Fagan Associates Archive for January, 2009

On May14th, Bruce Springsteen will be at the Times Union Center in Albany, NY. Springsteen has just released his new album “Working on a Dream”. Tickets for the concert will be $97 and $67 with the Albany arena seating a maximum of 17,500.

In April 1976, while attending Colgate University, I saw Bruce Springsteen along with 4,000 other fans at their hockey arena, Starr Rink. My ticket was approximately $5. As an aside, Springsteen played his usual array of “Tenth Avenue Freeze Out,” “Jungleland,” and “Rosalita.” Needless to say, this was a concert to remember and in hindsight the beginning of a budding music legend. By the way, the price of a gallon of gasoline averaged $0.60 per gallon during 1976.

Let me preface the balance of this column with the statement that Bruce Springsteen is my favorite musician. I am however, tired of being lectured by entertainers, sports stars and celebrities of all nature on how I should think and vote. Springsteen through his music and his off-stage statements has positioned himself as the defender of the “little guy” causing, in part, companies like ExxonMobil to continually defend itself against the title of “destroyer of the environment and bastion of corporate greed.”

Now to the crux of this article, if a gallon of gas had appreciated in lockstep with one Springsteen concert ticket (16 fold over the same time frame), we would be paying almost $10 for one gallon of gas. Why is it that Americans rarely complain about the private jets that entertainers use or the tens of millions of dollars that movie stars command? Why is it that we listen attentively to what these people say as if we were listening to our priest, reverend or rabbi but reject, almost entirely, all that our political and business people espouse.

Many times we get caught up in greed and American capitalism. Certainly executive compensation has been insane and certainly there has been unethical and downright illegal deeds done by corporations. However, there has been an immense amount of greed emanating from the “artistic community.” We think that this is hypocritical as many of these artists wax eloquently about how the rest of us should live our lives. Also, ironically, the media, rarely rails against the cost of Demi Moore’s latest movie or Bono’s latest concert.

Our thoughts are succinct. I’ll pay for the move/concert and you keep your political views to yourselves.

Late Thursday night, having arrived home from work and spent time with what really matters in life, my family, I sat down to watch the business news, do some work-related reading and review the current day’s carnage in the equity market. Ironically, after having read several articles both online and in hard copy, I couldn’t help but chuckle over two things, the first being the extreme level of pessimism out there and the second being the number of adages being used! So, in order to lighten up another dismal week on Wall Street, here are a few.

Evidence of “a watched pot never boils” can be seen in the ratings and revenue generated from advertising on the financial networks. Seems as if investors who couldn’t get enough of counting their money are now tuning back into real life, such as NCAA Basketball or the new episode of “Lost.” By the way, when did all of these reality shows begin to appear? While this may be bad for the business networks, this is good for the mental well-being of investors and good for the financial markets.

Needless to say, we have spoken with many clients over the past few weeks, and more often than not they say that they “wish they had sold all of their stocks a year ago and that maybe they will sell them now.” To that we respond, “why, so a year from now you will be saying that you wish you hadn’t sold a year ago!” We believe that unlike the Japanese economy and stock market, this will not last forever. Unlike Japan, the United States government has taken relatively quick and ultimately overwhelming action both on a monetary and fiscal front to combat this deep recession. This will fuel the rebound in the economy as the inventory correction in the manufacturing sector gets worked off. By the way, the Japanese economy, which has been in recession for nearly two decades, just reported another quarter of zero economic growth.

“There’s a tunnel at the end of the light.” No, that is not a typographical error, but a quote contained within an article illustrating the level of pessimism out there. Pessimism and fear is running rampant leading to a high level of volatility in the markets. Usually, when volatility is high, the market turns. That said, it is important that the major stock indices hold at or around these levels.

“Be patient.” Certainly, we have been using that statement a lot lately. But, it is true. Why is it that when there is a sale at your local grocery store, shoppers flock there like there is no tomorrow. However, when the stock market goes on sale, investors run for the exits. (Stop shouting! We agree that all of these shenanigans on Wall Street doesn’t help and is probably keeping investors away.) Historically, bear markets turn when there is indiscriminate selling of market leaders. Perhaps we are there now. Perhaps we have a little while longer. After all, stock market bottoms are a process and not an event. Regardless, we smell a major sale and are not ignoring it. We are speaking specifically to investors with more than a two year time horizon and not a trader with a two-day time frame.

Enough of the adages! Quite seriously, don’t buy into all of the negativity surrounding the current stock market. Recognize that in a down market you (and we) are going to make mistakes, and plenty of them. What we try to do is to identify those mistakes to learn from them going forward. One of the primary tenets of successful investing is not to beat yourself up over the mistakes, but as mentioned above, learn from them and look forward. Remember, a baseball player in the Hall of Fame only hits successfully thirty percent of the time meaning that he is unsuccessful seventy percent of the time!

This is now the time to look forward and, we believe, to perhaps buy another few shares of a company whose share price was much higher a year ago, but has come down, in part, due to the fear that investors are currently experiencing. Remember, buy low and sell high. Finally, don’t continue to live in the past, but rather concentrate on those stocks that will benefit quickest when the economy turns and you will see that your portfolio will “rise like a Phoenix from the ashes.” Oops, now there we go!

The year 2008 left investors gasping for breath, one that will go down as one of the worst years for investors. All investors, not just those invested in equities, are reeling from losses and are left scurrying for safety. Assets within money market funds and securities backed by our United States Treasury have ballooned as risk left the scene quicker than Elliot Spitzer.

We are confident that 2009 will be better (how can it not be?). Our projections for this coming year are based on a couple of assumptions, the first being that as the new year gets underway negativity will be in vogue at various points as the economic and corporate data that is released will paint a picture of an economy whose total output as measured by Gross Domestic Product will most likely shrink at an annualized rate of between six and ten percent during the first half of 2009. Any bouts of market upside will be met with skepticism. Skittish investors, those that believe it is different this time, will be scared out of the market again this year. That said, as sure as the sun rises after a cold, dark night, greed will eventually overtake panic and capitalism will once again win out.

Despite the sour economic news, a new sense of optimism will arrive along with the administration of President Barack Obama. Eventually, many who believe the glass is half empty will now look at that same glass as half-full. The psychology of the American economy and along with it the American Economy will improve as we progress throughout this New Year. Furthermore huge government infrastructure programs, meant to upgrade the bridges, roads, tunnels and schools of our nation, whose price tag will approach $1 trillion will mask economic weakness and create jobs.

Change is coming not only to Washington but throughout the United States. Last year around this time, consumers labored under $4 per gallon gasoline. Any discussion of lower energy prices was met with a lecture on supply and demand theory from economists. We even bought into the higher energy prices forever scenario. But, lo and behold, the unthinkable happened and gas prices tumbled. It is our belief that the unthinkable will happen again in 2009 and that is that the markets will make their way higher as the year progresses. We believe that slowly the pendulum is shifting and the risk will once again be with those that our out of the bond and stock markets rather than in them.

With the above in mind, the following represents our “Nine Investment Themes for 2009.”

Number One, all good things must end. Absent economic Armageddon, the rally in U.S. Treasury prices has pushed the yield to levels that make them wholly unattractive. The yield on the ten-year U.S. Treasury is currently 2.37%. We believe that investors should sell longer dated Treasuries and invest the proceeds into corporate bond funds. They should consider Loomis Sayles Bond (LSBRX) as well as the Oppenheimer International Bond Fund (OIBAX), both of which were pummeled during 2008 along with the “non-treasury bond market” but have solid long term records. In addition, the Oppenheimer International Bond Fund may also benefit from a dollar that could weaken during the year as our national budget deficit mounts.

Our second investment theme for 2009 is “big is beautiful.” We are both 6′4″ and weigh over 200 pounds (please no scales)hence big is something we embrace. The economy has shredded the competition for some of America’s larger companies, also known as “category killers.” Consider Bed Bath and Beyond (BBBY) which has delivered a knockout punch to Linens ‘N Things. Nike (NKE) continues to run circles around its competition as it benefits from a strong balance sheet and strong international sales. Finally consider Intel (INTC) as its balance sheet has $12 billion in cash, a seventy percent market share and is built to withstand a weak economy as its major competitor, Advanced Micro Devices (AMD) struggles.

Number three, don’t get too comfortable. This market humbles everyone so it makes sense to get paid to wait. Dividends are an important component of total return with U.S. Treasury yields at these historically low levels and Certificates of Deposit yielding a nationwide average of barely two-percent for a one-year commitment. How about an investment in Verizon Communications (VZ) with a dividend of 5.3%? FIOS and the Blackberry Storm are providing some pizzazz in these tough times and we believe Verizon rides through difficult times with its somewhat recession resistant business model. Exchange Traded Funds (ETFs) also provide diversification so we believe the iShares S&P U.S. Preferred Stock Index (PFF) whose dividend yield exceeds ten percent as well as the iShares Dow Jones Select Dividend Index (DVY) whose dividend yield exceeds five percent may be appropriate for your investment portfolio. One note of caution is that the DVY has a forty-percent exposure to financials which could may provide unwanted volatility.

Number four, take some risk. It is ironic that many investors want to become more cautious AFTER stocks have already fallen forty-percent. They forget the time-tested adage of “buy low and sell high” choosing instead to lock in these losses and move to more conservative investments. Despite the fact that became the ultimate four-letter word in 2008, many solid companies that got pounded will survive and eventually thrive. Consider Manitowoc (MTW), the huge crane maker from Wisconsin, one of many companies that will surely benefit from President Obama’s proposed stimulus package. Other similar companies include Chicago Bridge & Iron (CBI) and Shaw Group (SGR). Also, equity investors may be wise to consider an ETF that mirrors that NASDAQ 100, the Power Shares QQQ (QQQQ), a tech laden composite that is forty-plus percent from its fifty-two week high. Once again, the new administration seems to have made an upgrade to tech infrastructure a priority.

Number five, inflation will come back and it will be somewhat welcomed. During the first half of 2008 as Americans pumped $4 per gallon gas they moaned and complained. Food prices soared and gold spiked BUT (and this is a big but) the economy held up pretty well. Now nobody wants a return to $4 gas and rampant inflation but with the Federal Reserve printing money willy-nilly to combat this crisis, the dollar should weaken and long-term interest rates should rise. For this reason some exposure to commodities makes sense. Consider Exxon Mobil (XOM) the world’s largest integrated oil company or the Energy Select SPDR (XLE) to benefit from rising energy prices. Oil service companies Schlumberger (SLB) and Halliburton (HAL) could also make some sense. Finally, take a look at the Vanguard Inflation Protected Securities Fund (VIPSX), a no-load, open-ended mutual fund that invests in inflation protected bonds. In a world of rising inflation these bonds could provide solid risk-adjusted returns.

Number six, “infrastructure” will become the buzz word of the new Obama administration much like energy independence was the buzz word during the latter years of the Bush administration. We believe that the infrastructure play might be a bit different than was initially viewed. Yes, traditional “shovel in ground plays” like those companies noted under number four above will benefit, but technology infrastructure and alternative energy plays may endure longer with more upside potential. For this, symbol QQQQ is interesting but so would Cisco Systems (CSCO), a company that provides the highway to the inter- as well as to the intranet. We may look back on the monetary commitment to the technology portion of President Obama’s infrastructure investment much like that which was spend to get companies past “Y2K.” Education, long an Obama focus, could make countrywide internet access a priority. John Chambers, CEO of Cisco Systems, has done an excellent job managing through this financial crisis and with $ 27 billion in cash, Cisco should ultimately thrive. Trinity Industries (TRN) has struggled recently as the economy has stalled. However, this heavy cyclical corporation, a leading manufacturer of rail cars, guardrails, barges and wind towers should be a major beneficiary of an infrastructure program. We believe that Trinity’s stake in wind tower production has not been fully recognized by Wall Street. We can envision wind, that cheap, efficient and environmentally friendly source of power as a great alternative to carbon fuels for an administration aiming to be different and innovative.

Number seven, are you scared? A little bit of fear and adrenalin is never a bad thing. However, that historic level of fear that investors felt during 2008 will never be completely out of one’s mind. The bitter taste of 2008 will linger throughout this year. What to do if you will not dare put even a toe back into the stock market but want better returns than the meager one to two-percent offered at your bank? First and foremost avoid the temptation of fixed-income investments of longer-dated maturities as you may discover that “interest rate risk,” the risk that you are stuck in a low-yielding investment as interest rates climb, is as nasty as the principal risk shouldered by investors into the stock market. For that reason, we believe that the PIMCO Total Return Fund (PTDDX), a fund with a track record of eight up years over the last nine, a fund with a positive total return during 2008, might limit some of that risk for bond investors. With an average maturity of five years and a meaningful percentage of the assets of the fund sitting in cash, renowned fund manager William Gross, should be able to admirably navigate the rising waters of inflation. Want a stock that’s relatively safe? ()notice the word ‘relatively!’)? Johnson and Johnson (JNJ) may be as close as you can get. This healthcare and consumer products company with its Band Aids, baby powder and diverse nutritional and OTC health care products may be the perfect antidote for an ailing economy. Its three-percent dividend makes JNJ even more attractive.

Number eight, we regress back to the mean, aka semi-normal times, when stock investors are compensated for taking risk and those out of the market are punished. Winston Churchhill once stated, “may you live in interesting times.” To that we respond “C’mon Guvnor, gives us those boring but happy times that we loved so well and miss so much!” Any whiff of an economy that is stabilizing may send stocks sharply higher with some of the beneficiaries being JP Morgan Chase (JPM), Three M Company (MMM) and Deere (DE). These large companies have all been in both out of favor and exist in economically sensitive areas. However, they possess strong balance sheets, international exposure (for better or for worse) and at this time pay dividends that are generous and secure.

Finally, number nine, cash is king. But remember, so was George III and Marie Antoinette for the politically correct and we all know what happened to them. We believe that we are well in the midst of a bubble in cash as investors shun risk like the plague. That cash, now sitting in money markets, U.S. Treasuries and short-term Certificates of Deposit will eventually look for a new home, one whose return is not so meager. As investor appetite for risk returns, we believe this bubble in cash will burst resulting in a slowly accelerating exodus into first bonds and then stocks, ultimately helping these markets to begin to gradually repair themselves during 2009.

Some investors leave money on the table that is given to them, comes without risk and has nothing to do with investment returns, but rather with understanding how the tax code that pertains to your investments works as well as with keeping up with some changes that impact your lives. Over the past several weeks we have outlined several moves that you could have made by the end of 2008 to potentially save tax dollars. Now we turn to 2009 to identify the areas that are guaranteed to save investors tax dollars and are steps you should be taking (or not taking as we illustrate immediately below) now.

A portion of the Worker, Retiree, and Employer Recover Act of 2008 signed into law on December 17th, for calendar year 2009, suspends the Required Minimum Distribution for Individual Retirement Accounts. Generally, individuals are required to begin to withdraw from their IRA’s every year by April 15th following the year they reach age 70 1/2. According to Bob Trinz, Senior Tax Analyst for the Tax & Accounting Business of Thomson Reuters, this waiver is “is available to everyone regardless of their total retirement account balances, applies to all defined-contribution plans, including 401(k), 403(b), 457(b), and IRA accounts. Suspending the mandatory withdrawal allows retirees to keep the money in their account if they choose, and possibly recover some losses. The suspension for 2009 also applies to beneficiaries of retirement plan accounts and IRA owners.”

Another overlooked area that those employed can save taxes in is through investing in their company sponsored pension plan such as a 401(k), 403(b) or 457(b) plan. Given the precipitous drop in the stock market as well as the slowdown in the economy many investors are questioning whether or not they should continue depositing into one of these plans. In fact, several individuals have called our offices or contacted us on our radio show on 810 WGY with the intention of discontinuing their deposits. Assuming that there are no extenuating reasons for this action, we question them as to why they would stop depositing when the market is forty percent below where it was one year ago. We remind them that to “buy low and sell high” is the wish of all investors, but very few manage to accomplish this feat. Most tend to buy and then out of fear sell at a lower price, thus guaranteeing a lack of growth. Therefore, if you are investing in your company pension plan and are appropriately allocated for your objectives, keep on investing. Remember that you are dollar cost averaging at a historically low level as well as receiving a tax deduction on each dollar you contribute. Time will help you recover from these losses. Selling will only lock them in.

Moving away from steps you can take to minimize taxes and taking a look at a couple of issues that might impact your investment returns for 2009, we caution those investors that are currently investing into U.S. Treasury Securities or those considering such an investment. As the economy has come to a grinding halt, investors have fled most other types of securities designed for income such as corporate bonds, international bonds and preferred stock and rushed to U.S. Treasury Securities, thus pushing the yields down to record levels. For example, investors looking to lock up their money for ten years would receive only 2.23% on a U.S. Treasury Note. It is our belief that as this economic maelstrom passes, this “bubble” in U.S. Treasuries will deflate resulting in steep losses for unwary investors. We recommend that investors reposition some of their assets away from Treasuries and into more attractive fixed income securities such as Corporate Bonds, Municipal Bonds and Preferred Stock. We also believe that the U.S. dollar may weaken making international bond funds very attractive at this time.

Finally, given the drop in the stock market, many well-run mutual funds that were once closed are now open. We strongly recommend that investors take advantage of this window of opportunity to invest in one of these funds, as this window will not remain open forever. The Sequoia Fund (SEQUX) is one such example.

We realize this is a “mish-mash” of a column, but believe that if each issue that has been addressed above is tackled separately by the reader, a more successful 2009 will be your reward. From all of us at Fagan Associates to all of you, best wishes for a Happy, Healthy and Prosperous 2009!