Taking Stock

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Tony Crowell
Tony Crowell

How High The Moon?

Stocks are marking time near 21,000 on the Dow, up 3,000 points in four months. With so many uncertainties and political rancor dominating the news, the market’s ability to hold this level might cause some wishful investors to echo a once-famous economist who predicted that stock prices had “reached what looks like a permanently high plateau.”

That was Irving Fisher, holder of Yale’s first Ph.D. in economics, who made this famous prediction nine days before the stock market Crash of 1929. As the Great Depression dug deeper, Dr. Fisher, the first “celebrity economist,” continued to assure investors that a recovery was imminent, losing most of his personal fortune and academic reputation.

Investors are forever asking what the market will do. No one really knows and the more useful inquiry is into the strategy and tactics to be actually employed based on assessments of the economy and the prospects for stock sectors and their leaders. This inquiry usually points toward market valuation at one of three levels:

  • Fairly valued to moderately overvalued
  • Undervalued after a big dip
  • Way overvalued

Quickly discarding Dr. Fisher’s “high plateau,” today’s market seems to be in the first level, which is best handled with stocks in high-quality companies that I have emphasized in this column like Apple (AAPL-$138) or Amgen (AMGN-177). The second category, last seen after the Financial Recession in 2008, rewards aggressive buying of smaller, speculative companies. The third, which could be just over the horizon, calls for cash.

Professor Robert Shiller, winner of a Nobel Prize in Economics, teaches Financial Markets at Yale, where his reputation outshines the unfortunate Dr. Fisher. His Shiller P/E expands the earnings of the familiar Price/Earnings ratio to include inflation-adjusted earnings for the past ten years. The historical mean average of the Shiller P/E of the S&P 500 is 16.7 and its current value 29.6, a caution signal of overvaluation.

The current 10-year measuring period includes the crummy earnings during the 2007-2008 recession, pushing the ratio higher. Still, periods following readings over 20 have pressured investment returns. This month marks the eight-year anniversary of the current bull market, a reminder that successful investors do not give into emotion-based selling.

Since the fearful days of March 2009 when the Dow was around 6,500, it’s up 200%. Gold gained 31% and oil 17%. Visa (V-$88) is up 500% and Apple 1000%. There were plenty of price drops during those eight years but investors who stuck with quality stocks did well.

Much of the market’s rise since November seems fueled through investors anticipating that promised cuts in taxes, reduced regulation and spending on infrastructure will breed surging corporate profits. All these may yet occur but political changes are always uncertain and subject to all manner of delays. Stocks got off to a solid start this year but investors should review their positions, viewing them as they might appear after a ten percent market correction.

This view will be happier with positions supported by reserves in short-term bond funds. In addition to closed-end funds like Eaton Vance Limited Duration (EVV-$13), I am buying Vanguard Short-Term Bond ETF (BSV-$79).

Investor portfolios should always consist primarily of growing blue-chip stocks. Besides Apple, Amgen and Visa, our big ten include Nvidia (NVDA-$97), Amazon (AMZN-$850), Broadcom (AVGO-$221), Celgene (CELG-$124), Danaher (DHR-$87), Novo-Nordisk (NVO-$33), General Motors (GM-$36) and Morgan Stanley (MS-$46). Coming up fast are JP Morgan Chase (JPM-$91), Huntington Ingalls (HII-$213), Applied Materials (AMAT-$37) and Microchip (MCHP-$73).

The newest stablemate is Essent (ESNT-$34), a rapidly growing provider of mortgage insurance for homeowners. The company was founded after the home mortgage bubble burst and is thus not burdened with ghosts of bad underwriting. It earned $2.41 a year ago, a P/E of a modest 14, and rising housing starts will keep it on pace for double-digit growth.

Centering stock investments on growing blue chips is the heart of Mr. Warren Buffett’s strategy. It should be for all stock investors.

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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