From 9% to zero
Fear continues to dominate the stock markets as they come off a terrible quarter that left the S&P 500 stock average down 12% for three months and 8% for the first six months of 2009. It’s still up 12% for the last twelve months, a reminder that keeping perspective on investments is always helpful.
Current negative stock price momentum, egged on by the media, encourages investors to look toward the past. Frustrations resolving the oil spill and the wretched slow pace of restoring jobs are difficult barriers to looking toward recovery. While it may take a few weeks for the market to come out of its current skid, its future looks better.
The recent financial crisis led to many banks and other financial institutions being tarred, feathered and ridden out of town. This was richly deserved and scared other big companies into cutting back their expansion plans, trimming employees and building up cash reserves. These cost cuts and the disappearances of competition have created a current environment in which surviving companies, will disproportionately benefit in the early stages of the recovery.
This can be seen in the strong profit growth for most big U.S. companies in the last quarter of 2009 and the first quarter of this year. The prevailing gloom infected stock analysts yet the first quarter showed 78% of U.S. companies beat the earnings forecasts.
Analyst attitudes have not improved but corporate earnings have; results from the just completed second quarter are likely to continue to beat forecasts. The stage is set with record low interest rates, an accompanying absence of inflation (certainly free of any inflationary upward wage pressures) and record levels of cash hordes among the big companies.
In the stock market, valuations are remarkably subdued. Earnings for the twelve months for the S&P 500 are currently estimated around $88. At its current level of 1040, that’s a price to overall earnings ratio slightly less than 12, leaving plenty of room to the upside.
A liftoff to the upside will need something more than bargain prices for ignition. Causes could be a capped oil spill, positive earnings surprises or even some legislation achievements from Congress, although that may require Divine intervention. Pending these events, investors can ease their nerves by hedging with Ultra Short S&P 500 (SDS-$38), a derivative that replicates in reverse the price action of the S&P 500 by a 2:1 factor. With yields on cash reserves almost undetectably low, I suggest a bit of this to sitting on cash.
I still recommend higher yield corporate bond funds such as Credit Suisse Asset Management (CIK-$3) or Alliance Global High Income (AWF-$14. Both pay monthly distributions at a current 9% yield from diversified portfolios of bonds. ING Global Real Estate (ING-$6) has similar returns from a portfolio of REIT’s.
Readers have inquired about Tesla Motors (TSLA-$18), the new public developer of electric autos. As much as I am delighted to see innovative technology in this oil-dependent industry, I think its publicity may be ahead of its investment prospects. The popular auto sector has suffered for years from global excess capacity, now aggravated by surging growth in the growing numbers of competing Chinese automakers.
These competitive price pressures will bear on the forthcoming reoffering of General Motors stock although, like all taxpayer-stockholders, I hope this will be successful. Investors will probably be better off with stock in less glamorous companies like Waste Management (WM-$32). It yields 4% and its CEO spends time with his employees rather than running off to his sailboat like the CEO of BP (BP-$32), which yields zero.