Archive for July 2010
26
Long-Term Treasury Bonds: Consider Yourself Warned…
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Long-Term Treasury Bonds: Consider Yourself Warned…
by Alexander Green, Chief Investment Strategist
Monday, July 26, 2010: Issue #1309
The brickbats are starting to pour in.
For months, I’ve warned readers about the bubble developing in long-term Treasury bonds.
Yet what was the top-performing asset class in the first half of 2010?
You guessed it: Long-term Treasury bonds, with a total return – price gains plus interest – of 13.2%.
Why is this happening? Two reasons…
- U.S. stocks performed poorly over the first six months of 2010 – down 5.6%. That’s driving many to the perceived safety of Treasuries.
- The anemic euro is making U.S.-dollar-denominated securities attractive to international investors. And Treasuries are the traditional choice for those fearful of equities.
So does this mean there isn’t a bubble after all? Hardly. In fact, the risk now is greater than ever…
1999: An Internet Odyssey
In the fall of 1999, I belonged to a ritzy tennis club – a time when Internet and technology stocks were all the rage.
My playing partners knew I was in the money management business, so there was plenty of chatter among them about “the New Era” and how “the Internet changes everything.”
Occasionally, one of my buddies would ask which Internet stocks I was buying.
“None,” I said. (I was early to get into the sector and early to get out.) The valuations were outrageous and I didn’t think it would end well.
They were surprised by this view, but kept enthusiastically buying and trading Internet stocks like almost everyone else. And, indeed, those stocks kept right on going up.
As the weeks went by, a familiar ritual developed. I’d walk up to the group and – knowing I didn’t own any – they’d ask how my Internet stocks were doing.
Laughs all around.
This went on week after week, month after month. And judging by the guffaws, the question was funnier each week than the week before.
Until one day it wasn’t funny at all.
2000: Nightmare on Wall Street
In March of 2000, the Nasdaq started coming apart and Internet stocks nosedived. As I approached their courtside table one morning, they abruptly stop talking.
“Morning, guys,” I said. “How are your Internet stocks doing?”
Funny… that line was hilarious before. Now it generated obscene gestures, as well as various suggestions for me and “the horse you rode in on.” Hmm.
What is the lesson here (other than that we shouldn’t laugh at the misfortunes of others)?
It’s that you cannot make a rational judgment about when irrational behavior will end.
The “Twin Demons in the Distance” For Treasury Bonds
Internet stocks went up longer than any logical analysis would predict. So did home prices a few years ago.
And the situation with long Treasury bonds right now also defies analysis. Unless, of course, we’re headed into a massive, deflationary period. But if that’s the case, why are gold and inflation-adjusted Treasuries (TIPS) moving up, too?
Either buyers of gold and TIPS are wrong – or buyers of long-term Treasuries are wrong. I think you know where I stand.
As The Wall Street Journal reported on July 6: “The huge stimulus the Federal Reserve and U.S. government have provided to the economy over the past few years will inevitably push up both interest rates and consumer prices. While the threat isn’t imminent, it’s not too early to take steps to protect the bond part of your portfolio from those twin demons in the distance.”
Consider yourself warned.
Good investing,
Alexander Green
19
Is Apple the Perfect Growth Stock?
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Is Apple the Perfect Growth Stock?
by Alexander Green, Chief Investment Strategist
Monday, July 19, 2010: Issue #1304
I’ve often said that my stock-picking approach can be boiled down to this mantra:
Share prices follow earnings.
I challenge you to look back through history and find even a single company that increased its earnings quarter after quarter, year after year, and the stock didn’t tag along.
By the same token, try to find a company whose earnings were flat or declining year after year and the shares kept rising. It doesn’t happen, even in a roaring bull market.
But is growth in earnings per share all you really need? Could it be that simple?
Of course not.
Any company can increase its earnings for a while merely by cutting expenses. But eventually, a firm reaches a point where it can’t cut costs further without damaging the underlying business. (Obviously, if you reach the point where you’re selling off key infrastructure or laying off top people to boost short-term profits, you’re hurting the company’s long-term prospects.)
There are other important factors as well and I can illustrate a few of them by pointing to a near-perfect growth stock…
Want to See If a Company is Growing? Look to These Three Crucial Factors
In order to see robust bottom-line growth, you need to see substantial top-line growth. In other words, sales have to rise, too.
And Apple, Inc. (Nasdaq: AAPL) is doing just that.
- Sales & Earnings: The company is selling boatloads of iPods, iMacs, iPhones and iPads. In many instances, it’s been unable to keep up with demand. In the most recent quarter, sales jumped 49%. That enabled earnings to soar 90%.
- Profit Margins: This is another important factor. If competitors can come in and easily underprice you, your business is vulnerable.
But Apple is well-protected with its iron-clad patents on the Mac operating system and many of the key features of its bestselling products. So it’s no surprise that operating margins top 29%. Or that Apple is up 63% over the last 52 weeks, even after the recent market dip.
Over time, Apple has brought down the price of most of its products, but not because competitors were forcing them down. Management did it because they wanted to broaden the potential market for Apple’s products. That’s key.
- Return on Equity: This key metric is calculated by dividing earnings per share by book value (or net assets) per share.
Why is this important? Because it tells you how efficiently management is deploying the firm’s capital. Warren Buffett – who puts a great deal of emphasis on ROE – says anything above 17% is good. Apple’s return on equity is twice that.
Happy Customers… Happy Shareholders
Apple has done plenty of other things right, too. It’s a consistent innovator and is a world-class marketer. (Its products are so cool, customers find themselves lusting over things they don’t even need.) And it’s done a good job of keeping a lid on costs.
The end result? Earnings per share have boomed over the last decade. And while the broad market has gone nowhere, shares of Apple are up several-fold.
It’s a classic story of a company that keeps its customers coming back because it makes them happy. And the resulting increase in earnings keeps shareholders delighted, too.
Good investing,
Alexander Green
12
Why Burton G. Malkiel is More Right Than Wrong
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Why Burton G. Malkiel is More Right Than Wrong
by Alexander Green, Chief Investment Strategist
Monday, July 12, 2010: Issue #1299
At FreedomFest in Las Vegas last week, I debated Burton G. Malkiel, author of the investment classic A Random Walk Down Wall Street.
Malkiel is one of just a few men alive who has profoundly affected modern investment thinking. And his position is straightforward.
He believes that rational, self-interested investors take all public information and immediately incorporate it into the price of stocks. (This is where we get the term “efficient market.”)
He therefore concludes that market timing and security analysis is foolhardy… that it’s simply not possible to beat the market over the long term… and that you’d be well advised to give up that dream and just own a broad selection of index funds.
I actually agree with much of what Malkiel says. Much… but certainly not all.
Irrational Exuberance
For starters, you can count on investors to be self-interested. But rational? Not always. Just take a look at recent history…
- How rational were investors 10 years ago when they bid Internet and technology stocks to the skies, forgoing sales and earnings for financial metrics like “eyeballs” and “web hits?”
- How rational were investors five years ago when they put themselves deeply in hock to flip land, rental properties, vacation homes and condos because “real estate always goes up?”
- How rational were investors when they dumped stocks en masse 16 months ago – with the Dow at 6,500 – and plunked the proceeds into money market funds just as yields reached an all-time low?
It’s true that most investors behave rationally most of the time.
But it’s certainly not true that all (or even most) investors behave rationally all the time. And that creates opportunity.
Let’s take a look at another flaw in the “random walk” argument…
Get the Insider Advantage
Malkiel mentions that investors incorporate all “public information” into the price of stocks. But how about non-public information?
Most investors don’t have access to non-public information, that’s true. But that doesn’t mean no one has access to it.
Some of the best trades I’ve ever made have resulted from visiting a retailer and asking the manager how regional and national sales are going. Are they supposed to talk about these things? Absolutely not. But do they?
Sometimes they do. Gaining a bit of key information by talking to customers, suppliers, competitors and employees can give you an edge.
And how about company insiders? Officers and directors have access to all manner of material, non-public information. That gives them an enormous advantage over ordinary investors. And that’s also why Uncle Sam requires them to file a Form 4 with the SEC, divulging the details of their buys and sells.
If you watch what the insiders are doing, you won’t access the non-public information that they possess. But you’ll certainly know whether they think their companies’ shares are overvalued or undervalued. And that’s crucial information.
A 10-Year Market-Beating Performance
In short, Malkiel is right that it’s difficult to beat the market. But does that mean it’s futile to try?
Not only have men like Warren Buffett and Peter Lynch put the lie to that line of thinking, so has our own Oxford Club Trading Portfolio. The independent Hulbert Financial Digest confirms that we’ve beaten the market by a wide margin over the past decade.
But while Malkiel is wrong on some crucial points, he is absolutely right on several others. For example…
- He believes it’s a fool’s errand to try to time the market. I agree.
- He insists that an index fund will outperform the vast majority of actively managed funds over time. He’s right. They have and almost certainly will.
- He argues that index funds provide a big performance boost due to cost-efficiency and tax-efficiency. Right again – and this is far more important over the long haul than most investors realize.
In short, I agree with Malkiel far more than I disagree with him. His research – and similar work by John Bogle, William Bernstein and others – has had a profound impact on the development of my own investment philosophy. In fact, our Gone Fishin’ Portfolio is the very embodiment of much of what he espouses.
And Malkiel may be surprised to learn that this portfolio has beaten the S&P 500 – with far less risk than being fully invested in stocks – every year for over a decade.
I’d call that a non-random success.
Good investing,
Alexander Green
