Risk On, Risk Off
Wall Street loves jargon; its latest is “Risk on” or “Risk off” to label daily market swings. This is really only a more genteel description of the impact of greed versus fear on stock prices but it is a reminder of the importance of risk valuation in investment returns.
I have known investors to say, “I don’t want to take any risks.” That might be an understandable comment from someone who has suffered a nasty investment loss, or even an unhappy marriage, for that matter, but ignores the rewards that are available from realistic and sensible risk taking.
Investment analysts like to start risk analysis with the “risk-free rate,” usually 90-day Treasury Bills. This is currently one hundredth of one percent, about as low as a rate can get before going negative. This reflects a continuing flight from risk as buying pressure drives down yields. These low yields continue with longer maturities, reaching 2% only with ten-year terms. One-year CD’s average 0.8% and 30-year mortgages are quoted (but hard to get) around 4%.
One bit of Wall Street jargon beloved of bond traders is the “basis point,” which means a hundredth of a percent. T-bills, for example, a month ago were trading a single basis point higher. This slang might be useful for someone negotiating a home refinance to ask for “another five basis points” to enhance the negotiations.
Yields on stocks are well away from hair splitting differences calculated in basis points. IBM (IBM-$187), for example, yields 1.6% currently, almost as much as a ten-year government bond. IBM has also increased its dividend for 15 straight years. It has a high probability to continue to boost its dividends and its growing earnings are likely to lead to further increases in its stock price.
For investors, it is difficult to imagine why its stock would not be more suitable for almost any investor than a ten-year bond. An investor who dismisses IBM as “too risky” is probably insecure and one who insists on absolute certainty in investment valuations probably has issues with control. Either could easily recoup the costs of psychotherapy through more sensible risk to reward assessments.
Corporate CFO’s who need timing certainty in meeting obligations find bonds useful. So do professional traders who trade them using leverage. Investors should not try that at home, sticking to issues like Annaly Capital (NLY-$16). Annaly owns and manages portfolios of mortgage-backed securities. Its holders share in the income from the spread between the interest income on these securities and the cost of short-term borrowing by Annaly to finance these holdings.
Its current yield is 14%. Annaly also manages an affiliated REIT, Chimera (CIM-$3), which invests in more junior securities, and pays 17%. Both funds have a stated objective to provide attractive risk-adjusted returns to investors over the long-term, an objective that will be shared by rational investors taking a sensible view of risk. The obvious risk with the Annaly funds is a rise in short-term rates, pinching their spreads. With the Federal Reserve having committed to keeping short-term rates low through mid-2013, these funds remain very attractive.
DuPont (DD-$49) is another attractive risk-adjusted investment; its primary risk is sustaining growth in a challenging economy. The company just reported quarterly earnings of 69 cents a share, handily beating Wall Street estimates, as did its sales figures of $9.24 billion, up 32%. It also raised its earnings guidance for the rest of 2011 but still trades at only 11 times earnings with 22% growth expected. Its dividends yield 3.4% with further increases doubtlessly lying ahead.
Rather than trying to outguess the maneuvers of European heads of state dealing with the Euro mess, investors will do better using rational risk reward analyses. They also might bear in mind that the two successful big companies featured here, IBM and DuPont, both now have women as CEO’s. In my personal view, women have certainly presented risks but these have been greatly surpassed by their rewards.
Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1993. firstname.lastname@example.org 949.494.1376/