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Y H & C Monthly Newsletter- August 2010 Edition #27
(Please note: Investments results do not include dividends reinvested or received)
Index- 2010 Return Yearly Return from Date of Picks
Dow Jones +.003%
S&P 500 -.012%
Nasdaq -0.06%
Russell 2000 +.04%
July 2010 Picks +2.41
June 2010 Picks -1.67%
May 2010 Picks -03.14%
April 2010 Picks -1.42%
March 2010 Picks -3.46%
February 2010 Picks -0.86%
January 2010 Picks -13.70%
December 2009 Picks -10.80%
November 2009 Picks -04.60%
October 2009 Picks +9.90%
September 2009 Picks -0.15%
August 2009 Picks +21.93%
July 2009 Picks +21.27%
June 2009 Picks +21.08%
May 2009 Picks +109.89%
April 2009 Picks +71.00%
March 2009 Picks +145.17%
February 2009 Picks +95.10%
January 2009 Picks +64.80%
US Economic & Financial Markets Outlook: Low Volumes, Wide Trading Spreads, and is the “New Normal” correct?
During the month of July 2010, U.S. Financial Markets had a good month on the equity side as the Dow gained almost 7%, the Nasdaq advanced 6.99%, the S&P 500 tacked on 7.48%, and the Russell 2000 gained 2.58%. The most notable observation I can make about July is the lower volumes which took place in almost every stock I look at. On almost any non-earnings report day, the average trading volume of any stock was down at least 10-20% from an average non summer day. With lower volumes, bid-ask spreads become wider, so what happens is large price swings in individual stocks become normal.
With these wide price swings the typical situation on the equity trading floor, fixed income funds became far more aggressive on the publicity front, commenting on television at every opportunity on the inevitable doom and downfall in the equity markets. Why might bond funds become so vocal about the horrible outcomes in the stock market which have to take place? The answer lies in self interest, not a shock to most investors, even non astute ones. Over the last few years bond funds have seen massive capital inflows, and the funds must put the cash to work and boy have they ever. With bond yields trading as low as they have in many years (2 yr treasury-.61%, 10yr-2.99%, 30yr-4.07%), the interest rate risk for bonds, especially treasury bonds, has probably never been higher. These bond funds want to make sure capital keeps flowing in, and as such, their fees continue to go up, not hard to understand.
The standard line from bond fund managers is the world is now facing the “new normal.” The phrase means the developed world economies face a new situation of deleveraging (reducing debt), overcapacity in many industries, high unemployment which will last longer than usual and ultimately slower economic growth, resulting in lower returns for riskier assets. Investors have reacted favorably to the new normal hypothesis, if only evaluating it on a capital flow basis. However, I wonder is the new normal theory totally accurate, or are there parts of it that render more opportunity, especially in the equity markets?
I believe on a macroeconomic level, the new normal thesis makes sense, and many facets of the argument are presently occurring. Consumers are paying down debt at record levels, and there is plenty more of it to pay down before debt totals would approach normal levels (something like 5-10 years). Many industries are indeed suffering from overcapacity, and financial institutions are deleveraging and being forced to adapt to more stringent financial regulations which could lower profit levels and force institutions to provide higher reserve levels to make up for losses on impaired assets. Risk management and risk avoidance are the central priority in the investment community, which means money flows into fixed income products and away from riskier assets, like stocks and commodities. However, because of these conditions, greater opportunities are present in equities as poor macroeconomic data leads to massive equity selloffs where all companies are painted with a broad brush.
As such, high quality businesses become available for long periods of time at attractive prices. For example, for 6 months in a row, Verizon (VZ) has been trading anywhere from 26-33$ a share, and at a very cheap multiple in many different valuation areas. The stock yields 6-7% and throws off about 30-35 billion dollars a year of cash, with debt levels 3X cash flow. The company recently reported a nice quarter (it also spun off its holding in Frontier Communications) and the stock reacted favorably. The key point is the environment today is filled with broad negativity regarding the equity market and the result is there might be more opportunity in the equity market than many people believe, which is certainly not the “new normal” regarding equities.
Global Economic & Financial Markets Outlook: China Retreats, No Blowups from Europe, Chile Outperforms.
The most recent economic and financial news from continents around the world reveal a theme of the status quo. The various countries around mainland China continue to grow quickly, with questions about an impending real estate bubble in China, and what the repercussions are if the bubble pops? European countries released the results of the much publicized stress tests of their banks, yet questions remain about the true status of these institutions and the quality of their capital. India and Russia have been relatively news free regarding any economic problems, and these markets are relatively flat on the year.
Many international stock indexes remain underwater for the year, especially those related to China. The Shanghai composite is down -19.2%, the DJ China 88 Index retreated -22.0%, and DJ CBIN China 600 has lost -17.1% for the year. Certainly, all of these indexes might be a place to consider for investment, but require extensive research before putting down hard earned capital. On a positive note, a country which is investor friendly (stable government, transparency with rule of law, low tax rate) is Chile, and it has been reflected in the index returns during the year, +21.1%, as well as for the last three year, +9.8%. Anyone want some Chile, and I am not talking about Chile with beans?
Y H & C Investments: The Psychology of Investing: In the Midst of a Typical Summer, Where Are the Growth Markets and What to do About Them?
The summer of 2010 is 2/3 complete and is typical of most summers in the equity markets. Some volatility, lots of low volume days, and a continuation of the growth of a large overvaluation in a specific asset class. Two years ago during the summer, oil traded at 150 dollars a barrel. This year, I continue to believe the bond market is where the bubble continues to inflate. At some point, fixed income investors should be ready for severe pain when interest rates rise. One might also look at gold as another market loaded with bubble type risk. Amongst all the bubbles, it is more important for equity investors to look for potential markets which have bright growth prospects for many years in the future.
First, I think the small business market, in the U.S. and internationally, is a huge growth opportunity. In the U.S., around 60% of all businesses are considered small, and they drive most of the new hiring in the economy. Internationally, I would imagine small businesses outnumber large by a ratio of 3-1, and any products which can be sold to small business on a global scale offer a huge possibility for profits.
Second, health care related industries should be growth markets for many years to come, both domestically and globally. The need for better health care, especially personalized, is something which will benefit society in many different ways. Most important, it should improve quality of life and increase duration of life expectancy.
Third, alternative energy will be a growth industry for decades. Alternative energy in the U.S. accounts for just 1% of all energy produced. Solar, wind, electric grid improvements, electric cars, lithium production for batteries (just for you Sean), geothermal, and shale conversion are all areas to look into. With a massive market for energy, alternative resources which can lower their cost of production through quick consumer acceptance should ultimately reap the rewards of increasing market shares.
Fourth, the wireless and digital economies will see more consumer adoption for many years. With the growth of smart phones, wireless book readers, or any product which can be produced, distributed, and sold electronically, the digital economy will only become a more integral part of modern society. Younger generations are already increasingly forming habits on the internet using social networking, and look for the trend to continue.
Finally, a critical point is to focus on a specific industry and compare the competitive positions of the various companies in the segment. An investor only has so much capital available, so you want to find enterprises which you believe have the ability to last (balance sheet), as well as grow through intelligent reinvestment of profits. Ok, thanks for reading this month and as always, if you have any comments, questions, or concerns, please email me at info@y-hc.com.
As always, on any company mentioned here, past performance is not a guarantee of future returns. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charterholder.
Yale Bock, CFA
President, Y H & C Investments
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