From Shutdown To Surge
Only a few weeks ago, political dysfunction shoved the nation to the edge of financial default. The government shutdown was damaging enough but a failure to raise the artificial “debt ceiling” would have led to an unnecessary default on U.S. Treasury bonds. These are the medium of exchange for all major global financial transactions. Two centuries of well-intended foreign policies coupled with what became the world’s leading economy have made trillions of dollars outstanding of Treasury securities into the “risk-free” assets through which the global economy is financed.
Nearing a deadline, Congress deferred the issue to next January. Had a default occurred, the stock market would undoubtedly have suffered an October decline rivaling the October crashes of 1987 and 1929. Remarkably, investor polarities reversed and stocks enjoyed a blissful October leaving market averages near record levels poised for the largest annual increase since 1997.
This momentum may continue in the absence of attractive alternative investments. Interest rates are beginning to creep upward but still remain at very low levels with 12 month Treasuries paying a tenth of a percent. Bonds with longer terms pay higher yields but the mere prospect of higher yields drives bond values down.
Pimco’s much-publicized “Total Return” bond fund lost this week its position as the world’s largest mutual fund. Small wonder as it is down 2.3% this year while the Dow Jones Industrials and S&P 500 stock averages are up over 20%.
In the EuroZone, forecasts for growth in 2014 were cut to 1.1% with unemployment to remain stuck around 12%. This dreary outlook demands selectivity in choosing stocks. It has also tempered stock valuations of European companies, enhancing their relative value as market momentum builds here. Continuing recommendations include ARMH Holdings (ARMH-$46) and Diageo (DEO-$127) in the U.K., China Nat’l Offshore Oil (CEO-$195), Jazz Pharmaceuticals (JAZZ-$94) in Ireland, Luxottica (LUX-$52) in Italy, Nestlé (NSRGY-$72) in Switzerland, Denmark’s Novo-Nordisk (NVO-$171) and Japan’s Toyota (TM-$126).
Among stock sectors, energy has been much in the news with the prospects that exploration of shale deposits will return the U.S. to its former status as an exporter of energy. This increasing supply and an accompanying slowing of demand are depressing oil and natural gas prices. Investors should emphasize more dynamic sectors like Technology and even Finance.
In Tech, venerable companies like Cisco (CSCO-$23) and Intel (INTC-$24) are finally developing some momentum. Their strong finances will be helpful whenever stocks should stumble. IBM’s earnings growth slowed and it will require patience. All three offer attractive yields from regularly raised dividends.
The better behaving financial stocks are those removed as far as possible from the mortgage and housing industries. There still appears to be a hangover of unresolved mortgage issues, particularly among banks. Insurance companies have a clearer field and previous recommendation Prudential (PRU-$84) demonstrated that with a solid quarterly earnings report, up over 30% from last year.
American Equity Investment Life (AEL-$21) is a much smaller company ($2 billion sales) trading at only eight times current earnings. The company focuses on underwriting and selling annuities and related life insurance products. These are typically more profitable for those creating and marketing them rather than the purchasers.
Earnings increases look to be in the 7-10% range, dropping its P/E ratio to seven on estimated 2014 earnings. The dividend yield is only 0.7% but the company has increased its dividends for nine straight years.
Overall, stocks are selling at about the middle or their historic valuations of earnings. During market cycles, they seldom hang around this middle as their stock prices surge and then correct. We are entering a historically strong period with November and December posting price increases 82% of the years since 1928. The odds are favorable for continuing advances through December. We will then again face in January the resumptions of our Congress quarreling over fiscal policy and the “debt ceiling.” As Will Rogers said, “The country has come to feel the same when Congress is in session as when the baby gets hold of a hammer.”
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/