Situation: At the beginning of each quarter, Merrill Lynch picks 10 stocks (often including two “shorts” to bet against). I have come to respect their picks but rarely act on those. Why? Because they are, for the most part, risky companies in risky industries. But when the Q3 picks came out on June 30, I was startled. Most of the picks are Dividend Achievers, i.e., companies with a record of increasing dividends for 10+ yrs. As the industry leader, with $2.2 Trillion in client assets under management, Merrill Lynch is encouraging its clients to make defensive investments. They see a Bear Market coming.
Mission: Highlight reasons to expect a Bear Market, and analyze the recommendations by Merrill Lynch.
Execution: The US economy is on solid footing. Jobs are becoming more plentiful, and wages are climbing faster than inflation. The unemployment rate in June 2016 was 4.9% (vs. 4.6% in June of 2006). However, labor market participation (62.7% in June 2016) hasn’t returned to it’s high from 10 yrs ago (66.2% in June 2006). When those who are underemployed (i.e., part-time workers), and those who are out of work but too discouraged to look for jobs, are added to the officially unemployed (i.e., job seekers), the “U-6” unemployment rate for June 2016 was 9.7% (vs. 8.4% in June 2006). Another problem is that many of the jobs that had been available to those without a college education, and paid well enough to allow those workers to become homeowners, have disappeared. The Information Revolution is replacing the Industrial Revolution but beneficiaries need to have a 4-yr college degree in math, science, engineering or technology to participate fully.
On a global scale, the US economy is an outlier. No other economy can be said to have recovered from the Lehman Panic. Great Britain was recovering but now faces recession due to fallout from Brexit. The rest of Europe is mired in economic troubles mainly caused by an over-reliance on debt financing that cannot be resolved without increases in productivity through education, “creative destruction” of outmoded industries and employment practices, automation, and increased free trade to leverage its competitive advantages. China has an “800 pound elephant in the room” called State-Owned Enterprises. Those continue to grow through municipal borrowing despite the best efforts of China’s economic leaders. Japan has found no way to emerge from decades of recession. Brazil and Russia are in deep recessions. India and South Africa are on growth trajectories but remain mired in structural unemployment. The “Arab Spring” unleashed unimaginable levels of discontent that remain poorly understood but affect the entire globe. The economies of those countries will remain in stasis until political solutions acceptable to those populations can be implemented. What is the “root cause” for underperformance in so many regional economies? Experts point to modern communications, like social media. Anyone with access to a cell phone, laptop or TV is a candidate to develop a more materialistic lifestyle, by whatever means necessary.
We don’t know how the next Bear Market will be triggered, so the S&P 500 Index continues to make new highs driven by ever-lower interest rates. There are many candidates, overvaluation being prominent among them, with the S&P 500 Index sporting a P/E of 25. Growth of the US economy (GDP) faster than 3%/yr could cure that problem but it doesn’t appear to be happening. Perhaps our government agencies, our corporations and our households have borrowed too much money, and interest payments consume too much of those budgets to allow enough investment in growth. There is also too much uncertainty about the future, so companies are reluctant to move forward with hiring and expand operations. No one issue, whether Brexit or the upcoming US election, has the capacity to trigger a recession on its own. But the above-mentioned points will amplify any crisis atmosphere that arises out of a destabilizing event like a natural disaster, a nuclear accident, or a civil war.
Administration: The Merrill Lynch Q3 recommendations include two candidates for short sales and a company that recently went public. We’re not interested in those. But do check out the other 7 (including 6 Dividend Achievers) that are worth a look by anyone seeking “buy-and-hold” stocks for a retirement portfolio (see Table).
Bottom Line: Merrill Lynch analysts apparently think a Bear Market is coming soon, and have advised clients to pick stocks that are likely to hold value in such an environment. Seven appear suitable as long-term holdings (see Table). Six of those are Dividend Achievers: NextEra Energy (NEE), Realty Income (O), AT&T (T), Raytheon (RTN), Walgreen Boots Alliance (WBA) and Lowe’s (LOW). The non-dividend paying stock, salesforce.com (CRM), is the seventh and has growth prospects that could support continued price accumulation in a recession. However, our analysis suggests that only NEE is worth buying when the market is overheated (see Table).
Risk Rating: 6 (Treasuries = 1 and gold = 10)
Full disclosure: I dollar-average each month into NEE and T.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 13 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% used to buy ~$5000 worth of shares), Dividend Growth Rate is Dividend CAGR for the past 16 years, Price Growth Rate is the mean Price CAGR for the past 16 years (http://invest.kleinnet.com/bmw1/), and Price Return for selling shares in the 10th year is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 14
Sunday, August 7
Week 266 - “Buy-and-hold” Barron's 500 Dividend Achievers in the Consumer Staples Industry
Situation: Let’s say you’re in your 50s and have made good investments through the tax-deferred retirement plan at your workplace, and your IRA. But you doubt those investments will replace 80% of your income after you retire. Taxable investments will have to fill the breach, mainly stocks that throw off ~2.5%/yr in dividends and grow those dividends ~10%/yr. There is no mutual fund that will do that for you. You have to pick stocks and reinvest dividends while you’re still working. By the time you retire, annual dividends/share will probably amount to more than 4% of your initial investment in shares. You can have the dividends sent to your bank and spend that income while preserving the shares. Utilities (and Communication Services companies) pay higher dividends but grow those more slowly, so you’ll probably do as well by holding stock in Consumer Staples companies.
Mission: Find high quality Consumer Staples stocks to “buy-and-hold.” That’s not easy, given that the market for consumer staples grows slowly. However, the market has the advantage of low elasticity (i.e., it doesn’t stop growing during a recession). That stability means companies can try to grow earnings faster (enough to attract investors) by using leverage, i.e., over-borrowing. Usually, that leaves companies with negative Tangible Book Value. But their managers don’t worry about that because the risk of bankruptcy is low, since elasticity is low. The beauty of leverage is two-fold: 1) the government picks up the tab (interest isn’t taxable); 2) Return on Equity (ROE) soars because the company is mainly capitalized with long-term bonds. But you’re investing for your retirement, and know that leverage always creates risk, i.e., the stock’s price will collapse, someday.
Execution: As a prudent investor, you always want to avoid owning stock in companies that 1) carry twice as much debt as equity, 2) are capitalized more than 50% with long-term bonds, and 3) have negative Tangible Book Value (see Columns AD through AF in this week’s Table). Among the 20 Consumer Staples industry Dividend Achievers on the 2016 Barron’s 500 List, those restrictions leave us with only 8 to consider (see Table).
Bottom Line: You don’t want to outlive your retirement savings, so you’ll spend no more than 4% of your savings each year. But stocks are different than mutual funds because you can select stocks that pay a good and growing dividend. By using dividend reinvestment during your working years, those stocks can by paying a 4% dividend (on their initial cost) by the time you retire. That allows you to avoid selling any shares and simply spend the income. Those shares will continue to grow in value and spin off proportionately higher dividends. Your nest egg of shares in individual stocks becomes the rarest of retirement asset classes. It is one that grows during retirement while allowing you to take out 4%/yr. The trick is to find high quality companies that reliably pay a good and growing dividend. Most likely, you’ll find such companies in only 3 of the 10 S&P industries: Utilities, Communication Services, and Consumer Staples. This week we cover Consumer Staples.
Risk Rating: 4 (where US Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into PG, and also own stock in WMT, KO, HRL and ADM.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for price over the past 50 days (corrected for transaction costs of 2.5%), Dividend Growth Rate is Dividend CAGR for the past 16 years, Price Growth Rate is Price CAGR for the past 30 years, and Price Return in the 10th year is corrected for transaction costs of 2.5%. The calculation template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Find high quality Consumer Staples stocks to “buy-and-hold.” That’s not easy, given that the market for consumer staples grows slowly. However, the market has the advantage of low elasticity (i.e., it doesn’t stop growing during a recession). That stability means companies can try to grow earnings faster (enough to attract investors) by using leverage, i.e., over-borrowing. Usually, that leaves companies with negative Tangible Book Value. But their managers don’t worry about that because the risk of bankruptcy is low, since elasticity is low. The beauty of leverage is two-fold: 1) the government picks up the tab (interest isn’t taxable); 2) Return on Equity (ROE) soars because the company is mainly capitalized with long-term bonds. But you’re investing for your retirement, and know that leverage always creates risk, i.e., the stock’s price will collapse, someday.
Execution: As a prudent investor, you always want to avoid owning stock in companies that 1) carry twice as much debt as equity, 2) are capitalized more than 50% with long-term bonds, and 3) have negative Tangible Book Value (see Columns AD through AF in this week’s Table). Among the 20 Consumer Staples industry Dividend Achievers on the 2016 Barron’s 500 List, those restrictions leave us with only 8 to consider (see Table).
Bottom Line: You don’t want to outlive your retirement savings, so you’ll spend no more than 4% of your savings each year. But stocks are different than mutual funds because you can select stocks that pay a good and growing dividend. By using dividend reinvestment during your working years, those stocks can by paying a 4% dividend (on their initial cost) by the time you retire. That allows you to avoid selling any shares and simply spend the income. Those shares will continue to grow in value and spin off proportionately higher dividends. Your nest egg of shares in individual stocks becomes the rarest of retirement asset classes. It is one that grows during retirement while allowing you to take out 4%/yr. The trick is to find high quality companies that reliably pay a good and growing dividend. Most likely, you’ll find such companies in only 3 of the 10 S&P industries: Utilities, Communication Services, and Consumer Staples. This week we cover Consumer Staples.
Risk Rating: 4 (where US Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into PG, and also own stock in WMT, KO, HRL and ADM.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for price over the past 50 days (corrected for transaction costs of 2.5%), Dividend Growth Rate is Dividend CAGR for the past 16 years, Price Growth Rate is Price CAGR for the past 30 years, and Price Return in the 10th year is corrected for transaction costs of 2.5%. The calculation template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Subscribe to:
Posts (Atom)