Taking Stock

Tony Crowell
Tony Crowell

The Tree in the Forest

If a tree falls in a forest and no one is around to hear it, does it make a sound? This philosophical thought experiment reminds me of the muted manner in which the financial media is reacting to stock market averages climbing to new highs. During the past month, each of the three major market averages has set a new closing high and the media treated these new records as almost routine.

Granted, we are in the sixth year of a bull market, however, new highs quite often beget more new highs. Investors seem nervous, a welcome change from the euphoria that swept them up at previous market highs. Memories of the severe market collapses of 2007-2008 are still vivid and today’s worries over interest rates, currency issues and concerns of the survival of the European Union are keeping a lid on investor emotions.

These well-publicized concerns are probably already incorporated in market valuations, a popular subject of various gloomy cautions about possible stock overvaluations. The “Tobin Q” ratio, for example, which compares market values to replacement costs, has indicated overvaluation for most of the last 25 years. Price-to-earnings ratios are above their historic average but such ratios mean little in isolation. Many investors follow prices very closely, often too closely, overlooking the critical importance of corporate earnings to these ratios.

The recent slump in oil prices set back the energy sector while relative strength of the dollar has retarded export growth. These issues are cyclical and earnings growth in leading sectors appears headed for double-digit growth this year. The Federal Reserve will ultimately end its eight-year streak of interest rate cuts, probably this fall, provided economic growth continues. Even if they use skywriting airplanes to warn us, Wall Street sometimes denies reality and a brief sell-off is probable until investors get their wind back.

Interest rates are already creeping up. Ten-year U.S. Treasury bonds are up to 2.26 percent from 1.87 percent in March. These are still low rates historically but the end of the nearly zero-rate honeymoon will stagger long-term bonds. Leveraged companies like many REIT’s should be avoided. Mortgage rate increases may stifle the recovering housing sector.

Soaring earnings keep technology and biotechnology stocks ahead of the general market. Among prior buys, Celgene (CELG-$116), reported positive Phase II reports for a drug addressing Crohn’s disease. Its 2015 earnings will be around $4.75, up 28% from $3.71. New recommendation CVS (CVS-$104) is buying Omnicare, expanding its senior care programs. Applied Materials (AMAT-$20) dipped after regulatory concerns stopped its merger with Tokyo Electron. It then beat estimates for quarterly sales and earnings and forecast double-digit gains for the next few years.

Aetna (AET-$114), the large health insurer, is a new buy following its strong first-quarter earnings and increased guidance for 2015 from its earlier already raised guidance of “at least $7.00” to a range of $7.20-$7.40. This superior performance follows the company’s innovative announcement in January that it was raising the wages of its lowest-paid employees to at least $16 an hour. Its CEO pointed out that he expects reduced expenses relating to employee turnover and higher productivity from better pay.

Irvine-based Broadcom (BRCM-$47), another new buy, surprised Wall Street with earnings revisions up seven percent to around $3.00 for 2015. This leading developer of semiconductor solutions is a major supplier to both Apple and Samsung. It is very reasonably valued and there is even a 1.2% dividend with four straight annual increases.

On balance, economic and market indicators are favorable. Investors should anticipate the unexpected by sticking with quality stocks. A degree of healthy skepticism is always useful in this business. After all, someone said, If a man speaks in a forest, and there is no woman there to hear him, is he still wrong?

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 1995. [email protected] 949.494.1376/800.697.2622


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