Four Actionable Investment Themes

This is a challenging time for individual investors.  I get emails from many who wonder what they should be doing.

While I offer weekly updates in my  Weighing the Week Ahead series, the advice is general.  I am going to share several specific themes that flow from my regular analysis.  While I am very careful in offering specific advice to clients, the themes that I am mentioning are worth consideration by everyone.

Worry about Bond Funds

Investors have rushed into bond funds — mostly because of the perception of safety.

In this article I explained why  bond funds are risky, and why those needing fixed income should instead purchase specific bonds.

Doug Kass has a record of some great calls on tops and bottoms, including stocks in early 2009.  He now is calling a major top in bonds. (from Business Insider and Barron's)

"Finally, my favorite short of the next decade is the U.S. bond market, for those that possess deep enough pockets, have the fortitude and the patience. I am long ProShares UltraShort 20+ Year Treasury [TBT], which is the inverse, double-short bond ETF. Over the past 2½ years, bonds have achieved a near 60% total return. A remarkable feature is the consistency of positive returns and the absence of many drawdown years of consequence. Nevertheless, they should be viewed as a return-free asset class that is very risky. The 10-year yields under 1.5%, less than half the yield during the recessions in 2001 and 2008. That means I am paying over 65 times earnings for a 10-year-bond, a rich price even by Amazon's or LinkedIn's standards"

Whether or not you join Doug in trying to profit from a rise in interest rates, you should be wary about absolute losses in your bond fund.

Find a Growth Stock

Everyone can afford to own a growth stock.  Google (GOOG) is fine.  If you chose Facebook (FB), you were too early, but your time might come.  My favorite is Apple (AAPL).

Oppenheimer's Carter Worth, who has also been getting some well-deserved attention on CNBC's Fast Money program, had a helpful note on Apple last week. (See your OPCO rep for access).  He cited a very obscure fact — the number of times that Apple has declined 4% or more in a single day.  (answer to follow.

I have frequently noted the difficulty in trying to do short-term trading in Apple.  Those who sell have a problem finding a re-entry point.  The stock trades on news and psychology, with frequent gaps.  Those who choose to sell find themselves faced with "chasing" a rebound or perhaps missing a major rally.

If you subtract the $115 billion cash hoard and look at the P/E ratio on the rest of the stock price, you see a low single-digit multiple on a 20+ growth rate.  My own price target is $750, but it keeps moving higher.

(Carter Worth's answer:  92 times in 10 years).  I guess these were buying opportunities, as was last week's selling.  

It is notoriously difficult to time your entry in Apple.

  Find a Cyclical Stock

The current market prices cyclicals as if we were at the peak of the business cycle.  This means that the P/E multiple is at a low point, ignoring the strength in earnings.  Contrarian investors may choose to reject this notion, respecting the earnings strength of some of the leading companies.

My favorite candidate is Caterpillar (CAT).  The company announced great earnings, but like most others, refused to puff up future guidance.
I really like this choice.  Partly it is company specific, but I also think that we are in the early innings of an extended economic recovery — slower and longer than past examples.  The market has excessive fear of recession and too much emphasis on the "average" length of recoveries, even though there are only a few relevant examples.
The Fed has pedal to the metal for years to come, so this recovery will be slower and longer.
Find Some Enhanced Yield
For several weeks I have been citing the combination of buying dividend stocks and selling near-term calls as the best deal the market is offering.  You should be able to pocket 9% or so without any change in stock prices.  Readers have asked what sort of trades I am doing.  I have a method that is fussy about entry points, but many alternative approaches would work well.  Here is an example trade that I made for clients today.
In BlackRock Inc. (BLK), we bought the stock at 171 and sold the September 180 call for $2.00.  The stock is trading at a multiple of 13 or so with earnings growth over 20.  The dividend yield is (recently confirmed) at 3.5%.
If the stock does nothing in the next two months you will pocket the call premium of $2 and a dividend of $1.50, for a gain of over 2%.  If the stock rallies enough to get called away, you will make 9 points plus the call premium, for a gain of over 6% in two months.  If the stock declines, you will have a cushion from the call premium and the dividend.
The system requires finding good dividend stocks.  Many advisors suggest that this is enough, even without selling calls, so our "enhanced" method is a big improvement.
When I interview new clients I find methods that are just right for them.  Each person is different.
Despite this, nearly every investor can profitably include the ideas suggested here.

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  • Optrader0 August 1, 2012  

    Good post!
    One note: Hasn’t Kass called long bonds the “short of the decade” since 2010. I know he was buying TBT or calls on TBT back in August 2010.

  • oldprof August 1, 2012  

    Optradero — Doug was a little early on this call, as were many others. He has been more aggressive in recent days, so I thought it was worth noting.
    While I have also expected rates to rise for some time, it has not been a major theme (warning to investors) for me until recently.
    Summary: You are correct, and thanks!

  • Steve August 5, 2012  

    Since I’ve retired from Cat I have a huge Bias
    However like Cummings, Deere, Monsanto
    It’s not going away anytime soon
    It’s a ride both ways
    If you are on the wrong side just wait. Sometimes for a while but you can wait.
    Good call but I’m biased.

  • Sheldan August 5, 2012  

    Hello: There is a recent and compelling argument against shorting bonds at this time by Lacy Hunt and Van Hoisington (following work by Reinhardt and Rogoff).
    They claim that throughout history, when a government’s debt ratio gets extremely high, long-term bond yields remain quite low for extended periods – like a decade or two. That’s mainly because inflationary pressures in low-growth times, such as the present, are nil.
    They, as well as Gary Shilling, predict LT Treasuries might get to 2.0 percent or below, and that future investors will view today’s 2.5% yield with envy.
    Even so, at age 68, I’m a bit wary of taking an aggressive position on either side.
    Thanks for your very insightful commentaries.

  • David August 5, 2012  

    In reference to Doug Kass’s investment in TBT, you cautioned us to be “… wary about absolute losses in your bond fund.” Would you please expand on this. Thanks! David, a faithful follower

  • oldprof August 5, 2012  

    David — As we know, if interest rates go higher, the price of a bond moves lower. This is necessary for the coupon payment to match the market yield.
    If you own individual bonds as part of your portfolio, and you do not plan to sell the bonds, unless the company defaults you will collect your full principal and interest — no absolute losses. The portfolio is lower on a mark-to-market basis, but you do not care.
    Now let us suppose that you and I form a partnership to invest in bonds (a simple bond fund). Now try the same scenario. Interest rates move higher and the price of our bonds moves lower. We still collect the expected coupon and can plan to get our principal back at maturity.
    But I change my mind — either due to preferences or other personal reasons. I want half the money in the partnership, which is forced to sell the assets at current prices. Your losses are now locked in, since you could not hold to maturity.
    I go into a little more detail here:
    Fixed income investors should consider buying their own bonds.

  • oldprof August 5, 2012  

    Sheldan — To determine the risk you need to decide whether the data from all of the other countries is actually relevant for the current US situation. This step is usually skipped by pundits citing the R&R book.
    As to taking an aggressive position, I am not short bonds nor are my clients. I bring this up to suggest that you should consider replacing your bond funds with individual bonds. That is the conservative position.
    Thanks for bringing this up.