Blah

[clifp]

I just got my favorite/only investment newsletter, M* Dividend investor and I really like the cover story, especially the headline. Blah

Here are excerpts from it.

Quote:

BLAH! I’ve always wanted to write a cover story with a one-word title. Kind of catches the eye, eh? It would be more fun to say “Hurray!” or something more encouraging, but that will have to wait. Current conditions (market/financial/economic) are limiting my choices, both in terms of stocks and pithy expressions. Whether I look at the situation from the bottom up or the top down, blah is just about the only way for me to describe today’s investment landscape. Blah From the Bottom Up My view of the markets is informed primarily from the bottom up. In the course of any given month, I sift through hundreds of individual stocks. This never ending search usually involves looking at the same group of issues over and over, which lends a certain continuity to the process. (As you might expect, I don’t spend much time reading the annual reports of companies that don’t pay dividends at all.) Considering that it is often hard-earned money we’re being asked to part with when buying stocks, and that money deserves to be treated with care, I don’t think I ask for all that much: A good business, which means (1) identifiable and sustainable competitive advantages, (2) a strong financial position that keeps creditors safely at bay, (3) the likelihood that long-term profit growth should at least match inflation, and (4) a management team that reinvests retained earnings wisely. Such firms do exist, but they are rare. A good dividend, which generally takes the form of a current dividend yield well above the (pathetic) 1.9% of the S&P 500 Index, but must also be accompanied by a record showing that profit growth will be shared with investors through consistent and meaningful dividend increases. (Plenty of otherwise good businesses, like Apple AAPL, flunk this test.) A good price. As if the first two factors aren’t demanding enough, I also want to pay a reasonably low price. This isn’t because I’m trying to get rich quick, but rather because I know that some of my forecasts will prove too optimistic, and I want the protection that a discounted entry price can provide. In our two model portfolios, I hope to present you with the best of the best in terms of dividend-paying opportunities at any one point in time. This means the first and second criteria above must be satisfied continuously, but there is a logical limit to the third. If we’re actually going to earn decent total returns over time, stocks that are initially cheap will eventually have to go up and become somewhat less cheap. Even so, I can’t remember a time when so few of our portfolio holdings qualified as current buys. Of the 34 stocks between the Builder and Harvest accounts (Abbott Laboratories ABT being in both), only 4 traded below my Dividend Buy prices as of May 12. Although these 4 are still worth considering, this is where the B word starts to creep into my analysis. [Note the 34 stocks represent the normal dividend stock suspects PG, GE, JNJ, WFC, and KMP, plus a few REITS about 7 MLP, and about 1/2 dozen misc. stock. It is the non obvious ones which make the newsletter worth the $130.ClifP] Beyond the Builder and Harvest—territory covering the best of the rest, so to speak—conditions are worse. Out of the 700 or so other dividend-paying stocks Morningstar covers, only 4 more meet my basic purchase criteria at today’s prices.... The median consumer staples concern we cover is overpriced by 6%, pipeline master limited partnerships by 7%, fully regulated utilities by 14%, and real estate investment trusts by a hefty 26%. (I know inflation hedges are popular, but real estate is only a hedge if demand outstrips supply—something to keep in mind when you pass empty strip malls and office buildings.) Only big pharma looks cheap, with our fair value estimates suggesting 13% undervaluation, but the dividends are growing either barely (Bristol-Myers Squibb BMY) or not at all (Merck MRK). Talk about blah! ... The portrait painted by this bottom-up process of selecting stocks leaves me with the sense that the Builder and Harvest portfolios are indeed close to representing the best of the best (definitely not perfect, only close), but that even they may only be worth holding, not worth buying at this particular moment in time. Blah From the Top Down Thus far I’ve been talking trees, not forests. What might a broader, top-down view reveal that a 3-foot view doesn’t? (I’ll spoil the surprise: Blah suddenly looks good.) This would be a natural place to start reeling off statistics about the economy, but I’ll skip most of that to focus on just three primary factors that have been driving the stock market: corporate profits, monetary conditions, and valuations. Even as the rest of the economy struggles, corporate profits are back near record levels, both in absolute terms and as a share of gross domestic product. This tells us much about how the market got where it is today, but is much less helpful when we start thinking about tomorrow. Somewhere, there is a limit to how high corporate profits can go as a share of the economy. Unless the basic laws of capitalism were repealed when I wasn’t watching, competitive forces will eventually (arguably soon) reassert themselves and start driving profit margins lower. That would not be good for stocks, but even if margins merely stagnate at record levels, profit growth would then be tied to the rest of the economy—and that doesn’t look like good news either. I’ll summarize it this way: A one-two punch of debt (still too high everywhere outside the corporate sector) and demographics (how do you retire with $50,000 in credit-card bills and an underwater mortgage?) make subpar growth the most useful planning assumption for the decade to come. Monetary policy in this country—and most developed countries—has never been looser. It’s as if the only solution anyone could think of for a sharp recession and dull recovery was to pump trillions of dollars into the financial system, even if the most likely effect would be to inflate the prices of financial assets and scarce raw materials. That’s exactly what has happened. Money cannot get any easier, and once the Federal Reserve’s current program of quantitative easing ends in June, I see no way that the party as we’ve known it can continue unaffected. The bulls assert that everyone knows the end of QE2 is coming and therefore the hit is already discounted. To my mind, that’s like saying just because you recognize the fact that it will be cold in December means you won’t need a coat. Once the Fed is done buying an extra $75 billion of Treasuries every month, that money— which is used to fund giant federal deficits—will have to come from somewhere else. Other surpluses (household and corporate savings, inflows of foreign capital related to the trade deficit) have been diverted into riskier assets as the Fed bought all that Treasury paper. Soon, a lot of those surpluses will have to revert to balancing Uncle Sam’s checkbook. Earlier I floated the possibility that perhaps our fair value estimates were too low, and that’s why I’ve had such trouble finding stocks worth buying. But the top-down analyses of the market that I find have merit suggest that if anything is the case, it’s that our fair value estimates may be too high. One of my favorite market sages—a fellow who is often early in his calls, but rarely wrong in the end—is Jeremy Grantham of the institutional money manager Grantham, Mayo, Van Otterloo. In his most recent letter to clients (available at www.gmo.com), he pegs a fair value for the S&P 500 at 920, compared with a May 12 close of 1,349. The long-term, cyclically adjusted price/earnings framework of Yale professor Robert Shiller suggests a fair value for the S&P in the same range. I don’t necessarily agree with all the logic at work in these analyses, but I’m definitely concerned about the S&P’s pitifully low dividend yield, which would have to increase more than half just to get back to the bottom of old trend lines at 3%. In some areas dividends seem to be rising fast, yet the market’s yield refuses to improve meaningfully. Living Through Blah By nature I am one part worrier, one part skeptic, and one part cheapskate. Somewhere in the mix, however, is a genuine optimist. I may be nervous about the near-term fate of the stock market, but I’m not rushing to hold cash. I may be quite convinced that the market still faces significant long-term headwinds, but I can find and have found stocks that I believe can meet this challenge by paying large current dividends and providing healthy dividend growth. I may demand a low price when buying, but attractive valuations come around often enough (even if such opportunities are clustered around corrections) that I think it’s worth staying on the lookout for bargains at all times.

The editor Josh Peters, has been writing this letter since Jan 2005 (and I've been reading it nearly as long) and I can't remember him ever been so bearish. He was nervous during 2007 from a tops down perspective, but still founds stocks to buy. He was cautious but very bullish during Q4 2008 and throughout 2009. The guy is no Warren Buffet but he has modestly outperformed the S&P with a portfolio that was less volatile during the 2008 crash than the S&P 500 down -24% vs -37%.


I follow his recommendation pretty closely roughly (45% of my portfolio are current or former recommendations). Looking at my portfolio I don't have a single stock that I think is screaming bargain, sure I can argue that BRK, INTC, or an ABT should be 10-20% higher, and a couple of my small/micro cap stocks should be worth 2-3x (if and it is a very big if they execute). But there are also plenty of MLPs I own and companies like CMP that if they were 20% lower I wouldn't consider them a bargain.

I add Josh's commentary to the others I have been seeing posted are causing me to reduce my equity exposure where practical.

[traineeinvestor]

Thanks for posting - that was an interesting read.

A couple of observations:

1. the combination of a good company, running a good business, a good share price and a good dividend is, for many investors, the holy grail of stock picking - but, because so many people are looing for the same thing, presumably one would not expect to find very many companies which tick all the boxes during periods of comparative normality (as opposed to crisis conditions)?

2.

Quote:

To my mind, that’s like saying just because you recognize the fact that it will be cold in December means you won’t need a coat.

With respect, this is a very poor analogy - it does not matter how many people buy or do not buy coats, the weather in December will be unaffected by coat buying behavior. In contrast, what investors do will have an impact on the markets.

3. The markets (HK, Australia) which I follow have had meaningful pull back in prices while, at the same time, corporate earnings have been rising and are (in general) expected to rise further. I can find a lot of mid/large cap stocks which are selling at well below average historical valuation measures. You need to have a fairly negative outlook not to believe that there is value to be had in those markets. (This obviously says nothing about the US market).

[Nords]

Thanks, Clif, good read. I like Josh Peters too.

[clifp]

Quote:

Originally Posted by traineeinvestor Thanks for posting - that was an interesting read. A couple of observations: 1. the combination of a good company, running a good business, a good share price and a good dividend is, for many investors, the holy grail of stock picking - but, because so many people are looing for the same thing, presumably one would not expect to find very many companies which tick all the boxes during periods of comparative normality (as opposed to crisis conditions)? 2. With respect, this is a very poor analogy - it does not matter how many people buy or do not buy coats, the weather in December will be unaffected by coat buying behavior. In contrast, what investors do will have an impact on the markets. 3. The markets (HK, Australia) which I follow have had meaningful pull back in prices while, at the same time, corporate earnings have been rising and are (in general) expected to rise further. I can find a lot of mid/large cap stocks which are selling at well below average historical valuation measures. You need to have a fairly negative outlook not to believe that there is value to be had in those markets. (This obviously says nothing about the US market).

Interestingly enough Josh got back from his first trip from Australia a few months ago (I believe before the correction.) He was impressed with the dividend policy of many Aussie companies. Unfortunately, while he did find a few bargain, only a handful of Australian companies have US ADRs and so there were not any good bargains for Americans.