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Taking Stock

Tony Crowell

Stocks Send Vote Of No Confidence

The stock market sent a vote of no confidence in the government or in the economy, losing 15% in two weeks. The economy continues to make slow improvement; our government does not. Its fiasco in allowing an artificial debt ceiling to become an international financial crisis was avoidable and inexcusable. The country was held hostage by a self-centered pack of partisan peacocks.

This self-inflicted wound was followed by the loss of the country’s AAA credit rating. This had been its initial rating made in 1917 soon after establishment of Moody’s, the first credit rating agency. By coincidence, 1917 was also when Congress passed the original debt ceiling legislation in connection with funding the U.S. entry into World War I.

War is an expensive undertaking, particularly with modern technology. Over half of total federal spending goes for war, when the amounts are included for veteran’s benefits and medical costs for past wars, as well as the current defense budget and the supplemental amounts for the conflicts in Iraq and Afghanistan.

The Constitution gives Congress the power to declare war but the last declaration of war by Congress was in 1941. Since then, it has proven much easier to get into wars than to figure out how to pay for them. Some more effective restraints than the present War Powers Act seem appropriate. The brave men and women of our volunteer armed forces shoulder the human costs of our wars and revival of the draft might increase the sharing of their burden among the moneyed class.

Only partisan quarreling prevented a rational solution to our nation’s balance sheet issues. Besides spending almost as much on defense as the combined total of the rest of the world, the U.S. spends much more than any other developed country on medical care. It also has the lowest tax rates. These last two areas alone provide enough potential savings if approached rationally to have prevented the debt ceiling mess.

With the recent tax cuts due to expire next year, taxes will almost certainly be the next subject of Congressional debate. Its recent performance suggests that Standard & Poors may not be off base in its downgrade if it focused with the traditional banker’s emphasis on the “character” of a borrower. Despite now having only an “AA+” credit rating, U.S. government bonds are so highly sought after by nervous investors that recent frantic buying drove Treasury yields to record low rates. I suspect the S&P raters may be looking at the U.S. government as an old fashioned banker might assess the credit risks of the richest family in town after learning they had developed assorted drug addictions.

With the stock market souring rapidly, I bought ProShares Ultra Short (SDS-$25), a hedging fund structured to rise when the market dips. I also added to Goldcorp (GG-$50), which remains reasonably valued amid all this turmoil. Unfortunately, the turmoil has damaged not only investor confidence but also consumer confidence, which may slow down our economic recovery.

Any stimulus spending seems to be a political impossibility, thus the economy will have to continue its recovery on its own with growth this fall increasing only slightly. With the economy in slow recovery while the Congress is in rehab, stock selection must emphasize large cap companies with solid growth and dividend prospects.

Unilever (UN or UL-$31) fits nicely. Sales are $65 billion in 180 countries, with an increasing share in emerging economies. It yields 4% and trades at only 12 times earnings with earnings growth approaching 10% from growing sales to newer markets.

The Federal Reserve guaranteed low interest rates until 2013. This makes higher yielding dividend stocks and bond funds even more attractive. One beneficiary is Annaly Capital (NLY-$18), a REIT currently yielding 14%. Annaly borrows short-term to finance long-term mortgage holdings. The obvious risk is a spike in short-term rates, which the Fed has ruled out for now.

Our stocks have weathered this gale in good shape with our emphasis on large cap stocks while steering clear of banks and the housing sector. I expect this strategy to provide us with good returns for all of 2011 after this storm blows out.

 

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. [email protected] 949.494.1376/

800.697.2622 www.crowellroberts.com

 

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