Taking Stock

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By Tony Crowell
By Tony Crowell
Buy On The Rumors

The beat goes on. The Dow Jones Industrials closed Wednesday at the tenth consecutive record level for this index. That’s the longest record streak since January 1987 when the market hit 12 consecutive record days. Stock investors overall seem to believe that the new Administration will be able to boost corporate earnings with tax cuts, fiscal stimulus and decreased regulation.

Since November, the market’s advance has been remarkably regular. The last time the broad market lost 1% was back in October. After a brief hiccup in January, stocks resumed their advance and were up 1.8% in in January. This month’s not over but the S&P is up 3.8% so far in February. Should it stay ahead for the month, a nice correlation would develop.

Since 1945, there have been 27 years when the S&P gained in both January and February. The average then rose in every one of those 27 years with an average rise of 24%. February, historically the market’s second-worst month, isn’t over but it has a good start with less than a week to go. There is some logic to this as performance in the first two months offer an indication of how investors feel about the future.

There are several adverse winds developing that make it advisable not to crack on full sail. Margin debt is up, although modestly. Valuations have crept ahead of earnings growth. The Shiller cyclically-adjusted Price/Earning ratio is elevated while a simpler method based on the ratio between the S&P 500’s current price to the estimated future projections for the earnings of the 500 companies is almost 18, its highest level since 2004. That’s a caution signal as it is about midrange but it has increased in recent weeks.

Should the promised reforms ignite faster economic growth, earnings will increase, lowering the ratio, but investors should keep a weather eye on implementation of the promised changes. Meanwhile, the most immediate effect on the market may come from the Federal Reserve meeting March 14-15 that may well bring the first in a possible series of interest rate boosts.

The interest rate on the key 10-year bond is 2.4%, up a percent since the summer but down slightly so far this year. That is still a low rate by historical standards, giving the Fed some running room and its comments as we approach the Ides of March will be parsed thoroughly.

Pending the Fed meeting, it seems prudent to develop some cash reserves, perhaps 5% to as much as 20% of the value of stock portfolios. For “cash” I suggest closed-end bond funds with very short maturities. As the Fed takes incremental steps toward higher interest rates, bond prices will drop with the greatest slumps hitting the longest maturities.

Closed-end funds enjoy less marketing pushing than popular “mutual” funds and thus typically trade at moderate discounts from their asset values. I am using EV Limited Duration Income (EVV-$14) and Blackrock Limited Duration (BLW-$16). EVV currently yields 6.7% and BLW 5.7% with both paying monthly dividends. The “duration” of EVV’s portfolio is three years and BLW six years on a portfolio of slightly higher-grade bonds.

Franklin Universal Trust (FT-$7), a hybrid of one-third utility stocks and two-thirds medium-grade bonds, provides quirky diversification. Yield is 5.5% and it’s selling at a tempting 13% discount from net asset value.

Among our stocks, General Motors is increasingly attractive at a stock price of only six times earnings. Dividend yield is 4% with an increase probable this year. AMN Healthcare (AMN-$42) and Store Capital (STOR-$24) both beat earnings forecasts.

So did Nvidia (NVDA-$100) but it lost ten points as some analysts called it overvalued after its seventy point climb in a year. Warren Buffett said that analyst forecasts usually say more about the analyst than the future of the company. All four sectors of the company are doing quite well and it should not be sold because some analysts wanted the media to quote them.

Two Wall Street sayings are timely. The first is, “Don’t fight the tape.” Enjoy the present solid uptrend but bear in mind, “Buy on the rumor, sell on the news.” Investors collectively anticipate events and have bought stocks on the prospect of the new Administration launching various pro-business programs. When and if as these emerge, it is probable that they will disappoint some investors, triggering some selling. Cash is always handy at such times.

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

www.crowellroberts.com

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