My Dog Is Smarter Than The Market

All Gertie cares about is food, sniff walks, car rides, favorite toys, and napping. As long as her five favorite pastimes are regularly available, Gertie is content. She knows what makes her life comfortable. She doesn't get confused by distractions.

The stock market is all about distractions. The job of the successful investor is to not get sidetracked by those distractions. Think of Warren Buffett and his ability to see clearly by living in Omaha and always remembering his Ben Graham teachings, not the latest fad or concern of Wall Street. We are bombarded by news that seems important, but isn't.

Today the market exploded because consumer confidence was improved. That market survey took the Dow up 200 points and consumer stocks like Cracker Barrel Restaurants up 10%. Earlier, traders were worried about North Korean nuclear tests. Rather than reacting to extraneous events like surveys and rogue nations, the smart investor needs to be focused upon items that really matter.

 With breakeven points lower, the missing ingredient for celebration is sales growth. A resumption of demand will result in wonderful profits on the lowered cost base. That growth may be a long time coming, not just around the corner because consumers say they are more positive. Unless you are really confident that the "greenshoots" are valid, and imminent, I'd recommend staying with steady, dividend paying stocks. We've dropped a huge percentage from the market top and only bounced back a small amount. Waiting for a clear signal is the prudent approach. Like Gertie, an investor needs to know what is truly important. That is sales growth. If volumes are dropping a company has to continually lower its breakeven point; necessary but not positive. Don't bet the farm until you see demand return.

If you can't wait consider Olin, the manaufacturer of chlorine products and Winchester ammunition. Nicely diversified, OLN has been growing ammo sales while it's industrial chlorine sales lag. But volume is UP. Better still is that you can buy it for 3.5X cashflow and get a 6.5% dividend. The dividend payout ratio is modest so the dividend is safe for the forseeable future. OLN sells for $13 and has $3 in cash. I've been nibbling for awhile. Gertie has her 5 keys to a good life and I have 4. Growing sales, modest debt, a safe dividend, and a low EV/EBITDA entry price. Olin passes the sniff test.

Time to nap with the dog.

Wall Street Logjam Breached

Today Ford announced that they were going to offer about $1B of new common equity. The Ford news comes on the heals of bank announcements of successful equity offerings. On the debt side of capital raising, MicroSoft said it will sell debt, totalling $8, for the first time in its history. This offering follows Whirlpool and several industrial companies to the debt markets. After months of paralysis capital markets appear on the mend.

Bullish market forecasters have consistently touted the huge cash horde of institutional investors and opined that it was key to a mighty rally when finally deployed. It appears that the current market rally has been prying loose some of that idle cash. Additionally, there is an appetite for new stock and bond offerings. While it is good for the economy that capital is starting to flow again, it will lessen the strength of the stock market's rebound. Money that is invested in new issues of debt and equity, versus being deployed into already issued purchases, will reduce the pace of the market's rise. The new issues add to supply, thereby reducing demand. Since almost all new equity issues have been sold below the current market price, they inhibit the market's price recovery. 

All of the equity raising has been done by the marginally credit worthy, banks and auto makers, as they have needed to rebuild their balance sheets now that institutional investors have opened the door a crack. Credit worthy companies will follow the debt route as equity prices are too low to entice them to offer new shares. But now that water is getting through the logjam, they will come to market, at low interest rates, and sop up lots of institutional cash.

I've maintained that the economy isn't improving as fast as the market thinks and the current rally is overdone. Plus, Obama's antics are sure to bring higher interest rates and inflation. The willingness of professional investors to re-enter debt and equity markets spells competition for "risk free" assets [treasuries/agencies] and a continuation of the rate creep we are seeing. Smart companies are seeing the same thing or they wouldn't be issuing long term debt. 

Higher interest rates will present competition for stocks. That, plus the eventual recognition that the economy won't show a meaningful recovery for many quarters will cause stock prices to move downward over the next 6 months. RTPIX and dividend payers continue to make sense. 

WARM AND COZY RECOVERY

The dog needed to go out this morning and wasn't satisfied with the scents available in our fenced backyard. So, after some intense begging I agreed to take her for a walk in the neighborhood. Lots of dogs, activity, and aromas. But it was also 45 degrees! I beat a hasty retreat into the house in search of a polartec and socks. As I indulged her I remained warm and cozy, appreciative of the argyles that hadn't covered my feet in 6 months.

Investors and the media have been indulging their wishful thinking on an economic recovery and are starting to feel warm and cozy. Each economic datapoint is celebrated for its positive elements even though the actual statistic is terrible and proof positive that we are far from a healthy recovery. Bottoming is not necessarily indicative of an immediate, robust recovery. It's appropriate that companies have cut costs and driven down break-even points, but a recovery worthy of increased P/Es and rebounding stock prices should be driven by increases in sales volumes and adding staff. If the market overshot on the downside, maybe a slight bounce back was needed once it was determined that armageddon wasn't around the corner. But the move we've enjoyed since March is overdone, although it feels warm and toasty.

What's appropriate to invest in today? The same areas that have been prudent for the past six months. Defensive stocks that pay dividends, such as Waste Management and downscale companies like Aaron Rents. I write covered calls on holdings for current income and collect the dividends. Short term trades, on solid companies, as long as they stay trades, can garner a few dollars if the updraft continues. And with either a recovery coming or the recognition that the US isn't the credit it once was, inverse bonds have worked well and will continue to do so.

Rydex's Rising Rate Fund [RTPIX] moves inversely to the 10 year Treasury yield. As rates rise the fund increases in value, the opposite of normal bond prices. They accomplish this with hocus pocus, which is a little scary, but it has been effective. Rydex also has some double funds but I'd stay away from that much financial engineering. RTPIX dropped like a rock in mid March when the Fed said they were going to be supporting the real estate market by buying bonds. The price dropped about a dollar, but has since gone upward now that the 10 year is yielding 3.25%, up from about 2.50%. Fed announcements may push yields down again, but the longer term trend is upward. That's good for inverse funds.

The U.S. has a huge amount of debt outstanding and most of it is of rather short duration. Additionally the government will borrow another $2 trillion dollars to fund the current 2009 deficit! We currently have a Congressionally mandated debt limit of $12 trillion that will need to be raised later in 2009. Tax receipts are also going to be woefully short of projections due to lost employment, lack of capital gains, lower Wall Street incomes, and corporate earnings. Exporting economies and central banks have less reserves available for treasury purchases as economies around the world are suffering and must be supported. Competition for money and the recognition that the U.S. is not as credit worthy as it once was will pressure yields upward. I've had a RTPIX position and plan to keep it as rates are not going down. We don't need a recovery to cause rates to rise. RTPIX feels like my socks.

Conspicuous Consumption Is Dead; WalMart & McDonalds Rule

The elimination of home equity, HELOC availability, home equity cashouts, consumer credit card lines, small business credit card lines, and unbridled commercial real estate lending has caused a generational shift in spending and lifestyle. Consumers are attempting to save more and spend less. The spending that is occuring is going downscale. Our economy has changed.

The past three days I've been driving through the South, heading back to Nebraska for the Summer, trying to avoid viscous Spring storms that have blanketed the mid-section of the South. My path has taken me through parts of Florida, Alabama, Mississippi, Louisiana, Arkansas, Missouri, Iowa and tommorrow, Nebraska. My observations have been consistent. WalMarts and McDonalds are packed with customers while enclosed shopping malls and Starbucks aren't. America has traded down.

I'm not talking about just the unemployed or those that have experienced housing and credit problems. All of my acquaintances have been spending less and re-evaluating their lifestyles. Net Worths are still large and incomes, though reduced, very adequate. Still all feel compelled to spend less and wiser. This is good for our future, but going to be difficult for the present. The entire country is reverting to a Warren Buffett lifestyle. America is starting to live within its means.

The market has been bouncing back with avengence lately, although it does appear to be driven more by short covering than conviction buying. The move has been especially good to low priced stocks. Little thought has been given to the change that I have described. Many old, worthy companies will not be worthy of the bounce back as the consumer isn't going to participate like he/she has the past decade. 

I don't think the rally will last, but if I'm wrong I think the safest bet is to go downscale and own those names that are attractive to a newly wise consumer, low, middle, or upper income.