk about bubble territory.
One of the best data series for predicting economic conditions is the St. Louis Financial Stress Index and the Chicago Fed National Activity Index. Below in figure 4 you can see that financial stress is negative and heading lower (good) and the activity index is positive and moving higher (good). So not only is economic activity healthy and improving, the financial conditions exist to bolster continued improvement.
While many interpret this as a warning sign with the Fed announcing a tapering of QE III, I see it as a positive. While the U.S. Fed has announced a very modest reduction to QE III, new hire Janet Yellen does not have the history to indicate she will be hesitant to reapply the stimulus at the first sign of economic softness. Plus, the Fed has made a point to reiterate ZIRP policy, well into 2015. Remember that pre-crisis interest rate policy was monetary policy. So we are simply transitioning from extraordinary monetary policy to “normal’ monetary policy. In other words the Fed remains accommodative. And that’s not just in the U.S.
From the Daily Pfennig put out by Ever Bank, “…markets were focused on China and Japan. Japanese data showed inflation continues to move higher and manufacturing is recovering, but the yen still sold off to 5 year lows. The cash crunch in China ended as the government injected cash into the banking system. And commodity prices moved higher helping to boost the commodity currencies. “
The world is awash in cash, and continuing to get more. The financial crisis led to six years of belt tightening by consumers and businesses, and maybe, just maybe the world is ready to spend again. And just to confirm, Figure 7 shows total outstanding consumer credit – actually looks like we stopped pausing back in 2011.
One of the hardest things about market predictions is that there is really only a very loose correlation between economic growth and the stock market in the short run. In 2013 we had very anemic economic growth but an extremely strong stock market. 2014 is looking to be another year of steady if not spectacular economic growth. However the stock market looks to face two strong headwinds. First is the current valuation. To break a 20 P/E ratio there needs to be some feeling of “irrational exuberance” to ignore valuations and move higher. In 2013 the market was driven by some of the big technology names and IPO’s. But I don’t see much room for a sector rotation to undervalued companies too drive the averages in 2014. I did a simple stock screen on finviz.com. The only search criteria I used was NYSE listed stocks (3311 total) and screened for P/E under 15 (long term historic average) and positive earnings expectations for 2014 – not exactly a big hurdle. The results were a list of only 263 stocks. The market is broadly expensive.
This is not the time to fight the technicals which are very strong. But I would be very wary as we move forward. Any hiccup to the goldilocks scenario that is being priced into the market could lead to a very quick 20% correction. But there aren’t any obvious reasons to return to the secular bear levels (below 2000 highs) and stay there for any length of time. The world is simply awash with cash, and nobody is likely to do much monetary tightening for at least another year.