Fagan Associates Archive for September, 2011

Stock markets around the globe sold off over the past few days, in part due to the cautious statement issued by the Open Market Committee of the Federal Reserve after their regularly scheduled meeting on Monetary Policy this past Wednesday.

Most notably, the Fed replaced the statement that “downside risks to the economic outlook have increased” released after their August 9^th meeting with “there are significant downside risks to the economic outlook.”  Believe it or not, just with the addition of the word “significant,” market observers shuttered.  What follows are some additional observations by the Federal Reserve.

“Information received since the Federal Open Market Committee met in August indicates that economic growth remains slow.  Recent indicators point to continuing weakness in overall labor market conditions.”

“Investment in nonresidential structures is still weak, and the housing sector remains depressed.  However, business investment in equipment and software continues to expand.”

“The Committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually.”

“The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further.  (The dual mandate of the Fed is to “foster maximum employment and price stability.”)

To all of the above we respond, “tell us something we don’t know.”  Here’s what we think.

There’s about an even chance that the U.S. economy will enter into a recession within the next three quarters as a recession is defined as two consecutive quarters of negative growth in Gross Domestic Product.  However, that recession will be both short and shallow.

The stock market has in great part discounted the possibility that there will a short and shallow recession.  Perhaps there is another five to ten percent of downside risk if a recession proves shallow.  That said, it has not discounted another deep and long one.  This bears watching.

Over the intermediate (one to three years) to long-term, with the ten-year U.S. Treasury Note at 1.70%, dividend paying stocks are very attractive.  There are dozens of stocks, including McDonald’s, Proctor & Gamble, Intel, Bristol Myers and Abbott Labs that pay dividends far above this Treasury note.  Yes, you are assuming more risk.  However, there is also risk in locking ten-year money up at 1.70%.

This is not an easy environment to invest in if you don’t know what you’re doing.  We often say “just because you can afford to buy the plane doesn’t mean you can pilot it.”  Some can invest money on their own.  Others need help.  It’s an expensive lesson if you think you’re the former and it turns out you were the latter.

This political wrangling in Washington between the Republicans and Democrats is a mess and it is hurting consumer confidence.  Like it or not, what hurts Main Street hurts Wall Street and what hurts Wall Street hurts Main Street.  Both are hurting right now and the longer this finger pointing, campaigning and stalemate continues, the more there will be repercussions on both streets.  It will be very detrimental if this drags out until the 2012 Presidential Election.  We fear it may.  We hope it doesn’t.

First and foremost, let us state that investors are scared to death that “it’s different this time.”  Perhaps it is.  However, in believing that the United States has truly entered an eternal period of no or slow growth and a flat stock market, you are also taking risk that it is NOT different.  For example, by leaving long-term investment money at zero to two percent you are assuming opportunity risk, the risk that you will not have accumulated enough assets to meet your objectives.

Second, let us state that opportunity comes with risk.  Think back to 1999 when the economy and stock market were humming along just beautifully.  Unemployment was near 4%, Americans were building and buying houses like crazy and the stock market was at all-time highs.  Ask yourself this question, would you have been more or less apt to invest money in stocks at that point?  The answer is simple, more, much more.  The reason is clear.  Studies have shown that individuals and investors believe that the period of time that they are in will last forever, be they good or bad times.  In part, this is why after eleven years of zero returns on stock market indices, investors are shying away from what we believe will help them achieve their goals over the next eleven years – dividend paying stocks.

For this column we have put together a list of potential investment alternatives to your low-paying Certificate of Deposit, Annuity or U.S. Treasury Note.  However, keep in mind, this is for long-term investors only who wish to assume some risk.  Also, keep in mind that the ten-year U.S. Treasury note is yielding approximately 2.00% per year.

One logical alternative to a U.S. Treasury note yielding 2.00% is a basket of dividend paying stocks.  For example, Procter & Gamble (3.40%), Johnson & Johnson (3.60%), Altria Group (6.20%), Abbott Labs (3.80%), Pepsi (3.30%) and McDonald’s (2.80%) all yield much more than the ten year Treasury.  In addition, they have all INCREASED their dividends at least on an annual basis for more than twenty-five consecutive years.  Therefore, as an investor in any of these companies you are starting off receiving much income than a U.S. Treasury AND you have a good opportunity for increasing income every year.

Another logical alternative for mid- to long-term investors is a basket of dividend paying stocks that have increased their dividends every year for at least twenty-five years.  This can be found in the SPDR S&P Dividend ETF (symbol SDY) whose objective is to invest at least “80% of its assets in the fifty highest dividend yielding constituents of the stocks of the S&P Composite 1500 index that have increased dividends every year for at least 25 consecutive years.”

THE BOTTOM LINE – It is not during periods of economic prosperity that bull markets begin.  It is usually during periods of uncertainty.  A good way to mitigate this uncertainty and the risk that comes with it is as described above, by buying securities that provide income at or above the level of other, more guaranteed alternatives.  Certainly this adds risk to your metrics.  However, given the fact that interest rates are at multi-decade lows and provide little bang for the buck, it might be worth a look.

FOOD FOR THOUGHT – According to a lead anchor on business channel, CNBC “why would we ever lead with the house is not burning.”  Thus implying that bad news gets the viewers and viewers get the ratings.  Are we too into this reality TV, perhaps to our own detriment?  Perhaps we are getting too much information without the knowledge necessary to use the information to our benefit.