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Taking Stock

Tony Crowell

What To Do Now?

It’s still the same old story, a fight between fear and greed. After the sound and fury of recent market swings, stocks seem to be stabilizing around nine percent below the levels at which they began the year. Disappointing, yes, but hardly the disaster some predicted during the Congressional debt deadlock and the rating downgrade on U.S. Treasury bonds. Investors who decided to jump into cash may be wondering how to get back in the game.

Stocks are still in a major uptrend, up 68% since their 2009 low. Their recent decline put them in a technical “correction,” a signal to tread carefully. The recent market swings coupled with the aggravations of the financial media have left many investors quite rattled. Such periods of high anxiety have proven to be rewarding for bargain hunters.

Three cross checks for buying are interest rates, stock valuation levels and prospective earnings growth. The first, interest rates, could hardly be more favorable with the Federal Reserve having pledged to keep short-term rates almost at zero until 2013. This makes a sweet spot for companies like Annaly Capital (NLY-$18), which borrows short-term to invest in higher yielding long-term securities. Its yield will vary but is currently 14%.

Valuations are also attractive. Falling stock prices and rising dividends have brought the yield on stocks in the S&P 500 above the bond yield on 10-year Treasuries for the first time in almost 40 years. The price to earnings ratio (“P/E”) of the S&P 500, using estimated earnings for 2011, is around 12-13, at the low range of historic ratios.

Earnings growth as related to the strength of the economic recovery is less clearly defined. Our economy is largely consumer based and the American consumer has taken dual hits from the housing collapse and continuing high unemployment. Partisan quarreling in Congress and among Presidential candidates continues to fail to show a unified purpose toward restoring vigorous economic growth.

Consumer confidence is understandably weak but other indicators such as export orders, oil prices and increasing business spending all point to a continuing economic recovery, not a second recession, as some fear mongers seem almost to advocate. Under far worse economic conditions, President Roosevelt correctly said, “the only thing we have to fear is fear itself.”

In stocks, I am confident that this period will soon be remembered as a remarkable buying opportunity for stocks in large, growing companies. McDonald’s (MCD-$86), the quintessential American company, is trading at 15 times 2011 earnings while yielding 2.8% from dividends increased annually for 34 years. Yum Brands (YUM-$49), with KFC, Pizza Hut and other lines, is stronger in China but I prefer McDonald’s more focused management.

For similar reasons, I recommend Coca-Cola (KO-$67) over Pepsi (PEP-$63), which seems to have given up trying to catch Coke, becoming the world’s largest seller of snack foods. Pepsi is probably helping the growth of Novo-Nordisk (NVO-$106), my largest position in healthcare. It is the world leader in diabetes care.

Another consumer products company, Unilever (UN-$33), which I recommended last week, has ignored the recent sell-off, possibly because of its remarkable global market penetration. Its 3.6% dividend will help market jitters. So will the 1.8% dividend from IBM (IBM-$162), at an unusually attractive valuation on prevalent market dips. Sales are headed for another record with its P/E only 11 on 2011 earnings and another year ahead of dividend increases.

These strong fundamental strengths will help build stock portfolios during market storms. As Sam (Dooley Wilson) sang in “Casablanca,” “The fundamental things apply/As time goes by . . .”

 

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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