“It’s What You Learn After You Know It All That Counts.”
– Earl Weaver, former manager of the Baltimore Orioles
January is the time of year when strategists, economists, gurus, etc. all join in on the annual nonsense of predicting “What’s going to happen in the markets for 2013?” For many, this ritual is an ego trip, yet as Benjamin Graham inferred – forecasting where the markets will be a year from now is nothing more than rank speculation. Or as I have noted, “You might as well flip a lucky penny.” Manifestly, while forecasting is fun, it should in no way be construed as investment advice. That is why I try hard to avoid the annual guessing game and attempt to focus on what the markets are “saying,” which sectors look favorable, and which stocks I want to own in the new year. “Listening” to the message of the market in December 2011 produced this commentary in my 12/27/11 strategy report:
“Speaking to 2012, I remain steadfast in the belief there will be no recession, nor will Euroquake pull us into one. I also embrace the theme that the nation is moving in the direction of energy self-sufficiency and that an American manufacturing renaissance is taking place. Moreover, there appears to be the hint of a housing recovery, as well as a technology revolution. Combine these beliefs with the demographics of a baby boom echo, which should foster a new cadre of investors, and I think the SPX will have a mid-to-high single-digit return in 2012. If you layer in a 3% - 4% dividend yield on top of said return, the allure of equities becomes pretty compelling.”
While that diatribe did not produce a single-point target for the S&P 500 (SPX/1485.98) in 2012, it did target a total return range of between 9% and 13%. When overly “pressed” for a prediction, however, I tend to use the average yearly return for the SPX since 1926 of about 10% per year and add that to the SPX’s December 31st closing price. In this year’s case that would target 1570. Nevertheless, remember that over the past 86 years 5% per year of that return has come from earnings growth, 0.8% from price-to-earnings (P/E) multiple expansions, and a large 4.2% from dividends. Further, since 1926 the SPX has provided an average return of 15.4% when a Democrat was president versus 7.8% under Republican leaders. Still, those returns may be misleading since the Fed’s monetary policy is more important than who is president, but I digress.
Verily, what is lost in the “noise” of the yearly soothsaying contest are some simple tenets of investing. One of the best examples of these tenets was published in The Financial Analysts Journal in 1995. It was penned by Arthur Ziekel (at the time head of Merrill Lynch Asset Management) as a letter to his daughter on investing. To wit:
“Personal portfolio management is not a competitive sport. It is, instead, an important individualized effort to achieve some predetermined financial goal balancing one’s risk-tolerance level with the desire to enhance capital wealth. Good investment management practices are complex and time consuming, requiring discipline, patience, and consistency of application. Too many investors fail to follow some simple, time-tested tenets that improve the odds of achieving success and, at the same time, reduce the anxiety naturally associated with an uncertain undertaking.”
You can review these tenets on page three of this report.
With these tenets in mind, I turn to the stock market’s performance year-to-date, which shows some pretty impressive results with the D-J Industrials up 4.16%, the S&P 500 better by 4.19%, the NASDAQ Composite at +3.81%, and the economically sensitive D-J Transportation Average (TRAN/5695.27) leaping an eye-popping 7.32%. The Trannies Triumph has lifted that index to new all-time highs and in the process rendered one half of a Dow Theory “buy signal,” but the D-J Industrials would need to confirm with a similar new reaction high. Speaking to that, in last Friday’s Morning Tack I wrote:
“While it’s true a close above 13610.15 would be a new reaction high for the Industrials, I am not so certain it is a Dow Theory ‘buy signal.’ Recall we faced a similar dilemma last May when numerous pundits trumpeted that the Dow had broken below a previous reaction low thus rendering a ‘sell signal.’ I, however, stated that the reaction low being used was not correct and therefore no ‘sell signal’ was given. We all know what happened from there. Fortunately, or unfortunately, the Dow failed to close above the point in question (last Thursday) so we begin the journey anew today, but with the market overbought, and out of internal energy, it still suggests a pause/correction is due.”
While early Friday morning those comments were generally correct, by Friday’s close they were not because the D-J Industrial (INDU/13649.70) had indeed closed above the October 5, 2012 reaction high of 13610.15. Accordingly, I would give the market a half-hearted Dow Theory “buy signal,” but I would feel a whole lot better about it if the Dow had broken above its all-time closing high of 14164.53 recorded on 10/9/07. I would also feel better about it if the NYSE McClellan Oscillator was not so overbought and the stock market’s internal energy was not entirely used up. Nevertheless, even a half-hearted “buy signal” deserves respect given the history of such signals.
To be sure, there are certain “seers” that eschew using Dow Theory on the premise the stocks in the Dow have been changed so much that Dow Theory doesn’t work anymore; I totally disagree. Consider this; there was a Dow Theory “sell signal” on September 23, 1999 preceding a subsequent Dow Dive of about 30%. Then there was a “buy signal” in June of 2003 that led to a 52% rally followed by a Dow Theory “sell signal” on November 21, 2007. That signal, if taken, avoided a 49% Dow Debacle, which was finally reversed with a Dow Theory “buy signal” in July 2009. For the record, over the last 15 years the only Dow Theory false signal, at least by my method of interpretation, occurred in May of 2010 during the “flash crash.” That one-day crash of 1000 points turned out to be a four-standard deviation event, an occurrence that is supposed to happen once every 43 years.
As for the here and now, last week the Industrials closed at their highest level since 10/31/07, thus confirming the Trannies traverse to new all-time highs. While the Industrials are not at all-time highs, an equal-weighted index of U.S. stocks is at all-time highs. Likewise, as chronicled in these missives, a number of other indices are at new all-time highs. Plainly, the reasons for such action are unprecedented liquidity from the central banks, strengthening auto and housing markets, better employment readings, improving corporate earnings, and a less dysfunctional government. To this last point, I held fast to the belief the “fiscal cliff” would see a last minute solution and have carried that belief forward to the “debt ceiling” debate. This time, however, we didn’t have to arrive at a last minute cure because it appears the Republicans are going to approve extending the debt ceiling until a later date. As stated, once these twin “Armageddons” pass, and take their place on the great wall of media creations, investors will have to focus on economic fundamentals and corporate performance; and, here the message is improving noticeably. Accordingly, while I am probably a bit too cautious in the short-term for the aforementioned reasons (no internal energy and the overbought condition), there is nothing to suggest over the intermediate and longer-term stocks are not going to trade higher.
A screening of Raymond James’ universe of stocks surfaces some names that look attractive both fundamentally and technically with favorable ratings from our fundamental analysts, as well as decent dividend yields: AmerisourceBergen (ABC/$45.85/Strong Buy); Apartment Investment & Management (AIV/$27.59/Outperform); Huntington Bancshares (HBAN/$7.00/Strong Buy); Newell Rubbermaid (NWL/$23.12/Strong Buy); Plum Creek Timber (PCL/$47.32/Outperform); Rayonier (RYN/$55.00/Strong Buy); and Valero Energy (VLO/$36.76/Strong Buy).
The call for this week : The indices, in the short-term, are entirely out of internal energy and over-bought. To me, that counsels for caution despite the half-hearted Dow Theory buy signal generated by last Friday’s new reaction closing high by the Industrials, which confirmed the D-J Transports sprint to new all-time “highs” last week. Whatever happens in the near-term, there is nothing to suggest the path of least resistance is not higher over the intermediate and longer-term. Therefore, I would accumulate favored stocks, as well as the indices, on any ensuing pullbacks.
P.S. – I am in Dallas this week speaking at conferences and seeing accounts. I will be back next week.
A fool and his money are soon parted.
Investment capital becomes a perishable commodity if not handled properly.
Be serious. Pay attention to your financial affairs. Take an active, intensive interest. If you don’t, why should anyone else?
There is no free lunch.
Risk and return are interrelated. Set reasonable objectives using history as a guide. All returns relate to inflation. Better to be safe than sorry. Never up, never in.
Most investors underestimate the stress of a high-risk portfolio on the way down.
Don’t put all your eggs in one basket.
Diversify. Asset allocation determines the rate of return. Stocks beat bonds over time.
Never overreach for yield.
Remember, leverage works both ways. More money has been lost searching for yield than at the point of a gun (Ray DeVoe).
Spend interest, never principal.
If at all possible, take out less than comes in. Then, a portfolio grows in value and lasts forever. The other way around, it can be diminished quite rapidly.
You cannot eat relative performance.
Measure results on a total return, portfolio basis against your own objectives, not someone else’s.
Don’t be afraid to take a loss.
Mistakes are part of the game. The cost price of a security is a matter of historical significance, of interest only to the IRS.
Averaging down, which is different from dollar cost averaging, means the first decision was a mistake. It is a technique used to avoid admitting a mistake or to recover a loss against the odds. When in doubt, get out. The first loss is not the best but is also usually the smallest.
Watch out for fads.
Hula hoops and bowling alleys (among others) didn’t last. There are no permanent shortages (or oversupply). Every trend creates its own countervailing force. Expect the unexpected.
Make decisions. No amount of information can remove all uncertainty. Have confidence in your moves. Better to be approximately right than precisely wrong.
Take the long view.
Don’t panic under short-term transitory developments. Stick to your plan. Prevent emotion from overtaking reason. Market timing generally doesn’t work. Recognize the rhythm of events.
Remember the value of common sense.
No system works all of the time. History is a guide, not a template.
Arthur Ziekel, of Merrill Lynch Asset Management, in a letter to his daughter dated October 17, 1994
© Raymond James