Situation: By now, you know that many are predicting that we are in the late stages of a bull market. Euphoria is the last stage, and in the present climate, one would expect that euphoria will begin happening as the new tax bill takes effect. Two or 3 years later, the stock market will over-correct to the downside and recession will likely soon follow. Now would be a good time for small investors to begin to protect themselves. One way to do that would be to “bulk up” on cash equivalents and Treasuries. The money you still have in equities will need to move in the direction of high-yielding Dividend Achiever type stocks.
Why should we start making these changes now? Because the yield curve is flattening (see Appendix below), which is the best indicator that Financial Services professionals have to predict a market crash.
Mission: Draw up a portfolio of stocks and bonds that will carry you through a market crash relatively unscathed.
Execution: see Table.
Administration: There are 4 ways to raise cash for a crash.
1) Have a Rainy Day Fund that covers 6 months of expenses and is inflation-protected. All of us resist maintaining this “Dead Money Account.” Why? Because it keeps taking money away from spending as our income increases. The trick is to make it painless by a) eliminating transaction costs, tax payments, and inflation risk, and b) paying into the Account automatically. Sounds great, but how? By going to the US Treasury website and directing that a transfer of $25+/mo be made from your checking account into an Inflation-Protected Savings Bond (ISB). Follow a First In/First Out (FIFO) policy when cashing-out your Rainy Day Fund, since you’ll lose an interest payment if you cash-out sooner than 5 years. Taxes are only due after you’ve drawn down the Account.
2) Increase your Cash-Equivalents Allocation: dollar-average into 2-Yr Treasury Notes. Normally, this allocation is whatever cash cushion you like to maintain in your Savings, Checking, and Brokerage Accounts. But now isn’t a normal time. You need to plus-up those cash holdings and build a “backstop.” Why? Because there’s a material risk that your household will soon be living on less income (that is, a reduction upwards of 5%/yr). The easiest way to build a temporary backstop is to go back into www.treasurydirect.com and invest $1000 every 2 months in a 2-Yr Treasury Note. After 2 years, you’re done. You’ve allocated $12,000 that will start paying $1000 into your Checking Account every 2 months. Meantime, you can track the value of this investment through the ticker SHY (iShares 1-3 Year Treasury Bond ETF -- see Line 20 in the Table),
3) Reduce your Equity Allocation but retain Dividend Achievers with above-market yields. This week’s Table has suggestions that may assist you. Those stocks were chosen largely on the basis of a) high ratings from S&P, b) above-market yields, c) the likelihood of payouts continuing to increase in a recession, d) P/E ratios at or below market, and e) predicted losses in a bear market (see Column M in the Table) that are less than or equal to those predicted for the S&P 500 Index (at Line 20). When the crash hits, you will be tempted to sell these (your most crash-resistant stocks) because you’re afraid they’ll fall further. Don’t. Instead of reinvesting dividends, just have the dividend checks sent to your mailbox. If you aren’t a stock picker, simply invest in VYM (Vanguard High Dividend Yield ETF at Line 17 in Table) and XLU (SPDR Utilities Select Sector ETF at Line 14).
4) Increase your Fixed-Income Allocation: dollar-average into 20+ Yr Treasury Bonds. In a Bear Market, you may need to raise cash by selling assets. You might want to sell assets that have temporarily spiked upward in value because stocks are crashing. Only one asset that will predictably do that for you: 20+ Year Treasury Bonds, which are already being bought up and flattening the yield curve (see Appendix below). These are the Treasuries you’ll be buying, and later turning around to sell. So, you’ll need to have a brokerage account that is fee-based (that is, you’re charged ~1% of Net Asset Value/yr in return for transaction costs being waived). Then dollar-average into TLT (iShares 20+ Year Treasury Bond ETF at Line 15 in the Table). Sell those when you think the stock market has bottomed, and spend the proceeds on stocks in that Fire Sale.
Bottom Line: To avoid sleepless nights and migraine headaches, pull in your horns now. Stop gambling (but restart after the market collapses). Build up your Rainy Day Fund, and invest in cash equivalents, high-yielding high-quality stocks, and long-term Treasuries. When the crash hits, people will tell you to stop buying stocks altogether. Why do they say that? Because nobody can say for sure how long the market will keep going down. But Walmart (WMT) and McDonald’s (MCD) will be booming, even while layoffs in the Industrial Sector continue to make headlines. The End of the World isn’t happening. Get over it. Read the Wall Street Journal. When the Bear looks to be getting tired, call your stock broker and buy.
Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-cost average into NEE and TGT, and also own shares of PEP, PFE, HRL, and MO. I am executing on the 4 suggestions above for raising cash.
APPENDIX: The yield curve is Flattening. What does that jargon term mean? Savvy investors are moving money out of growth stocks and into Long-Term Treasuries, even while the Federal Reserve is raising Short-Term interest rates. It doesn’t make sense. Long-Term rates would typically move up in tandem with Short-Term rates, provided the economy is truly gaining strength.
You can follow that increase in Long-Term Treasury Bond prices (which move in the opposite direction of interest rates) by going to Yahoo Finance and entering TLT (for iShares 20+ Yr Treasury Bond ETF). Click on “chart” and select the 2 Year chart. Then on “indicator” and choose a 200-day moving average. That will show the steady upward movement in the price of those bonds—because buyers outnumber sellers. That results in a steady downward movement in the rate of interest being earned by new buyers, which flattens the yield curve.
There are several explanations why Long-Term interest rates might fall even as Short-Term rates are rising: “the likeliest...is the simplest: markets are losing confidence in the Fed’s ability to raise [Short-Term] rates without inflation sagging.” You might want to learn more about the falling yield curve, so read on.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 28
Sunday, January 21
Week 342 - Industrial Companies in “The 2 and 8 Club” (Extended Version)
Situation: There are many industrial companies that enjoy good earnings over long time intervals. But these earnings are yoked to the economic cycle and tend to be volatile. This unsettles investors. Companies in the Financial Services, Consumer Discretionary, and Information Technology industries face the same problem. However, those 4 industries are also responsible for most of the growth in the US stock market. Stockpickers have to either stare at ugly “paper losses” from time to time, or behave like retail investors and “buy high, sell low.” For the former group, which has absorbed losses, studies show that they’ll spend 4% less money on consumer goods than customary. But when the stock market is up a lot, they’ll spend 4% more. The mechanics of maintaining what you’ve obtained may be difficult to explain to your life partner, but your heirs will understand. The harder part (for your life partner) is to understand why you allocate more money to the stock market when its down but less when its up!
The takeaway message from this is that money needs to be taken “off the table” when the market is frothy, and spent. With the current market, now would be a good time to start doing that. At every one of Berkshire Hathaway’s annual meetings that I’ve attended, Warren Buffett reprises his famous quote: “Be fearful when others are greedy and greedy when others are fearful”. In other words, allocate more of your income to the stock market when the economy is in a slump. Baron Rothschild put a fine point on it 202 years ago, when he profited mightily from the defeat of Napoleon at the Battle of Waterloo: “Buy when there’s blood in the streets, even if the blood is your own”. Caveat Emptor: The opposing argument, that “timing the market” never works, is widely respected.
Mission: If you want to at least keep up with the S&P 500 Index, you’ll have to focus much of your research on industrial stocks. So, here are 6 industrial stocks that 1) pay good & growing dividends, and 2) are highly rated by S&P and Morningstar. See our Week 329 blog for a detailed explanation of how we pick stocks from the Barron’s 500 List that have at least a 2% dividend yield and an 8%/yr dividend growth rate (over the previous 5 years).
Execution: see Table.
Bottom Line: Industrial companies take advantage of a growing economy. However, their stock prices fluctuate more widely than most investors can tolerate. You have to be a bit of a gambler to become an enthusiast. Over the long term, you’ll grow to be happy with the rewards. Just don’t expect your risk-adjusted total returns to be any better than you’d realize from owning shares in an S&P 500 Index fund, unless your hobby is to analyze industrial companies. To do so, it helps if you decide that only a few companies are likely to reward the time you spend on their study. We think the 6 industrial companies in “The 2 and 8 Club” are worth your time (see Table).
Risk Rating: 7 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-cost average into MMM, and also own shares of CMI and CAT.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
The takeaway message from this is that money needs to be taken “off the table” when the market is frothy, and spent. With the current market, now would be a good time to start doing that. At every one of Berkshire Hathaway’s annual meetings that I’ve attended, Warren Buffett reprises his famous quote: “Be fearful when others are greedy and greedy when others are fearful”. In other words, allocate more of your income to the stock market when the economy is in a slump. Baron Rothschild put a fine point on it 202 years ago, when he profited mightily from the defeat of Napoleon at the Battle of Waterloo: “Buy when there’s blood in the streets, even if the blood is your own”. Caveat Emptor: The opposing argument, that “timing the market” never works, is widely respected.
Mission: If you want to at least keep up with the S&P 500 Index, you’ll have to focus much of your research on industrial stocks. So, here are 6 industrial stocks that 1) pay good & growing dividends, and 2) are highly rated by S&P and Morningstar. See our Week 329 blog for a detailed explanation of how we pick stocks from the Barron’s 500 List that have at least a 2% dividend yield and an 8%/yr dividend growth rate (over the previous 5 years).
Execution: see Table.
Bottom Line: Industrial companies take advantage of a growing economy. However, their stock prices fluctuate more widely than most investors can tolerate. You have to be a bit of a gambler to become an enthusiast. Over the long term, you’ll grow to be happy with the rewards. Just don’t expect your risk-adjusted total returns to be any better than you’d realize from owning shares in an S&P 500 Index fund, unless your hobby is to analyze industrial companies. To do so, it helps if you decide that only a few companies are likely to reward the time you spend on their study. We think the 6 industrial companies in “The 2 and 8 Club” are worth your time (see Table).
Risk Rating: 7 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-cost average into MMM, and also own shares of CMI and CAT.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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