Hiding From Risk
Stocks kept their course during a challenging quarter. After selling off in May and rallying in June, the market ended off three percent for the three-month period. For the first six months of 2012, the Dow Jones Industrials gained five percent and the more broadly based S&P 500 index was up eight percent. Our portfolios were ahead of these benchmarks, outperforming them in both up and down markets.
As always, we can’t look back at our wake but must anticipate the risks and rewards of our course. The media do such a thorough job of informing us of every adverse development that they have succeeded in maintaining investor attitudes of nervous anxieties. The result has been a continuing menu of quite reasonable valuations on most stocks in the midst of an interest rate environment at record lows.
These factors normally induce a stock market trading substantially higher than today’s levels. It seems that we are fated not to live in normal times, whatever they are or were. The leading worries are the unsettled political and fiscal conflicts in the U.S. and the monetary and economic turbulence in Europe.
Stock markets rallied at the close of the quarter as initial steps among European leaders indicated recognition of the common merits of working together toward a solution, an approach that would be a good idea for our Congress. The Euro Zone problems are complex and will take time to resolve.
Investors will benefit from patience. After all, it took over a decade after the Declaration of Independence for the 13 original American colonies to agree on a Constitution. These colonies had all incurred debts that they were unable to pay. Ratification was assured only after the newly formed federal government assumed the indebtedness of the 13 original states. The country was thus founded on its first government bailout.
Those were riskier times than today although the subdued levels of stocks might suggest otherwise. This fear of risk causes many investors to pursue artificial safety in government bonds or overvalued popularized stocks. Johnson & Johnson and Proctor & Gamble are good examples. These are fine companies with solid balance sheets but their stock prices have gone nowhere over the last five years. In contrast, stocks usually seen as less solid like Deere (DE-$82), Cummings CMI-$99) and Costco (COST-$94) are up about 50% in five years despite the market having lost five percent.
With investors still fleeing from their perceptions of “risk,’ stocks seen as “riskier” like these have been sold off to quite reasonable value and are buys. Costco is a new recommendation. It is is mirroring the success of TJX (TJX-$44), the successful operator of discount stores like T. J. Maxx.
FMC (FMC-$54) is also a new buy. Founded in 1883, it is now a global chemical company with leading positions in the agricultural, industrial and consumer markets. Its technologies improve delivery of medications, enhance foods, power batteries, augment crop yields and advance manufactures of ceramics, plastic, paper and textiles.
These uses are all cyclical but the company has achieved growth over the past three years well over ten percent in both sales and earnings. Current estimates look to earnings for 2012 of $3.40 to $3.50, up 15%, a price: earnings ratio of 15.
The U.S. political uncertainties will be resolved, at least temporarily, in four months. It is conceivable that the new Congress might make some progress toward cleaner energy. Cummings is ready with advanced Diesel engines.
The surest beneficiary would be natural gas producers. Exxon Mobil (XOM-$85) is the biggest producer of natural gas. Total sales are up to $500 billion, debt is low, the price: earnings ratio is ten, it yields 2.7% and has raised its dividend for 29 straight years. This is the same yield as a 30-year government bond, which has no prospects for improvement in either yield or value. The contrast in their ratios of reward to risk is laughable.
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/