Archive for May, 2011
Political strategist James Carville famously stated, “It’s the economy stupid,” during the 1992 presidential campaign. Despite a historic record approval rating of 90 by President George H.W. Bush after the 1991 Gulf War victory, Bush Sr. still managed to lose the election to President Bill Clinton because of a weak economy. President Barack Obama would serve himself well to pay attention to history if he wants to enter the “two-termer” club. Pundits are placing their bets on Obama due to his large campaign war chest, a post-Osama bin Laden extinguishment approval bump, and a cloudy Republican candidate weather forecast. If however, the unemployment rate remains elevated and the current administration ignores the spending/debt crisis, then the President’s re-election hopes may just come crashing down.
Price Follows Earnings
The similarly vital relationship between the economy and politics applies to the relationship of earnings and the equity markets too. Instead of the key phrase, “It’s the economy stupid,” in the stock market, “It’s all about the earnings stupid” is the crucial guideline. The balance sheet may play a role as well, but at the end of the day, the longer-term trend in stock prices eventually follows earnings and cash flows (i.e., investors will pay a higher price for a growing stream of earnings and a lower price for a declining or stagnant stream of earnings). Ultimately, even value investors pay more attention to earnings in the cases where losses are deteriorating or hemorrhaging (e.g. a Blockbuster or Enron). Another main factor in stock price valuations is interest rates. Investors will pay more for a given stream of earnings in a low interest rate environment relative to a high interest rate environment. Investors lived through this in the early 1980s when stocks traded at puny 7-8x P/E ratios due to double-digit inflation and a Federal Funds rate that peaked near 20%.
Bears Come Out of Hibernation
Today, earnings portray a different picture relative to the early eighties. Not only are S&P 500 operating earnings growing at a healthy estimated rate of +17% in 2011, but the 10-year Treasury note is also trading at a near-record low yield of 3.06%. In spite of these massively positive earnings and cash flow dynamics occurring over the last few years, the recent -3% pullback in the S&P 500 index from a month ago has awoken some hibernating bears from their caves. Certainly a slowing or pause in the overall economic indicators has something to do with the newfound somber mood (i.e., meager Q1 real GDP growth of +1.8% and rising unemployment claims). Contributing to the bears’ grumpy moods is the economic debt hangover we are recovering from. However, a large portion of the fundamental economic expansion experienced by corporate America has not been fueled by the overwhelming debt still being burned off throughout the financial sector and eventually our federal and state governments. Companies have become leaner and meaner – not only paying down debt, but also increasing dividends, buying back stock, and doing more acquisitions. The corporate debt-free muscle is further evidenced by the $100 billion in cash held by the likes of IBM, Microsoft Corp. (MSFT), and Google Inc. (GOOG) – and still growing.
At a 13.5x P/E multiple of 2011 earnings, perhaps the stock market is pricing in an earnings slowdown? But as of last week, about 70% of the S&P 500 companies reporting Q1 earnings have exceeded expectations. If this trend continues, perhaps we will see James Carville on CNBC rightfully shouting the maxim, “It’s the earnings, stupid!”
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and GOOG, but at the time of publishing SCM had no direct position in IBM, MSFT, Blockbuster, Enron, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Our 3.5 billion year old planet has received a temporary reprieve, at least until the next Mayan Armageddon destroys the world in 2012. Sex, money, and doom sell and Arnold, Oprah, and the Rapture have not disappointed in generating their fair share of advertising revenue clicks.
With 2 billion people connected to the internet and 5 billion people attached to a cell phone, every sneeze, burp, and fart around the world makes daily headline news. The globalization cat is out of the bag, and this phenomenon will only accelerate in the years to come. In 1861 the Pony Express took ten days to deliver a message from New York to San Francisco, and today it takes a few seconds to deliver a message across the world over Twitter or Facebook.
The equity markets have more than doubled from the March 2009 lows and even previous, ardent bulls have turned cautious. Case in point, James Grant from the Interest Rate Observer who was “bullish on the prospects for unscripted strength in business activity” (see Metamorphosis of Bear into Bull) now sees the market as “rich” and asserts “nothing is actually cheap.” Grant rubs salt into the wounds by predicting inflation to spike to 10% (read more).
Layer on multiple wars, Middle East/North African turmoil, gasoline prices, high unemployment, mudslinging presidential election, uninspiring economic growth, and you have a large pessimistic poop pie to sink your teeth into. Bearish sentiment, as calculated by the AAII Sentiment Survey, is at a nine-month high and currently bears outweigh bulls by more than 50%.
The Fear Factor
I think Cullen Roche at Pragmatic Capitalism beautifully encapsulates the comforting blanket of fear that is permeating among the masses through his piece titled, “In Remembrance of Fear”:
“The bottom line is, stay scared. Do not let yourself feel confident, happy or wealthy. You are scared, poor and miserable. You should stay that way. You owe it to yourself. The media says so. And more importantly, there are old rich white men who need to sell books and if you’re not scared by them you’ll never buy their books. So, do yourself a favor. Buy their books and services and stay scared. You deserve it.”
Here is Cullen’s prescription for dealing with all the doom and gloom:
“Associate with people who are more scared than you. That way, you can all sit in bunkers and talk about the end of days and how screwed we all are. Think about how much better that will make you feel. Misery loves company. Do it.”
All is Not Lost
While inflation and gasoline price concerns weigh significantly on economic growth expectations, some companies are taking advantage of record low interest rates. Take for example, Google Inc.’s (GOOG) recent $3 billion bond offerings split evenly across three-year, five-year, and ten-year notes with an average interest rate of 2.3%. Although Google has languished relative to the market over the last year, the market blessed the internet giant with the next best thing to free money by pricing the deal like a AAA-rated credit. Cash-heavy companies have been able to issue low cost debt at a frantic pace for accretive EPS shareholder-friendly activities, such as acquisitions, share buybacks, and organic growth initiatives. Cash rich balance sheets have afforded companies the ability to offer shareholders a steady diet of dividend increases too.
While there is no question high oil prices have put a wet towel over consumer spending, the largest component of corporate check books is labor costs, which accounts for roughly two-thirds of corporate spending. With unemployment rate at 9.0%, this is one area with no inflation pressure as far as the eye can see. Money losing companies that go bankrupt lay-off employees, while profitable companies with stable input costs (labor) will hire more – and that’s exactly what we’re seeing today. Despite all the economic slowing and collapse anxiety, S&P 500 operating earnings, as of last week, are estimated to rise +17% in 2011. Healthy corporations coupled with a growing, deleveraged workforce will have to carry the burden of growth, as deficit and debt direction will ultimately act as a drag on economic growth in the immediate and intermediate future.
Fear and pessimism sell news, and technology is only accelerating the proliferation of this trend. The good news is that you have another 18 months until the next apocalypse on December 21, 2012 is expected to destroy the human race. Rather than attempting to time the market, I urge you to follow the advice of famed investor Peter Lynch who says, “Assume the market is going nowhere and invest accordingly.” For all the others addicted to “pessimism porn,” I’ll let you get back to constructing your bunker.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and GOOG, but at the time of publishing SCM had no direct position in Twitter, Facebook, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Approaches used in baseball strategy are just as varied as they are in investing. Some teams use a “small ball” approach to baseball, in which a premium is placed on methodically advancing runners around the bases with the help of bunts, bases on ball, stolen bases, sacrifice flies, and hit-and- run plays. Other teams stack their line-up with power-hitters, with the sole aim of achieving extra base hits and home runs.
Investing is no different than baseball. Some investors take a conservative, diversified value-approach and seek to earn small returns on a repeated basis. Others, like William J. O’Neil, look for the opportunities to knock an investment out of the park. O’Neil has no problem of concentrating a portfolio in four or five stocks. Warren Buffett talks about how Ted Williams patiently waited for fat pitches–O’Neil is very choosy too, when it comes to taking investment swings.
The Making of a Growth Guru
Born in Oklahoma and raised in Texas, William O’Neil has accomplished a lot over his 53-year professional career. After graduating from Southern Methodist University, O’Neil started his career as a stock broker in the late-1950s. Soon thereafter in 1963, at the ripe young age of 30, O’Neil purchased a seat on the New York Stock Exchange (NYX) and started his own company, William O’Neil + Co. Incorporated. Ambition has never been in short supply for O’Neil – following the creation of his firm, O’Neil the investment guru put on his computer science hat and went onto pioneer the field of computerized investment databases. He used his unique proprietary data as a foundation to unveil his next entrepreneurial baby, Investor’s Business Daily, in 1984.
O’Neil’s Secret Sauce
The secret sauce behind O’Neil’s system is called CAN SLIM®. O’Neil isn’t a huge believer in stock diversification, so he primarily focuses on the cream of the crop stocks in upward trending markets. Here are the components of CAN SLIM® that he searches for in winning stocks:
C Current Quarterly Earnings per Share
A Annual Earnings Increases
N New Products, New Management, New Highs
S Supply and Demand
L Leader or Laggard
I Institutional Sponsorship
M Market Direction
Rebel without a Conventional Cause
In hunting for the preeminent stocks in the market, the CAN SLIM® method uses a blend of fundamental and technical factors to weed out the best of the best. I may not agree with everything O’Neil says in his book, How to Make Money in Stocks, but what I love about the O’Neil doctrine is his maverick disregard of the accepted modern finance status quo. Here is a list of O’Neil’s non-conforming quotes:
- Valuation Doesn’t Matter: “The most successful stocks from 1880 to the present show that, contrary to most investors’ beliefs, P/E ratios were not a relevant factor in price movement and have very little to do with whether a stock should be bought or sold.” (see also The Fallacy of High P/Es)
- Diversification is Bad: “Broad diversification is plainly and simply a hedge for ignorance… The best results are usually achieved through concentration, by putting your eggs in a few baskets that you know well and watching them very carefully.”
- Buy High then Buy Higher: “[Buy more] only after the stock has risen from your purchase price, not after it has fallen below it.”
- Dollar-Cost Averaging a Mistake: “If you buy a stock at $40, then buy more at $30 and average out your cost at $35, you are following up your losers and throwing good money after bad. This amateur strategy can produce serious losses and weigh down your portfolio with a few big losers.”
- Technical Analysis Matters: “Learn to read charts and recognize proper bases and exact buy points. Use daily and weekly charts to materially improve your stock selection and timing.”
- Ignore TV & So-Called Experts: “Stop listening to and being influenced by friends, associates, and the continuous array of experts’ personal opinions on daily TV shows.”
- Stay Away from Dividends: “Most people should not buy common stocks for their dividends or income, yet many people do.”
Managing Momentum Risk
Although O’Neil’s CAN SLIM® investment strategy does not rely on a full-fledged, risky style of momentum investing (see Riding the Momentum Wave), O’Neil’s investment approach utilizes very structured rules designed to limit downside risk. Since true O’Neil disciples understand they are dealing with flammable and volatile hyper-growth companies, O’Neil always keeps a safety apparatus close by – I like to call it the 8% financial fire extinguisher rule. O’Neil simply states, “Investors should definitely set firm rules limiting the loss on the initial capital they have invested in each to an absolute maximum of 7% or 8%.” If a trade is not working, O’Neil wants you to quickly cut your losses. As the “M” in CAN SLIM® indicates, downward trending markets make long position gains very challenging to come by. Raising cash and cutting margin is the default strategy for O’Neil until the next bull cycle begins.
While some components of William O’Neil’s “cup and handle” teachings (see link)are considered heresy among various traditional financial textbooks, O’Neil’s lessons and CAN SLIM® method shared in How to Make Money in Stocks provide a wealth of practical information for all investors. If you want to add a power-hitting element to your investing game and hit a few balls out of the park, it behooves you to invest some time in better familiarizing yourself with the CAN SLIM® teachings of William O’Neil.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Wade Slome, President of Sidoxia Capital Management (SCM), worked at William O’Neil + Co. Incorporated in 1993-1996. SCM and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in NYX or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Fred J. Young worked 27 years as a professional money manager and investment counselor in the trust department at Harris Bank in Chicago. While working there he learned a few things about wealth accumulation and preservation, which he outlines in his book How to Get Rich and Stay Rich.
There is more than one way to skin a cat, and when it comes to getting rich, Young describes the only three ways of getting loaded:
1.) Inherit It: Using this method on the path to richness generally doesn’t take a lot of blood, sweat, and tears (perhaps a little brown-nosing wouldn’t hurt), but young freely admits you can skip his book if you are fortunate enough to garner boatloads of cash through your ancestry.
2.) Marry It: This approach to wealth accumulation can require a bit more effort than method number one. However, Young explains that if the Good Lord intended you to find your lifetime lover through destiny, then if your soul-mate has a lot of dough Young advises, “You [should] graciously accept the situation. Don’t fight it.”
3.) Spend < Earn: Normally this avenue to champagne and caviar requires the most effort. How does one execute option number three? “You spend less than you earn and invest the difference in something you think will increase in value and make you rich,” simply states Young. Sounds straightforward, but what does one invest their excess cash in? Young succinctly lists the customary investment tools of choice for wealth creation:
- Real estate
- Own their own business
- Common stocks
- Savings accounts (thanks to the magic of compound interest rates) – see also Penny Saved is Billions Earned
If faced with choosing between good luck and good judgment, here is Fred Young’s response:
“You should take good luck. Good luck, by definition, denotes success. Good judgment can still go wrong.”
Like many endeavors, it’s good to have some of both (good luck and good judgment).
The Role of Courage
Courage is especially important when it comes to equity investing because buying stocks includes a very counterintuitive behavioral aspect that requires courage. Following the herd of average investors and buying stocks at new highs is easy and does not require a lot of courage. Young describes the various types of courage required for successful investing:
“The courage to buy when others are selling; the courage to buy when stocks are hitting new lows; the courage to buy when the economy looks bad; courage to buy at the bottom…The times when the gloom was the thickest invariably turned out to have been the best times to buy stocks.”
Keeping the Cash
Becoming rich is only half the challenge. In many cases staying rich can be just as difficult as accumulating the wealth. Young points out the intolerable pain caused by transitioning from wealth to poverty. What is Young’s solution to this tricky problem? Seek professional help. The risks undertaken to build wealth still exist when you are rich, and those same risks have the capability of tearing financial security away.
There are three paths to riches according to Fred Young (inheritance, marriage, and prudent investing). Some of these directions leading to mega-money require more effort than others, but if you are lucky enough to have deep pockets of riches, make sure you have the discipline and focus necessary to maintain that wealth – those deep pockets could have a hole.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Excerpt from No-Cost May Sidoxia Monthly Newsletter (Subscribe on right-side of page)
Before the announcement of the killing of the most wanted terrorist in the world, Osama bin Laden, the royal wedding of Prince William Arthur Philip Louis and Catherine Middleton (Duke and Duchess of Cambridge) grabbed the hearts, headlines, and minds of people around the world. As we exited the month, a less conspicuous royal rally in the U.S. stock market has continued into May, with the S&P 500 index climbing +2.8% last month as the economic recovery gained firmer footing from the recession of 2008 and early 2009. As always, there is no shortage of issues to worry about as traders and speculators (investors not included) have an itchy sell-trigger finger, anxiously fretting over the possibility of losing gains accumulated over the last two years.
Here are some of the attention-grabbing issues that occurred last month:
Powerful Profits: According to Thomson Reuters, first quarter profit growth as measured by S&P 500 companies is estimated at a very handsome +18% thus far. At this point, approximately 84% of companies are exceeding or meeting expectations by a margin of 7%, which is above the long-term average of a 2% surprise factor.
Debt Anchor Front & Center: Budget battles remain over record deficits and debt levels anchoring our economy, but clashes over the extension of our debt ceiling will occur first in the coming weeks. Skepticism and concern were so high on this issue of our fiscal situation that the Standard & Poor’s rating agency reduced its outlook on the sovereign debt rating of U.S. Treasury securities to “negative,” meaning there is a one-in-three chance our country’s debt rating could be reduced in the next two years. Democrats and Republicans have put forth various plans on the negotiating table that would cut the national debt by $4 – $6 trillion over the next 10-12 years, but a chasm still remains between both sides with regard to how these cuts will be best achieved.
Inflation Heating Up: The global economic recovery, fueled by loose global central bank monetary policies, has resulted in fanning of the inflation flames. Crude oil prices have jumped to $113 per barrel and gasoline has spiked to over $4 per gallon. Commodity prices have jumped up across the board, as measured by the CRB (Commodity Research Bureau) BLS Index, which measures the price movements of a basket of 22 different commodities. The CRB Index has risen over +28% from a year ago. Although the topic of inflation is dominating the airwaves, this problem is not only a domestic phenomenon. Inflation in emerging markets, like China and Brazil, has also expanded into a dangerous range of 6-7%, and many of these governments are doing their best to slow-down or reverse loose monetary policies from a few years ago.
Expansion Continues but Slows: Economic expansion continued in the first quarter, but slowed to a snail’s pace. The initial GDP (Gross Domestic Product) reading for Q1 slowed down to +1.8% growth. Brakes on government stimulus and spending subtracted from growth, and high fuel costs are pinching consumer spending.
Ben Holds the Course: One person who is not overly eager to reverse loose monetary policies is Federal Reserve Chairman, Ben Bernanke. The Chairman vowed to keep interest rates low for an “extended period,” and he committed the Federal Reserve to complete his $600 billion QE2 (Quantitative Easing) bond buying program through the end of June. If that wasn’t enough news, Bernanke held a historic, first-ever news conference. He fielded a broad range of questions and felt the first quarter GDP slowdown and inflation uptick would be transitory.
Skyrocketing Silver Prices: Silver surged ahead +28% in April, the largest monthly gain since April 1987, and reached a 30-year high in price before closing at around $49 per ounce at the end of the month. Speculators and investors have been piling into silver as evidenced by activity in the SLV (iShares Silver Trust) exchange traded fund, which on occasion has seen its daily April volume exceed that of the SPY (iShares SPDR S&P 500) exchange traded fund.
Obama-Trump Birth Certificate Faceoff: Real estate magnate and TV personality Donald Trump broached the birther issue again, questioning whether President Barack Obama was indeed born in the United States. President Obama produced his full Hawaiian birth certificate in hopes of putting the question behind him. If somehow Trump can be selected as the Republican presidential candidate for 2012, he will certainly try to get President Obama “fired!”
Charlie Sheen…Losing! The Charlie Sheen soap opera continues. Ever since Sheen has gotten kicked off the show Two and a Half Men, speculation has percolated as to whether someone would replace Sheen to act next to co-star John Cryer. Names traveling through the gossip circles include everyone from Woody Harrelson to Jeremy Piven to Rob Lowe. Time will tell whether the audience will laugh or cry, but regardless, Sheen will be laughing to the bank if he wins his $100 million lawsuit against Warner Brothers (TWX).
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain commodity and S&P 500 exchange traded funds, but at the time of publishing SCM had no direct position in SLV, SPY, TWX, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.