That's Right: Buy Some Stocks

I've advocated holding large cash reserves and gold bullion for some time.  I also have favored gold bullion over gold stocks for reasons previously explained.  With gold bullion up nearly 3% today, it is now up 20% so far this year, while GDX, the ETF of leading gold mining stocks, is off 10% before today's likely drop.  That's a performance gap of 30 percentage points in only seven months!


I reiterate that now is time to begin investing some of the large cash horde.  It may not be the ultimate bottom in the market, but stocks are massively oversold and likely to have a snap-back rally soon.  Blue-chip multinational stocks are my favorites here, as their dividend yields are often higher even than the coupon on most 30-year government bonds around the world.  I also like agriculture as a long-term theme, and farm equipment makers Agco and CNH Global, for example, plunged 16% last week alone and now have p/e's of 10 times current-year earnings estimates.


I am definitely not optimistic about economic growth or profit estimates, but the stock market often moves sharply opposite of what the conventional wisdom would expect, particularly with respect to the economy.


While I'd like to see some market sentiment measures--such as the put/call ratio--reflect even deeper pessimism, the rush to sell anything but gold and bonds is resulting in some intriguing values in the stock market.


Steve Lehman
LehmanInvest.blogspot.com/


S & P 500:  1200

Contrary Market Signal Flashes?

I think we all know someone who is a great contrary market signal, who always seems to be on the wrong side of major turning points.  I'm thinking today of someone who was once known as "The Maestro" for his purported mastery of global economic and monetary policy.  That's right, Alan Greenspan.  Today on "Meet the Press" he said he expects stock prices to continue their declines and that U.S. Government bonds are safe investments.  


With the 10-year Treasury Note now yielding about 2.5% and blue-chip, multinational stocks yielding 3.5% or better, I think the stocks will be superior investments.  In ten years, that 10-year T Note will still be providing an income return of 2.5%, while the stock (assuming a 7% dividend growth rate) will yield nearly 7% and appreciate in value.  Or a drug stock, for example, that now yields close to 5% will probably offer modest income growth and even some capital appreciation over the next decade.


Finally, the "Former Maestro" said there will be no economic "double dip' but will slow down.  How much slower could growth be than the recently reported 0.7%?


Steve Lehman 
LehmanInvest.blogspot.com/


S & P 500:  1200

Buy Stocks--Some, At Least

The recent decline in stock prices, culminating in today's plunge of 4-6% in major indexes, presents investors with a challenge.   The economic news is worsening, and it is likely that earnings estimates will erode in the weeks to come.  Yet, investor sentiment has plummeted.  When this has happened before, it has been a good time to buy stocks.


When market sentiment reflects widespread optimism, that is not necessarily a signal that stocks will quickly decline.  Prices often as not seem to rise even further, as it is difficult to time market tops.  Market bottoms, however, are different.  Deep pessimism has been a reliable buy signal.  And my favorite market sentiment indicators now signal a buying point for stocks, for a trade at least.


I've advocated holding significant cash levels for some time, and now is the time to start to use it (though I recommend never being fully invested, because of times like the last two weeks).  I suggest buying stocks tomorrow morning, unless of course, one's asset allocation to equities is already at or higher than the appropriate strategic level.


Steve Lehman
LehmanInvest.blogspot.com/


S & P 500:  1200

Emerging Markets—A Safe Bet or Not?

The case for investing in emerging economies—stocks, bonds, and currencies—has seemed solid.  Ever since Goldman Sachs economist Jim O’Neill coined the term BRICs (Brazil, Russia, India, and China) a decade ago, these four leading emerging economies and their markets have shown rapid growth and investor acceptance.

As the largest developed economies (the U.S., Europe, and Japan) struggle, their political systems seem gridlocked as they face unpalatable fiscal and demographic realities.  The BRICs and other leading emerging countries, however, have much lower debts and faster growth prospects.  Average sovereign debt is about 40% of GDP versus about 100% in developed countries.  The BRICs have more than $4 trillion in currency reserves as well, so the ability to withstand problems would seem much better than in previous business cycles.  The long-term conceptual case for their currencies, bonds, and stocks still seems compelling.

But now might not be the time to make major allocations to these markets.  The rapid economic growth in recent years was accompanied by a surge in credit issuance.  As with the U.S. housing and credit bubble, credit growth in the BRICs in particular has become excessive.  Monetary authorities have tried to restrain such credit growth as evidence of bad loans is mounting.

A credit-induced economic slowdown is not likely priced into the currencies and securities of emerging market countries.  It seems prudent to be very selective in making purchases of emerging market stocks and bonds.  In addition, several of the currencies—Brazil notably—are historically quite overvalued relative to the U.S. dollar in terms of relative purchasing power.  Gains in the stocks or bonds of emerging markets could be offset by currency losses if the U.S. dollar rises in price relative to emerging market currencies.  After large gains already in these markets, one should exercise caution at current levels.

Steve Lehman

LehmanInvest.blogspot.com/

Gold Stocks Versus Gold Bullion

In a period of rising gold prices, such as the last decade, gold stocks would be expected to perform well.  But the mining business is very difficult, and it is particularly difficult for large companies to increase their production, or even to maintain current production levels.  

There are various reasons for the difficult economics of the business.  As with the oil business, the easily accessible reserves have long since been exploited.  In addition, with a large base of current production, it is difficult to find new resources that are large enough to result in a material percentage gain in overall output.  In addition, production costs that include energy, raw materials, and labor, have increased steadily.

Newmont Mining’s latest earnings report illustrates the challenges.  Its net income per share rose only 1.3% over the prior year, even though the average gold price realized by the company rose 26% during the period.  Its production costs rose from $507 per ounce to $588.

I have long favored gold bullion, or financial instruments linked to bullion, to mining stocks.  Over the past five years, the price of gold has risen 150%, while Newmont’s share price rose 14% and the GDX Index of mining stocks rose 47%.   With a correction in the gold price in its eleventh consecutive year of gains quite possible and a potential decline in the stock market also likely in my opinion, I would trim or sell gold stocks and defer additional gold bullion purchases.

Steve Lehman

LehmanInvest.blogspot.com/

Multinational Earnings Growth Is Highly Dependent on a Falling Dollar

Aggregate profit growth in the U.S. has been impressive in recent years, in spite of weak economic growth over the past decade.  Of course this is due in part to more robust international operations of leading U.S. multinational corporations.  Coca-Cola, for example, derives approximately 80% of its profits from outside the U.S.

While Asia and South America have had faster economic growth than the U.S., Europe and Japan have been sluggish.  It is exposure to rapid growth in emerging markets that has provided a particular boost to the U.S. multinationals. 

I think, however, that investors don’t appreciate the substantial impact that the declining foreign exchange value of the U.S. dollar has had on the earnings of U.S. multinational corporations.

IBM is an example of a leading U.S. multinational that continues to increase its profits at an impressive rate.  Investors appreciate companies with strong profit growth, but they especially appreciate companies with consistent revenue growth.  IBM has become primarily a computer services business.  In the most-recent quarter, IBM’s servies revenue grew 10%, which is impressive in a developed-world economy that is still struggling.  But after excluding currency gains, the revenue growth was only 2%.

The conventional wisdom for some time has been that the U.S. dollar will continue to fall, with the only question being how rapidly and against which foreign currencies?  (I agree that would seem most likely.)  But the contrarian in me is uneasy with what seems to be so obvious.  What if the U.S. dollar would actually RISE in value, or at least hold its value?  Those optimistic earnings estimates for the S & P 500 would switch from a support for current stock-price levels to a substantial drag.

Steve Lehman

LehmanInvest.blogspot.com/

The Failure of Cash As a Store of Value: There Are Alternatives

For years, the policies Alan Greenspan and Ben Bernanke of setting short-term interest rates near zero percent have been perverse.  They have penalized the prudent (savers) by producing a negative real, after-tax return.  They have rewarded the speculators, who borrowed at near zero percent and levered up in various markets that offered a positive interest-rate spread (the “carry trade”).  This effectively removed a primary role of a nation’s currency—a “store of value.”

For those who were willing to reduce their liquidity and venture out with a longer-term commitment to earn an after-inflation yield of zero or more, yields of 3.5%-4.5% on intermediate- to long-term U.S. Government bonds haven’t seemed high enough to justify the risk posed by deteriorating Government finances.  It has been necessary to be creative in addressing this conundrum.

There have been two creative alternatives for protecting the purchasing power of cash reserves.  The first has been to purchase hard (or “soft” agricultural) assets, whose values have been rising because of imprudent central-bank policies and the decline in the foreign-exchange value of the U.S. Dollar.  Hard assets can be purchased directly, but there are storage and illiquidity issues from that approach.  Alternatively, there are exchange-traded funds whose prices are linked to assets such as gold, agricultural commodities, oil, and natural gas (among others).  The price of gold is up 35% over the past year, and the price of my favorite agricultural ETF (the Rogers Index—symbol RJA) is up 35%.  Now that’s a store of value! 

Despite the likelihood of a near-term correction after such a sharp rise, both gold and agricultural commodities remain attractive, as do other hard assets.  Gold will likely continue to rise unless the world becomes more peaceful and governments become fiscally responsible.  Agricultural commodities remain historically cheap on an inflation-adjusted basis compared to other goods and asset markets.  Oil faces increased scarcity, in my view, and natural gas prices are quite inexpensive on a BTU basis.  In addition, expansion of liquefied natural gas capacity will facilitate gas becoming more of a global fuel.  The price of natural gas is less than half what it was in the summer of 2008.  There is an ETF (symbol:  UNG) linked to the price of gas.

The second creative alternative to sitting on U.S. cash that yields close to zero is foreign currencies.  While institutional investors have ready access to forward contracts on currencies and to short-term government bonds in other countries that individuals cannot easily purchase, there are ETF’s linked to foreign currencies.  Various ETF’s linked to foreign currencies have been excellent stores of value over the past year.  Examples include the Australian dollar (+21%), the Swedish Krona (+13%), and the Canadian dollar (+9%).  Australia, of course, benefits from strong commodity demand, as does Canada, particularly from the rising price of oil.  Sweden, my preference relative to the Euro for several years, has a budget surplus and healthy GDP growth.

So there are alternative stores of value for investors.  After all, given the doubling of stock prices over the past two years and a sharp rise in corporate bond prices as well, it is prudent to keep reserves (a store of value) in anticipation of better investment opportunities in the future.   

Steve Lehman

LehmanInvest.blogspot.com/

S & P 500:  1340

Russell 2000:  837