Wednesday, February 29, 2012

Take Profits Now

I reiterate my strong urging to take profits on stock holdings now and build cash reserves for better future buying opportunities.

Reliable market sentiment indicators are at historically high levels--levels that have been associated with significantly negative returns on stocks.  

Reduce stock holdings, patiently hold cash, and research potential stocks to buy while setting price targets for purchases.

Steve Lehman

S & P 500:  1370

Tuesday, February 28, 2012

Insider Trading Flashes Warning--But Does It Matter?

Following the buying and selling decisions of company executives concerning stock in their own companies makes conceptual sense.  As Warren Buffett has noted, which side of a trade would you rather be on--that of an individual (or even institutional) investor, or that of a corporate insider, who presumably knows the prospects of that company better than anyone?

While there are various reasons for an executive to sell shares (such as exercising options or diversifying for estate planning), an executive usually buys shares for one reason--an expectation that the shares will rise in price.  I acknowledge that companies often require senior executives to own a specified amount of company stock, so buying in that case would not necessarily indicate the stock is undervalued.  But in general, I continue to pay attention to reported insider transactions.

Yet the empirical results are mixed.  In the 1990's, insiders generally bought all the way up to the peak before selling near the peak in 2000.  They then bought near the low in 2002.  But then the record sours.  They sold in 2003 and missed the market rise to the peak in 2007, and started buying in the summer of 2008, before the plunge in the autumn of 2008.

Recent reports reflect an increase in insider selling.  That by itself is not sufficient reason to sell stocks at current levels.  A 25% rise in the last four months and widespread optimism among sentiment measures is, however, reason enough to raise cash.

Steve Lehman

S & P 500:  1370

Monday, February 27, 2012

Stock Market Decline Likely

Among the many factors that affect the stock market, two of the most important are corporate earnings and market psychology.  Both currently are neutral to negative.

In both cases, expectations among market participants are crucial in determining the direction of stock prices.  High expectations make high returns unlikely, while low expectations make high returns likely.  When corporate earnings are expected to rise sharply, stock prices have produced poor returns historically. I've noted that consensus expected earnings growth for 2012 have come down, which is a good thing.  However, an examination of earnings revisions on an individual company basis show neutral to negative conditions, with only a small number of prominent companies showing positive revisions.

I consider market sentiment to be the most important market factor over short to intermediate periods.  (Valuation is the most important factor over long periods.)  Unlike the neutral-to-negative condition of earnings revisions, market sentiment measures currently are highly negative for stock market returns.  Sentiment measures now indicate high levels of optimism, which historically has led to negative returns for stocks.  I won't conjecture what specific developments might be attributed to a decline in stock prices (high oil and gasoline prices have been frequently cited by others recently).  I just think that conditions are primed for a decline in stock prices.

The indicators that I follow are such that my asset allocation model now warrants a significant reduction in stock holdings (and to a lesser extent gold) and an unusually high level of cash reserves.

Steve Lehman

S & P 500:  1370

Wednesday, February 22, 2012

Was Buffett Wrong, Or What Is Wrong With the Rail Stocks?

It has been a little more than two years ago since Warren Buffett's Berkshire-Hathaway made its stunning bid for Burlington-Northern railroad, for $44 billion--the largest acquisition in Berkshire's history.  Buffett said the bid reflected his confidence in the long-term prospects of the U.S. economy, and the rail industry in particular.

Berkshire paid nearly 20 times forward earnings for Burlington.  Even if it is the best rail operator in the industry, why are CSX and Norfolk-Southern selling for only 11 times forward earnings, and Union Pacific at 13 times?

The great investor might have overpaid for Burlington, but even so, why is there such a disparity in valuations?  And why have the transports been so weak when the Dow and the S & P 500 reached four-year highs this week?

I'd still raise cash here but would consider buying the rails on a correction.

Steve Lehman

S & P 500:  1358

Monday, February 20, 2012

A Crowded Trade or At Least a Time to Raise Some Cash?

There are times when the conventional wisdom not only is sensible (that's why it's conventional), but is also right.  Take the popularity of dividend-paying stocks.  That was last year's best mainstream investment strategy (which I concurred with).  The logic of buying stocks of some of the world's leading companies at 10-15 times earnings with dividend yields far above those on cash and even intermediate-term government notes was compelling.

This week's Barron's calls my attention to the possibility that it may be time to look elsewhere for compelling values.  Valuations admittedly are generally not stretched, but the special feature of this week's Barron's highlights the financial advisors who Barron's considers the tops in their field.  Most advocate the dividend-paying approach.

While I continue to think the dividend-paying stocks approach will be appropriate for many more months--at least until interest rates rise sharply--the 20-25% gain in stock prices in the last four months and the surge in optimism as reflected in sentiment surveys cause me again to urge raising some cash.

Yes, I realize the news from Europe and the U.S. economy is better, but price matters, and stock prices have moved significantly higher already.

Steve Lehman

S & P 500:  1361

Wednesday, February 15, 2012

What Does Weakness in the Dow Transports Portend?

I am not a proponent of the Dow Theory position that sustained gains in stock prices cannot occur unless the major Dow Averages (Industrials, Transports, and Utilities) "confirm" each other.  However, the Dow Jones Transportation Average has broken down technically.

Particularly curious--and potentially troubling--is the weakness in rail stocks.  If the U.S. economy is improving and the manufacturing sector in particular is improving, why wouldn't rail stocks be stronger performers?  I especially wonder this because last year's leaders, defensive stocks with high dividend yields, have lagged the returns of more cyclical stocks so far this year.

I think the high levels of investor sentiment warrant a cautious position toward stocks after the 20-40% gains in many stocks over the past three months.  The weakness in the transportation sector adds further support to this position.

Steve Lehman

S & P 500:  1343

Tuesday, February 14, 2012

Reconsider Financials?

I have long had a bias against financial (particularly bank) stocks, for reasons explained in prior posts.  Though it is still appropriate to require a higher hurdle for financial stocks to clear to warrant investment (particularly because of the opacity of their financial statements), there will likely be times to favor the group.

A contrarian anecdotal sign appeared in Barron's this week that may indicate that investors have become too pessimistic about the stocks.  A full-page ad for an ETF of high-dividend yield stocks touted that it has no financial stocks.  Perhaps sentiment is too negative on the group.  

On the other hand, the vehement objection of the major banks and investment banks to the Volcker Rule suggests that future profitability will be impaired.  Proprietary trading had been a huge profit source for these firms in recent years, and the requirement that banks divest or shut down such activities in order to continue to receive the Federal guarantee will change the nature and size of their profits in the future.

A common view has been that stocks won't have a lasting gain until the financial stocks lead the move, or at least participate.  They're off to a good start this year.  Though I am still wary of the largest bank stocks, I am investigating very small banks, ideally geared to the booming agricultural economy.  

My hunch is that the market will decline over the near term and that maybe later this year might be a better time to own the major financial stocks.

Steve Lehman

S & P 500: 1345

Sunday, February 12, 2012

He's Baack......

Jeremy Siegel, author of  Stocks For the Long Run, is back.  Siegel was closely associated with the 1990's mania in the stock market at the time when an even more bullish book, Dow:  36,000, in hindsight rang the bell for the peak of the 18-year bull market.

Siegel is featured in this week's Barron's touting stocks again after the doubling of the S & P 500 over the last three years and a 20% gain over the past three months.  

Barron's should know better.

How short people's memories are!  This anecdotal evidence is in addition to high bullish readings on sentiment surveys such as the American Association of Individual Investors, Market Vane, and Consensus Inc.

Investors should raise some cash here.

Steve Lehman

S & P 500:  1343

Wednesday, February 8, 2012

Dividends Matter--For More Than Just Current Income

For some time, I have thought that a lasting investment theme will be to focus on dividends by owning shares in some of the world's leading companies that pay high and growing dividends.  The demographics of aging societies in the developed world, combined with historic low levels of interest rates on savings and government bonds, should provide strong demand  for the shares of such companies.

But there is another reason to focus on dividends--what a company's dividend actions indicate about the company's long-term prospects.  With dividend payout ratios at historically low levels in recent years, many companies favored share buybacks over large dividend increases.  This was seen as a way for company managements to avoid being criticized for overpaying for corporate acquisitions, which commonly happens when companies are flush with cash.  By announcing large share buybacks, the positive news effect and actual purchases of stock are expected to drive up the share price (and increase the bonus of many executives).  

It even became popular among some prominent Wall Street firms to add a stock's dividend yield to the percent of a company's stock that is repurchased in a buyback program to produce a "total yield" that is much higher than just the dividend yield.  I think, however, that only the cash dividend received by shareholders is the true "yield."  All else equal, a company's purchases of its own shares will add demand and help support the share price, but I have not seen empirical, quantifiable, support for this that would support counting the "buyback yield" as equal to the "dividend yield." 

Unlike a stock buyback, which is temporary, an increase in a company's dividend is a tangible reflection of the confidence that the company's management has in its future prospects.  Companies generally dislike cutting dividends (which is very unpopular with shareholders).  So a company typically doesn't raise its dividend unless management thinks the higher dividend level can be supported well into the future.

A recent example flashed a compelling buy signal based on the above rationale.  Seagate Technology, a leading manufacturer of disk drives), had been paying an annual dividend of $.12 per share.  In late October of last year, the stock was languishing at $12 a share (down from a 2007 high of $29).  Analysts were cautious at best about the company's prospects, as the technology sector has been moving to portable devices such as smart phones and I-pads, instead of personal computers.  But the company then raised the dividend sixfold, to give the stock a prospective dividend yield of 6%.  On that sign of management confidence, the stock spiked.  Management recently raised the dividend another 39% while announcing that quarterly earnings far exceeded analysts' estimates.  The stock is now $26, for a 116% return in roughly three months (plus dividends).

Though this example is extraordinary in the immediacy of the gains to shareholders from large, positive moves concerning a company's dividend, the point is that dividends matter in more ways than one.  And that is something that I think can be counted on in an otherwise uncertain world.

Steve Lehman

Thursday, February 2, 2012

Interim Top Imminent?

Key measures of market sentiment indicate rising optimism, which will reduce prospective returns.  But an anecdotal sign may be even more important--the imminent IPO of Facebook.  

As I hear that valuation is irrelevant for a stock like this--and in the short term that is correct--I have a sense that this much-hyped launch might mark at least an interim top for the U.S. stock market.

And with the S & P 500 only a couple of percent from its post 2009 high, I reiterate my advice to raise cash for better investment opportunities in the future.

Steve Lehman

S & P 500:  1325