Taking Stock

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By Tony Crowell
By Tony Crowell

Breaking Records

Another day, another record. Led by the broad S&P 500 Stock Index, the Dow Jones Industrial Average and the Nasdaq Composite Average are scoring record highs. These broad concurrent moves are without precedent and demonstrate buying strength throughout diversified industry sectors.

The severe financial recession of 2007-2009 cut deeply and the market’s strength is partially based on recovery from overshoots to the downside. This recalls the recovery from the Great Depression, which remains the only tougher uppercut to the stock market. In nominal terms, that took 25 years although factoring in dividends reduces this interval.

Today’s broad moves point to new records ahead although they raise concerns of possible overvaluations and of developing fragility as a result of investor greed. CNN publishes a “Fear and Greed Index” based on seven market indicators. It is currently at a disturbing 92, showing “Extreme Greed.” A month ago, it was at 36, reflecting “Fear.” The Dow Industrials are up a thousand points since then, illustrating how investor emotions are usually overreacting in the wrong direction.

Presently, the technical strengths of the market are likely to continue the parade of new highs but investors should use this gauge as a cross check for their own emotions. A correction of 10% or more is historically inevitable, best countered now by overweighting portfolios with stocks in strong companies like Apple (AAPL-$154), Amgen (AMGN-$186) and Morgan Stanley (MS-$49).

Greed and lead to problematic stock valuations as happened in the infamous “dot-com” market of 2000-2002 that took average Price/Earnings ratios above 200. Successful investors like Warren Buffett use interest rates as a less emotional aid to valuations.

In a CNBC interview this week, he pointed to the current 10-year Treasury bond yield of 2.3% and his belief that stocks will do considerably better than that. He said that if interest rates on the ten-year were at five or six, [As they last were in 2007.] there would be a wholly different valuation standard for stocks. Pointing out that no one really knows where interest rates will go, he hypothesized that if interest rates were 100 basis points [1%] higher in three years, stocks would still be cheap. If 300 or 400 basis points, they won’t look cheap.

Yale Professor Robert Shiller is another of my mentors and his 10-year P/E ratio is at its highest level since the dot.com bubble of 2000. He points out he still owns U.S. stocks and that his indicator was never intended as a short-term market indicator, “short-term” meaning one to two years.

Investors who think they are investing while listening to the latest headline news should remember that definition of “short-term.” A week is not long-term. Developing patience will probably help gaining increased abilities for accepting calculated risks.

That could include the housing sector, which is buoyed by low rates and a persisting shortage of new homes. Toll Brothers (TOL-$42), a new buy recommendation, is a nationwide builder of luxury homes. Its recent quarterly report reflected an 18% increase in sales with a 42% gain in earnings. This marked the twelfth consecutive quarter of year-to-year increases.

The company raised its 2017 guidance to a band of $5.6 billion to $6 billion compared with $5.17 billion in 2016. It forecast home deliveries in a range of 7,000 to 7,300 units at average prices of $800,000 to $825,000. Analysts forecast 2017 earnings per share at an average of $3.19, up from $2.18.

Both the Dow and the S&P 500 are up 13% for the first nine months of 2017. There will be dips, as always, but further gains are probable. Many of our stocks have enjoyed good runs and might pause for a few beats. Current strong buys include semiconductor equipment makers Applied Materials (AMAT-$51) and Lam Research (KRCX-$182). Among banks JPMorgan Chase (JPM-$97) and Bank of America (BAC-$26) are quite attractive. Mr. Buffett spoke very highly of BofA in his interview.

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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