Saturday, February 6, 2010

Taking Central Bankers at Their Word

Per, G-7 Pledges to Keep Stimulus Even Amid Budget Stress:

Group of Seven finance ministers pledged to maintain the flow of stimulus into their economies even as investors focus on mounting budget deficits.

“The position for most countries is to support the economies now and get the budget deficit down as the economy recovers,” U.K. Chancellor of the Exchequer Alistair Darling, 56, said in an interview in Iqaluit, Canada last night as finance ministers and central bankers began meeting. “You will see a determination from the G-7 countries to do just that.”

Don't fight the Fed(s).

Where the tape and the Fed diverge, as is the case lately, don't be too sure of the trend, if there is one.

Adjusted for "flation", I expect that the general stock market trend for some time is down, but we live in a nominal world where nominal secure and even insecure yields are depressed.

You can buy a 5-year Treasury note and in 5 years you will have about $111 back on your $100 investment, ignoring taxes and earning interest on interest. Similarly, a 10 year Treasury will get you $136 or so in 10 years on your $100.

Now, consider Best Buy as one of many alternative investment choices. The company currently pays about a 1.5% dividend. Let us say that over 10 years, it will average 2%, so you will get $20 in income on your $100.
The stock is at about $36 per share. If at the end of 10 years it rises to $45 or more, you will have earned 25% on the growth of your capital plus $20 in income from dividends, so you will have $145 back on your $100. This beats a 10-year Treasury. If the stock goes back to $45 sooner, you're fine as well.

If BBY meets current expectations for the year ahead, it is selling for 11 times next-year earnings. The reciprocal of that is called the earnings yield and is 9%. Most of the income goes into growth efforts. A "catch" is that BBY sells far above the value of its assets, namely cash and tangible assets. How much is its good name and strong market position worth? I don't know, but one of the long term risks of this stock market is exactly that problem. In a structurally attractive stock market, valuations are depressed, and many stocks sell for or for less than cash in the bank, not to mention cash plus the depreciated value of their total assets.

Assuming central bankers succeed in keeping the general price level rising, BBY and numerous other large strong companies appear to have intrinsic investment appeal despite the above risk; that is, relative appeal compared to the historically unattractive alternatives.

This analysis leads one to Jeremy Grantham's analysis. Financially strong companies with strong market positions, rising dividends, and the prospects of diminished competition given limited funding for competition are selling in the stock market for the same P/E or lower P/E's than much weaker companies.

The huge rally in the riskiest assets over the past 11 months has finally created some valuation mismatches. They are not as extreme as those existing in the 2000-2 period where tech and large-cap growth were wildly overpriced and homebuilders, HMOs and other stocks were wildly cheap, but they now exist and can allow investors to construct a stock portfolio which is partially insulated from moves in the averages.

No guarantees, of course, but it's good to have central bankers and governments together fighting for growth if you are a businessperson, with debasement of the currency an outcome they all desire.

Copyright (C) Long Lake LLC 2010

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