Fagan Associates Archive for August, 2011

The huge news regarding the stepping down of Apple CEO Steve Jobs and thus handing over the reins to current COO Tim Cook had dominated the business airwaves for about twelve hours Wednesday night until it was announced that Berkshire Hathaway CEO and legendary investor Warren Buffett was investing $5 billion in Bank of America.  What does this all mean?

Regarding Jobs and Apple, short- and mid-term this should mean nothing to a company that has its product cycles well mapped out for approximately the next three years.  However, over the long term it remains to be seen if the innovative Apple bench is deep enough to offset the loss of the visionary, Jobs.  Despite not having Steve Jobs at the helm, at eleven times 2012 earnings, more than $73 per share in cash and no debt, along with an excellent management team, now with a chip on their shoulders and something to prove, we believe that a pullback in Apple should not be sold.  We believe that the loss of Jobs is akin to the loss of Walt Disney.  Both have created an environment that nurtures product creation and to a great extent institutionalized these qualities.  This will be tested over the next several years.

Regarding Buffett and Bank of America.  Warren Buffett will invest $5 billion in perpetual preferred stock of the beleaguered banking giant which will also provide t warrant to buy 700 million shares of common stock at $7.14 each.  Has the Greenspan Put been replaced by the Buffett Put?  This caused Bank of America to initially surge more than twenty percent early Thursday before settling nearly ten percent higher by the close.  The entire banking sector also rallied on the belief that “the bottom must be in” if Buffett was investing.  We say, not so fast.  Sentiment is still very negative regarding the financial sector and it will take more time before the housing market sorts itself out.  This should keep any bull markets that begin in the financial sector in check.  We have not taken a stake in Bank of America and at this time, we continue to prefer JP Morgan Chase, First Niagara and FNB Corp.

Last, but not least, there has been much talk lately regarding the likelihood that the economy over the next year will be similar to 2008, when credit markets shut down and the economy sank.  Although we do firmly believe that the economy is slowing and perhaps at a stall speed, we do not believe that we are setting ourselves up for another economic freefall like the one we went through during2008.  We have always been of the belief that this economic recovery will be modest, at best, filled with fits and starts.  We have not changed this outlook.  At this point in time we are looking for this recent economic slowdown is temporary and that the economy will reaccelerate over the next two to three quarters to approximately three percent GDP growth, not great, but not another recession either.

THE BOTTOM LINE – We do not believe that we are in for a robust economy or for a robust stock market.  However, valuations are reasonable for stocks, but most likely overvalued for bonds.  With this in mind, there will most likely be a slow migration out of fixed income and into highly liquid, dividend paying U.S. stocks over the next year or two.  We think that this would be a smart move if you have a three to five year time horizon and can stomach some risk.

Just as it pays to establish an escape route from your home in case of a fire, it pays to establish a disciplined plan of action pertaining to your investments, all the while keeping in mind that panic is not a strategy.  It is with this in mind that we thought it was timely to provide a ten step program that might help you navigate these turbulent investment waters.

Step number one.  Assess your current financial situation.  Items to include your income, perceived job security, details of your pension plan, projected Social Security benefits, insurances (life, health, disability, property and casualty), real estate values, mortgage information and other debt.

Step number two.  Get an historical perspective on this period in history.  Is it really different this time or are in a phase in our history that will pass?  Keep in mind that the stock market generally moves up over a twelve to twenty year period with mini bulls and bears contained within and then moves sideways over the next period with mini bulls and bears in between.  We believe that until further notice, we are obviously in a sideways moving period and have been so since early 2000.

Step number three.  Given the above, begin to determine your appropriate asset allocation.  Some rules of thumb include the older you are, the more fixed income (bonds) you should include in your portfolio.  The more guaranteed your pension plan, the closer you are to realizing the benefits of that plan, and to what extent that pension plan along with Social Security will meet your income needs during retirement, the more equities (stocks) one should include in their portfolio.  The more prone you are to making emotional investment decisions, the more you should include fixed income investments.  Keep in mind that the opposites of the above also hold true and that we are speaking in generalizations only.

Step number four.  Sell the peripheral holdings.  Get out of investments you don’t understand or investments that contain volatility that exceeds your temperament.  These may include but are not limited to emerging market funds, aggressive growth funds, non-investment grade (junk) bonds, and small cap stocks.  Sell so that you can sleep at night.

Step number five.  Hold some cash.  Depending upon your situation, we believe that anywhere from zero to twenty-five percent of your account is appropriate.  Too little and you may sell in panic.  Too much and you are not moving toward your long-term goals.

Step number six.  Buy some dividend paying stocks.  Do you realize that the ten-year U.S. Treasury Note yields only 2.10% and that Proctor and Gamble stock yields over 3.40%?  Moreover, interest rates are at or near a fifty year low and P&G has not only paid, but increased its dividend every year for the past fifty-three years.  With this in mind and assuming that P&G does NOT increase or decrease their dividend over the next ten years, should the stock decline thirty percent over this time frame you will still make a little money.  A pool of these stocks sounds like a better alternative for long-term investors than money sitting at zero percent in your bank account.

Step number seven.  Recognize that too many investors have their fingers on the sell trigger and too many investors have guns in the form of their computers.  Try to determine if perhaps you are one of those individuals that does not have the temperament or time to invest on your own.  There is an old adage that says, “just because you can afford the ticket doesn’t mean you can fly the plane.”  Simply put, yes, it is your money, but perhaps your time, talent and temperament are better spent elsewhere.

Step number eight.  Be disciplined.  Don’t chase the stock market on up days thinking that you have missed the boat.  There will be many more boats to come around.  The volatility will continue.  Be patient and let the stock market come to you.  What a novel idea, buying on the down days.

Step number nine.  Gain some perspective.  We’re both around fifty.  If statistics hold true, that means we have only about thirty more Summers to enjoy.  All that you can do is do your best and work toward reaching your goals.  It is kind of like dieting and exercising, it is your best shot, but doesn’t promise anything.

Step number ten.  Become and investor, not a day trader.  The media wants you to act, act, act, by always yelling fire in a crowded room.  Think of the preceding nine steps to gain perspective.  Buy low, sell high. Sounds easy but is rarely accomplished by the retail crowd because they are often scared out of their investments at the wrong time.  If history is any guide whatsoever, this is truly what will prevent you from reaching your goals.

As with any painful experience, investors are fearful of a repeat of 2008 when the major United States stock market indices plunged more than fifty percent.  However, despite the similarities and volatility and root causes of the recent correction, at this time we do not believe that we are setting the stage for another bear market.  That said, we remain concerned over the current stalling of the modest economic recovery, but believe that we will gradually regain some forward momentum putting at least a floor under stock prices within ten percent of current levels and perhaps a even bid higher.

First and foremost, it is rarely the devil that you know that gets you into trouble, but rather the devil that you don’t.  Simply put, as we justifiably fret over the global economic issues affecting our economy, political, business and economic leaders are trying to find a solution.  From an historical perspective, it is therefore unlikely that we will have a repeat of a meltdown of the financial system as we did in 2008.

The U.S. financial system and economy is on much sounder footing now than in 2008.  Both banks and consumers have taken advantage of the passage of time and low interest rates to substantially repair their balance sheets by deleveraging and raising capital, where appropriate.  In addition, U.S. corporations are in their strongest financial position in decades.

The housing market is right-sizing.  The bubble in housing that was fueled by the securitization of mortgages, low hurdles to qualify, a lack of governmental oversight and poor decisions on all fronts that resulted in home ownership spiking to an unsustainable record high of 69.2% of population in 2004 has eased to 65.9% during the second quarter and is most likely on its way back down to at least 63.0%, the multi-decade prior norm.  Although this could be construed as a negative, we don’t think so as the economy has been able to absorb this headwind from a moribund construction sector without again tanking.  Furthermore, even if there were another leg down in the housing sector, due to the first downturn, it would negatively impact the economy much less.

Although the official Unemployment Rate stands just over nine percent all the while recognizing that real unemployment is in the mid-teens, we believe that the bleeding has at least stopped and that if weekly data that relates to Initial Claims for Unemployment Benefits continues at the current level of approximately 400,000 the nation’s unemployment situation should not deteriorate.

Central bankers around the world realize that the global economy is slowing and that some may have to at least cease hiking interest rates, notably within the countries of China and India.  Historically, when central bankers cease hiking rates, economic activity picks up.  One can also expect increased economic activity as the Japanese economy regains its footing after their earthquake/tsunami and if the political instability in the Middle East remains relatively low.

Interest rates in the United States are at multi-decade lows.  We realize that this is a function of the slow economy.  However, regardless of the reasoning, low interest rates are beneficial to economic growth.  These low rates will help once business and consumer demand increases.

Finally, despite the debacle surrounding the debt-ceiling during the month of July, we agree with Winston Churchill who accurately observed that “you can always count on Americans to do the right thing – after they’ve tried everything else.”  We hope that we can include our elected officials in this lot who royally fouled up the debt debate and now must work hard to get it right and regain the trust of their electorate.  Otherwise, gold by its recent spike higher will continue to send congress a message to get its house in order, including entitlement programs such as Medicare, Medicaid and Social Security.

THE BOTTOM LINE – We realize that headwinds will remain.  We are not saying that the economy is doing well.  We realize and have noted over and over again that economic growth for the foreseeable future will be modest, at best.  However, given the downturn in the stock market over the past few weeks, it pays to look at the risks to the economy and therefore to investors.

After a day on Wall Street that many would like to forget and with the realization that stocks can go lower from here, we believe that the worst a past and that STOCKS ARE REASONABLY VALUED and more than one halfway through this correction.  Fundamentals are sound.  Valuations are reasonable.  Stocks are held by strong hands rather than weak ones.  America has begun to deal with its financial issues.  Cash positions that institutions, individuals and corporations are holdings are enormous.

Over the past month we have raised some cash, moved to more conservative positions and purchased the Permanent Portfolio (PRPFX), a mutual fund dominated by gold holdings.  However, now is the time to put together a shopping list and then begin to nibble.  Don’t go all in.  A “buy me” bell is not going off. Look for companies with strong secular growth stories (MCD, AAPL, COP, LVS, NKE, GOOG, MA, V) and then buy on weakness.

Bottom line, think long term and remember that unlike, 2000 and 2008, stocks are fairly valued and offer opportunity over the next 3 years.  Over the next 3 days, who knows.  Stocks could head lower, but like noted above, now is the time to look for opportunities and not for cover.