Turnaround Monday- Didn't Wait for Tuesday

As was strongly suggested on yesterday's post, today the European and U.S. stock markets staged what looks to be a major intra-day reversal, both in Europe and here.  Spanish and Italian govvies were clobbered.  The SPY closed below its 150 day sma once again, and has a 10 week pattern now of lower highs since the April 2 high.  Lower lows coming soon to a stock market near you would be highly unsurprising.

I am long a variety of utilities because of my favorite reason to buy/own stocks:  income in a world starved for seemingly secure income; and technicals.  These include ED, AVA, SWX, WGL, XLU.  Note these have replaced my zero-coupon Treasuries, on which I took profits the week before last, and now I am increasingly ramping into the utilities as a preferred income and price appreciation play.  Today's drop in interest rates is perfect for this thesis.  My expectation is that utilities will suffer profit-taking on days like today but then go up a nice amount when we have days as we did last week when stocks rebound and rates go up.  I'm banking on some resumption of the historical relationship between the 10 year T-note and utility yields.  Some utes could go up 50%++ if that occurred near today's record-low T-yields.  (Not counting on that!)

I also own a few of the small community S&Ls/bank stocks I have mentioned for quite some time on The Daily Capitalist.  I prefer not to name them b/c they are so illiquid.  Finally, I own a very modest amount of stocks with varying charts that are "normal" operating companies, are ultra-high quality, have the leading position in essential growth industries, and have TTM P/Es of 7-14.  In general, they all are GARP stocks that are well off their highs but with record earnings, and all pay dividends and have substantial tangible book value.

I am also long a significant amount of some of the leveraged closed end tax-exempt bond funds, the largest holdings being NIO and NVG.

I see investors turning away from the SPY until it yields double the 10-year Treasury.  This process takes time.  That's how it ended up in Japan, with a 1% 10-year JGB and a 2% Nikkei yield.  In the US in the 1940s, the market had periods where the highest-quality stocks yielded 7-9% with T-bond yields marginally higher than today's.

Once people really start worrying about stocks, a 2% SPY yield is trivial.  They can go out for lunch and come back to find the SPY down that much, just like that.  Thus we saw the psychology to get high dividends- and note back in the '40s, stocks often traded close to tangible book value, which as the decade drew to an end got to be understated due to inflation.  I expect the lust for high dividend income is likely to return.  For now, utilities with seemingly secure dividends are the best way I see to make investment lemonade out of today's ZIRP-era lemons.

I also took very small trading profits on GTU, having bought it late last week at a zero premium to NAV, selling it today with bullion a little below where it was when I purchased GTU but the premium to NAV had rised to 3+%.  Every little bit helps.  GTU does not fit the income theme!  With oil turning to the downside today, I don't want more than a core gold holding, the trend being your friend and all that.

The '500' Fills the Gap

While many individual stocks look reasonably valued on a price-earnings basis, the market as a whole is looking more and more tired and more and more like a "sell" rather than a venue for gamblers.

The chart nearby (click on to enlarge) shows the S&P 500 for the past two years. It has now filled the gap around 100 created when things began to implode late in September.

Not shown is that the index is slightly more than 20% above its 200 day moving average. On the one hand, this reflects the dramatic turnaround in corporate profits. Teleologically, companies cut back inventory "too much", especially in view of all the government stimulative measures. Worse, companies cut back staff and are reluctant to hire; though, they will eventually hire if profits hold up.

Moving on, the VIX, an index that reflects actual or feared volatility and in practice correlates with the perceived trend of stock prices, has collapsed 25% from about 28 to about 21 in only two weeks. This is a large decline in a short time. In the rally since March, this situation has either been followed by a correction in stock prices or some stability in prices offset by a rise in the VIX (a rising VIX means rising volatility, and generally reflects bearish sentiment). Of course, past performance doesn't predict future . . . you know the rest. But it's nice to have precedent on your side.

From a technical standpoint, the financials, which led this rally, lagged today even as a bullish event happened over the past two days, which is a significant widening in the 2-10 year Treasury spread. Higher quality, boring stocks that have not participated in the rally began to participate, such as MCD and GSK. Might the fast money be "tired of" financials?

Nokia before the opening and IBM after the close each saw their stocks fall on bad news, which is what happens in an average market. Meanwhile, Intel had a legitimate beat-and-raise and the stock did not do much, even though it is depressed on a 2-year basis. And Alcoa, with a less impressive earnings beat, has also done little since an exuberant day; in fact it has trended down over the past week. So, under cover of rising averages, we are seeing lots of new 12-month highs, little but rising earnings estimates, and other bull market action, but evidence of fatigue.

What happens in a wild bull market is that you see stocks trading way above their 200 day moving averages. We are seeing this. When these stocks have the worst fundamentals, many prudent investors simply stand back. MU and AMD are two of many examples. Not counting its recent minor drop, GS is about 40% above its moving average and is quite the momentum stock these days. Meanwhile, there has been nearly zero corporate insider buying for several months. These guys are almost always right, though with a lag.

These sorts of stocks, even if the fundamentals are strong, have so much profit in them that in a normal bull market, one not fueled by short covering or hot money, that they move up more slowly.

Eventually, financial markets are weighing machines. The weights comprise return of capital or dividend payouts. A rising stock price for 2 decades did AIG shareholders no good when it went near zero, given the lack of meaningful dividend payouts along the way. With the S&P 500 once again yielding more or less exactly 2.0%, and with old Wall Street hand remembering when a normal (wide) fluctuating range of dividend yields was 3% at bull market tops and 6% at bear market bottoms, what we are seeing is levitation ahead of proven fundamentals.

Unfortunately, indicators such as Gallup.com's polling shows that consumer spending has not risen at all.

Based on 14-day averages of responses to smooth out weekend and other variations, Gallup found that in May 2008, consumers spent as much as $112/day above and beyond fixed costs such as mortgages (!).

Two months ago, that had rebounded from below $60/day to as high as $72 (Aug. 18). The index has dropped back to $60. Where are the money printers when we need them?

The same polling continues to detect no net hiring, which has been quite accurate in predicting the BLS monthly data. Employment is almost undoubtedly shrinking at a significant pace, and initial unemployment claims are probably understating the case due to reluctance of large and small companies to hire. And when they can hire overseas, they are doing so. There are no healthcare benefits and few if any payroll taxes in China!

The 10-year Treasury yield is back to 3.47% at a time when the CPI is negative and rents are falling for the first time in 17 years. The real yield is very high. As the peak momentum of the economic move off the bottom inevitably arrives--some week-- measured in various ways--it is likely that the media will start talking of a growth slowdown. Not only are Treasuries a buy for real return, if you ask virtually anyone which asset class will provide a better return over, say, two years or ten years, choosing between stocks, gold and Treasuries, how many people do you know who will say Treasuries? (I would also suspect that if people were asked to choose between all cash for 10 years vs. a 10-year Treasury, most people would take cash over a 3.47% annual yield.)

Gold was down on a day when oil surged. This smacks of profit-taking, given that the dollar was unchanged against a basket of other currencies.

The stock averages look vulnerable here, and many individual issues probably are more likely to drop than rise. However, the boring stocks such as MCD, GSK and WMT that have done little or nothing since March could rise even if the averages have what might be a pause that refreshes a/k/a a correction.

In a confusing world in which the financial crisis remains unresolved, yours truly remains long government securities, dividend stocks with strong long-term charts, gold and cash. Dynamic it's not. But given an outperformance over stocks by 40% last year by being in bonds and cash and out of stocks, I don't feel that aggressiveness is needed right now. Avoiding losses and investing for income and/or capital gains when they appear low risk is the DoctoRx watchword in managing money.

NOTE: Nothing said herein is investment advice for any individual. Econblog Review and DoctoRx are NOT professional money managers.

Copyright (C) Long Lake LLC 2009

Health Care Bill Less Likely to Pass Soon: Investment Considerations

In the New York Times article Democrats May Limit Tax Increases for Health Care Plan, the real news is the likely acceptance by the President that this priority of his is going to involve a longer time line than he wishes:

But rather than repeating his demand that each chamber of Congress pass a health care bill before the August break, Mr. Obama emphasized the need to reach a final agreement by the end of the year. “So let’s fight our way through the politics of the moment,” he said. “Let’s pass reform by the end of this year.”

Despite White House insistence to the contrary, the end-of-year deadline suggested that Mr. Obama was backing away slightly from his timetable; previously he had called on Congress to send him legislation to sign by mid-October.

Given EBR's focus on generating income with one's capital (or else owning gold to profit from or at least keep up with inflation), it brings the reader's attention to Eli Lilly, which yields 5.9%, sells for 8 times this year's estimated earnings and has rising earnings estimates both for this year and next year. In addition, while its market cap is close to $40 B, a small number of super-giant pharma companies could acquire it. The long-term chart of LLY happens to stink, but yours truly owns it. The stock is back where it was a dozen years ago. A previously-miserably run company that appears to have stabilized is Bristol-Myers Squibb ("BMY"), which yields 6.2%.

This spring, EBR mentioned a small number of stocks with strong fundamentals and strong long-term and short-term charts. Amongst them was Teva ("TEVA"). Teva recently hit an all-time high, has a long-term growth rate in the high teens, yields as much as cash in the bank (1.2%), and sells at 12 times estimated next year's earnings. This has been a beautifully-run (Israeli) company that has delivered for shareholders while being uninvolved in the various shenanigans afflicting so much of American industry.

None of LLY, BMY or TEVA play the stock buyback game to a significant extent. Teva can win regardless of the fate of health care reform. It is felt at EBR that valuations on LLY and BMY are low enough that P/E risk is low even if "Obamacare" passes, and that if it fails, P/E and dividend yield could allow for substantial long-term returns to shareholders.

Note: The author of this post owns TEVA and LLY and may sell either without notice. None of the commentary herein constitutes advice to anyone to buy or sell any security.

Copyright (C) Long Lake LLC 2009