Week in Conflict Leads to Buy List - Weekly blog # 764

Mike Lipper’s Monday Morning Musings

Week in Conflict Leads to Buy List

 

 Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

            

 

 

Trading Didn’t Tell Us Much 

Over-simplification: Buyers largely believe that inflation is the sole problem facing the market and the Federal Reserve will take care of it by managing short-term interest rates. As the stock market went up the first two days of the week, more shares transacted at rising prices. 

 

The next two days saw prices decline in reaction to a greater than expected fall in November retail sales. Department stores led with a more than -2.5% decline compared to an overall average decline of -0.6%, vs. an estimated decline of -0.2%. (Visits to the high-end The Mall at Short Hills in early and mid-December saw a lack of salespeople, incomplete stock, and vacant stores.) There is a second group of investors, some of which were trading and many more not. I call them Realists. 

 

Friday’s transactions were partially misleading in that over $4 trillion dollars’ worth of options came due. Options users often hedge individual securities, exchange-traded funds, and other derivatives. On Friday both the NYSE and NASDAQ traded over 5 million shares on the downside, vs. a total transaction count of 5.4 million shares on the NYSE and 5.5 million shares on the NASDAQ. (Remember, about 40% more shares were traded off the exchanges.)  1.7 million and 2.4 million shares were traded on the upside. (Thus, I am not sure how to interpret these actions, other than them giving us a clue on the size of the speculative market.)  

 

Although the believers will hopefully be right, it does not appear it will be soon. Economists have created an index of leading indicators which are still going down by about 1% per month. The believers, particularly those that are Washington oriented, focus on national numbers. They do this because it leads them to policies where they can harvest votes. The realists are more attuned to measures that track the wealth of the country and the world. This year the aggregate wealth on main street has been rising due to an inflated sample of real estate prices rising faster than public portfolio values have been declining. These people recognize their good fortune but worry about inflation and the decreasing purchase value of their currency. 

 

A leading retail-oriented broker indicated their clients have been buying mostly corporate/municipal bonds and commodities, while selling declining US government bonds. Thirty-year bonds have fallen 35%, the worst in over a century. (Never have they fallen 3 years in a row.) 

 

Commodities are finishing the year as the best asset class for a second consecutive year. Commodities are going up in price because of actual and perceived shortages, both at the industrial level and to a lesser extent at the food level. When demand drops for industrial goods in a dampening economy, some commodity prices will also drop. This is exactly what OPEC+ fears, a fall in demand.) 

 

Brokers also see a sharp increase in the purchase of tax-exempt bonds. Many of these bonds are backed by expected state and local income taxes. These revenues will likely drop when individual and corporate income drops and won’t be meaningfully offset by rising rates for political reasons.

 

Thus, in an attempt to preserve investor wealth and purchasing power, a major portion of their wealth may be exposed to rising interest rates and a decline in purchasing power. After which rates could fall if “The Fed” reduces them. It is exactly the reason I am suggesting long-term prudent investors begin investing a portion of their assets in something that was previously mostly attractive to seniors. 

 

Tactical Reserve Preparation 

This time it’s different in that capital is being temporarily retrieved from risk assets. (The length of time out of the market will be determined by changing investment and personal conditions.) Since none of us know what the future will bring, we should utilize some of our money to defend against the possibility of stagflation, which could last ten years or more. This has happened twice in the last century.  

 

The tactical reserve is best structured by buckets. One bucket being long-term oriented and another short-term. The latter would be kept in locally deposited savings accounts, money market funds, and 2 year or shorter US Treasury paper.  

 

The larger portion, or perhaps the total of the tactical reserves should be invested in Equity Income stocks, an old asset class that is slowly becoming available. For many years these investments were difficult to find due to low interest rate yields. 

 

Currently, 2-year US Treasuries are yielding 4%. In this weekend’s WSJ I was pleased to find 48 stocks out of list of the 1000 largest equities yielding above that number. My filter was common stocks yielding between 4.0 and 5.99% whose price/earnings ratio was below 15x. Every investment has risks and those with yields of 6% or more are believed by the market to have some capital risk. Also, stocks with a P/E above 15 may not have earnings approximately equal to twice the current dividend. Most of these companies regularly raise the dividend at least as much as inflation. Another helpful characteristic is a significant number of shares being held by a family or other interested parties, like some pensions, endowments, and income oriented mutual funds. 

 

While there is some portfolio diversification in the list of 48, it is not as diversified as the broad-based market indices. The largest common denominator on the list is financial companies, with a heavy collection of domestic and foreign banks, particularly Canadian. The list includes Citigroup. Real estate and utilities are also prominent. I was pleasantly surprised to see 3 fund management company stocks I own in order to participate in a growing financial services business. Furthermore, there were names of major holdings in the investment companies I own. I also found some names of stocks I should investigate for inclusion in my tactical reserve or other portfolios. 

At this point the task shifts from security selection to portfolio construction and ongoing management. As we are building a tactical reserve, we need to avoid unnecessary exposure to losses. The first rule is to reduce risks by diversification. The best way to start is to have a beginning portfolio of at least five holdings, which hopefully will grow to ten distinct holdings in time. Pick your holdings from each of the sectors - Domestic banks, foreign banks), non-bank financials, life insurance, property owners, energy providers and servicers, industrial producers of needed products, and utilities. (Some pay dividends in dollars while making their money in different currencies, including commodity aided currencies like the Canadian dollar.) Be careful to limit the maximum single holding to twenty percent of this account.  

 

When operating the account, small cash distributions should be transferred to the cash account. If the prices of the holdings drop ten percent more than the market, stop buying. If prices fall twenty percent or more, consider selling half or all the holding. 

 

Remember, these operating procedures are suggested for the tactical reserve account. A different set of rules and procedures would be more appropriate for accounts having different target dates for payments. The other important thing to remember is that the quicker an investor learns humility, the bigger the ultimate return.    

 

For long-term subscribers who will share their intended use of the list with me, I will make the list available to them.   

 

 

 

Did you miss my blog last week? Click here to read.

Mike Lipper’s Blog: What does your 4.0 Profile Tell You? – Weekly Blog # 763

Mike Lipper’s Blog: Week Divided: Believers vs Investors – Weekly Blog # 762

Mike Lipper’s Blog: This Was The Week That Wasn’t – Weekly Blog # 761

 

 

 

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