Friday, March 29, 2013

"If Life Were Only Like This" - Great Woody Allen Movie Scene

I will be on vacation next week, so the next post to Random Glenings will be published on Monday, April 8.  

Until then, I thought I would leave you with this great clip from Woody Allen's movie "Annie Hall". I don't know about you, but wouldn't it be great if this could only happen in real life!

Thursday, March 28, 2013

Seven Reasons Not To Give Up on Stocks

With market averages trading at all-time highs, deciding whether to reduce or eliminate stock positions has become a favorite topic among investors.

A market correction after nine months of strong performance would not be unprecedented. Markets rarely move in one direction all the time, and so it should not come as a surprise if the stocks retrace some of their recent gains in the weeks ahead.

That said, in my opinion, I would not be changing stock commitments at this point, unless there will be a need for funds in the near future.

Many are worried that the global economies may slow as we head towards the second half of 2013.  However, as I discuss below, the direction of markets and the economy can often diverge markedly.

In addition, given the dismal track record of the economics profession over the past few years, I would be hesitant to make investment decisions based on any economic forecasts.

As I have listened to analysts and company managements over the past few months, most indicate that while sales trends are not necessarily robust,  business continues to show modest growth.

More importantly, from an investor's standpoint, corporate managements are keeping a close watch on the expense side, and should be able to maintain today's robust operating margins.  If this is the case, many will probably be able to grow earnings in 2013 in the mid to high single percentage range.

Finally, serious bear markets are typically preceded by tightening credit conditions, and there is little evidence of any unease in the bond markets today.

Here are my seven reasons to stick with stocks:

1. Central Banks Want You to Take Risk - Keeping interest rates near 0% makes it painful to hold cash reserves. Federal Reserve policy will likely remain accomodative for at least another couple of more years, as will the Bank of Japan and the European Central Bank.;

2. Stocks ≠ the Economy - Stocks can do well even if the economy struggles. Strategist Ned Davis looked at data going back to 1948, and found the correlation coefficient between nominal GDP and the S&P 500 is just 0.13.  Put another way, changes in GDP explain less than 2% of the year-to-year variation in stock prices;

3. Stocks Are Cheap Relative to Bonds -  The earnings yield of U.S. stocks is at their lowest valuation relative to bonds since 1980.  The dividend yield of the S&P 500 is 2.1%, compared to a 1.9% yield for the 10-year U.S. Treasury note; the last time stocks yielded more than bonds was in the 1950's. Stocks are not without risk, but they at least offer the best chance of earning positive real returns in the years ahead;

4. Investors ♥ Bonds - Bonds continue to be the investment of choice for many despite negative real (i.e. inflation-adjusted) yields. Individuals may have added almost $20 billion to U.S. stock funds this year, but this amount is only 3.5% of the withdrawals since 2007. Bond funds, meanwhile, have seen a $44 billion inflow so far in 2013, even with rates at historic lows. As investors become less focused on the 2008 bear market, and more aware of the meager bond returns they are earning, we are likely to see a significant rotation from bonds to stocks;

5. This Isn't 2008 - The S&P 500 is about +10% higher than where it stood 5 years ago, yet corporate profits are +50% greater. Corporate America has continued to prosper, but the market's valuations have not kept pace. Also, unlike 2008, credit markets do not show any signs of financial stress;

6. Corporate Cash Balances  - Corporations have stashed away more than $2 trillion in cash reserves. Managements will be under considerable pressure to deploy some of their hoard either in the form of share buybacks; dividends; or M&A activity. All three of these decisions would be favorable for stocks;

7. Pension Funds Are Underinvested In Stocks - Pension fund allocation toward equities has gone from 60% in 2005 to 38% today.  Meanwhile, allocation to fixed income has gone from 27% to 41%, despite the fact that most bonds do not offer rates anywhere close to assumed actuarial rates.  Eventually there will have to be some reallocation.

Wall Street estimates for the S&P 500 are for earnings to reach around $112 in 2013.  If you put a 14.5x price/earnings multiple on this figure (or about where we are trading now), you come up with a year-end value for the S&P 500 of around 1600, which is probably not a bad "guesstimate".

A Few Thoughts On Cyprus

This note from last week's Economist magazine makes an important point about the Cyprus banking crisis (I added the highlight):

Cyprus is odd, because virtually all its banks’ liabilities are deposits (as opposed to longer-term bonds). Yet, of the 147 banking crises since 1970 tracked by the IMF, none inflicted losses on all depositors, irrespective of the amounts they held and the banks they were with. Now depositors in weak banks in weak countries have every reason to worry about sudden raids on their savings. Depositors in places like Italy have not panicked yet. But they will if the euro zone tries to “rescue” them too.

The fact that the European Central Bank (ECB) is going to force depositors, not taxpayers, to take losses in return for an ECB bailout may mark an important change for investors to consider.

Here's the take of Gemma Godfrey, head of investment strategy at Brooks Macdonald and a frequent CNBC commentator:

So what does this mean for investing? Two interesting outcomes. Firstly, we may see a wider divergence within the banking sector as greater scrutiny over capital adequacy rewards some and punishes other. Funding costs within the periphery are unlikely to ease. Secondly, it casts a severe shadow over the value of stress tests to gauge the safety of investment in a bank. Cypriot banks passed tests in 2011, which raises doubts over the veracity of the Fed’s own investigations which led to 17 out of 18 US banks passing. Optimism in both cases could be argued as too high.

With the Fed likely to remain accommodative, bullish market sentiment may continue to overshadow concerns elsewhere. However, Cyprus has highlighted that we’re far from an end to the crisis.

Much of the blame for the Cyprus crisis has been blamed on Russian "flight capital" seeking an offshore haven.

However, columnist Heidi Moore writes in the London Guardian that wealthy Russians had known of the bank problems in Cyprus for months, and had been moving assets to other safer locales, including New York:

The meltdown of the Cypriot financial system came as no surprise to well-connected, wealthy Russians, who bundled some of their money to the United States. "Many of our clients had a heads-up on this issue," said {New York attorney} Mermelstein. "Cyprus had started having the conversations about what it was intending, and that's been going on for half a year." 

That's why some wealthy Russians seemed insulted by the insinuation that the collapse of the Cypriot banking system this week caught them by surprise. Cypriot banks were suffering "substantial outflows" for weeks before the meltdown, according to the country's finance minister, Michael Sarris.

It was only a few years ago that commentators were writing of the ascension of the euro block nations versus the U.S. Now it would seem that the U.S. is the unexpected beneficiary of the turmoil in other parts of the world.

Wednesday, March 27, 2013

Looking for Sparks in the Energy Group

Energy stocks were disappointing performers in 2012.

While the S&P 500 rose by more than +13% in price last year, energy stocks gained only +2%.  Only the utility sector (-3%) did worse in 2012.

The energy sector has regained some ground in 2013, modestly outperforming the market averages, but as the chart above shows, the group still has a long way to go to draw closer to the S&P.

On Monday I headed over to Barclays to hear their integrated oil analyst Paul Cheng talk about the stocks in his group.

I have long been a fan of Paul's, and several of his recommendations over the last decade that I have been following him have made significant gains for my clients.

Paul's recent thoughts can be summarized as follows:  buy the refiners, but don't expect much from the rest of the stocks he monitors until late 2014, at the earliest.

The majors (which includes Exxon, Chevron and Conoco) are all in the midst of major capital spending projects to try to improve production.  Last year the majors all reported declines in oil production, and this year does not appear to offer much hope for any improvement.  It won't be until a couple of years from now that their expenditures yield any significant results.

In Paul's view, however, the majors continue to make sense for defensive investors.  Regardless of their 2013 production levels, virtually all of the majors have huge financial resources, and their dividends can be easily maintained if not raised.  If you have to own one, Chevron would be his pick.

In a startling contrast to Paul's tepid views on the majors, he is a raging bull on the refining stocks.

Despite the fact that many refining stocks have already moved sharply higher this year, Paul thinks that companies like Valero; Marathon Petroleum; and Phillips 66 could easily double from today's levels.

Paul thinks the market is drastically underestimating the earnings leverage that the refiners will enjoy from the combination of ample oil supplies and strong demand both domestically and internationally.  The U.S. is now a net exporter of petroleum products for the first time since the 1970's, and this trend is likely to continue as American refiners can operate much more efficiently and profitably than foreign competition.

The only real risk to the refining stocks, Paul believes, is if U.S. oil production declines from current levels - a prospect that appears unlikely given the massive spending that is ongoing throughout North America.

Tuesday, March 26, 2013

What's Dell Really Worth?

Last month I wrote a piece comparing Michael Dell's bid to take his company private to John Rockefeller and Standard Oil a century ago.

As I wrote on February 11, 2013,on Random Glenings,  when the Supreme Court ruled in 1911 that Standard Oil was to be broken up based on antitrust regulations, Rockefeller was unfazed.

I quoted extensively from Ron Chernow's excellent book on Rockefeller called Titan:

John Rockefeller - head of Standard Oil - was not fazed.  Here's what Ron Chernow wrote in his epic book Titan about Rockefeller:

Rockefeller reacted {to the decision} with studied nonchalance.  He was golfing at Pocantico with Father J.P. Lennon from the Tarrytown Catholic church when he learned of the decision, and he did not seem particularly disturbed.  "Father Lennon," he asked, "have you any money?" The priest said no, then asked why.  "Buy Standard Oil, " Rockefeller said - which turned out to be sound advice.

Chernow went on to write why Rockefeller was not concerned by the government's decision:

Those who had seen the Standard Oil dissolution as condign punishment for Rockefeller were in for a sad surprise:  It proved to be the luckiest stroke of his career.  Precisely because he lost the antitrust suit, Rockefeller was converted from a mere millionaire, with an estimated net worth of $300 million in 1911, into something just short of history's first billionaire...

What quickly grew apparent...was that Rockefeller had been extremely conservative in capitalizing Standard Oil and that the split-off companies were chock-full of hidden assets...

For years, the shares of Standard Oil had been depressed by the antitrust litigation, but with the litigation ended, they bounced back to a more normal level....

During the ten years after Standard Oil's 1911 dismantling, the assets of its constituent companies quintupled in value.

I then went on to Michael Dell's bid:

Michael Dell recently announced that he was leading a group of investors (including Microsoft) trying to take the company he started private.
Is Dell truly undervalued, or is Mr. Dell's move simply a sign that his frustration with Wall Street has gotten too great?

I am inclined to believe that Dell is worth far more than the the bid of $13.50 to $13.75 that Mr. Dell and his consortium are offering. Like Rockefeller, there are parts of the company that Dell knows that the Street is greatly undervaluing. Rather than try to convince investors to change their generally bearish view, taking the company private allows the true value of the company to be unlocked.

As you have no doubt read, several other money managers have now entered the bidding war for Dell, although their bids are not too different that Michael Dell's.

What was interesting to me, however, is the comments of billionaire investor Leon Cooperman, as quoted in this morning's New York Times:

Leon Cooperman, the billionaire investor and longtime Wall Street denizen, was railing on Monday about the deal of the moment: Michael Dell’s $24 billion effort to buy out the troubled computer maker he founded.

“Management-led buyouts are a giant case of inside trading by management against their own shareholders,” Mr. Cooperman told me, continuing: “Dell has a moral responsibility to work for his shareholders.

“He’s not doing this because he thinks his company is overvalued. He wants to make money.”

The article goes on to quote famed investor David Einhorn:

David Einhorn, the hedge fund manager, went so far as to suggest, perhaps cynically, that the swoon in Dell’s stock price in the second half of 2012 may not have been unwelcome inside the company.

“Michael Dell probably didn’t mind the stock falling,” Mr. Einhorn said on a conference call with investors recently. “For him, it created an opportunity. Now, he wants to take Dell private, and voilĂ !”

Still, it is also worth noting that Dell has struggled in recent years. Sales have been under pressure, and Dell's operating margin of 7% on revenues last year is not inspiring.  So it is possible that Michael Dell is becoming too emotional about the company that he started in his college dorm room two decades ago.

But I wouldn't bet on it.