Traderbill's Financial Markets Weblog

…over the past 12 months thru yesterday, GE stock is -5.7% (for 2007 it was -0.4%), or -2.8% with dividends reinvested (indicated dividend yield is 3.5%…they boosted dividend by 10%). Here is a well diversified, multinational company with  good management and a dividend yield 50% higher than the S&P 500 which is bogus as it includes those big financial companies where the dividend is in question. This is a pretty good indicator of problems in the equity markets. GE deserves to do poorly if nothing else than the fact that they own NBC…more importantly CNBC which provides no investment value except from a few qualified guests while a crew of actors purports to tell you how to make money in the markets (before you say “so what, so does TB,” remember TB does not tell you what to do but merely try to provide a different point of view than the mainstream media that looks thru the rearview mirror and is paid to be bullish…all the time).

The point is that there are few if any defensive stocks, especially following a year in which the big gains came from a handful of stocks like Google, Research in Motion, Mastercard, etc. All are now trading below their 40 day moving average and have negative returns for the first 5 trading days: Google is down 8.6%; RIMM -15%; Mastercard -8%. How about Goldman Sachs which posted a return of 7.9% last year (+24% to the 10/31 high as it posted blowout earnings (and paid management accordingly), despite the subprime debacle, and is now -7.1% year to date. Even Berkshire Hathaway is down 5.6% ytd after being up 28.7% last year (35.4% to the 12/11 high). Maybe you are not concerned about this but TB is, and you can bet that those managers who beat the market last year are…and may well be taking those profits off the table. 

Officially we have a 10% correction (you have to love the terms the equity guys use) from the market highs: S&P 500 is down 11% 10/10 high close; Dow Industrials -10.6%; Dow Transports are down 10.5% over the past 12 months and 23.9% since the 7/19 high…they peaked early which should have been a clue but was ignored by everyone; Russell 2000 Small Cap is -9.4% for the 12 months and -16.6% from the 10/10 highs. Meanwhile the AMEX Composite is +17.7% (20.8% with reinvested dividends) and off just 6.8% from the 11/6/07 high due to international stocks (including foreign ETF’s).

 This is starting to look very much like a bear market. Is there a bright spot…yes…ONE! Utilities.

Since losing 26.7% in 2002, utilities have been up double digit every year since. Here are the returns with dividends reinvested: 2003 +29.4%; 2005 +25.1%; 2006 +16.6%; 2007 +20.1%…for the entire five years you would have been up 194%….24.1% annualized…how many managers can boast that kind of performance…and in an INDEX to boot…sadly TB ignored them like everyone else after 2004 thinking those returns could not be repeated…the one thing is that the returns fell by about 5% each year from 2003 thru 2006 but jumped again last year which is truly hard to believe. YTD they are still +2.1%!  TB is not however telling you to go out and buy utility stocks as they have a dividend yield of just 2.8% and a price earnings ratio of 17.5%. Still, they may be the closest thing in stocks to a defensive stock.

Can you name anyone who would have told you to buy utilities at anytime over the past four years? TB can’t think of anyone…and worse he can’t think of anyone who would have told you to buy bonds – except for junk bonds or emerging markets were the spreads were unrealistically low reflecting the demise of the risk premium due to highly leveraged hedge funds sopping up the supply.

Yet over the past 10 years the Merrill 1-3 year Treasury Index has had a total return of 4.75% without a negative return and only three years less than 3% (1.57% in 2005, 0.91% in 2004 and 1.9% in 2003) and four years of 5% or better returns…7.32% last year. If you had bought the 10 year treasury note and rolled it at each auction you would have earned 5.52%, the 30 yr 6.50%…those are not bad returns for a security with no risk of default. TB has always liked the 1-5 year area of the curve. Over the past 10 years the return on the Merrill 1-5 Treasury Index has been 5.13% annualized…and Investment Grade Corporates and you get 5.32%…not that much better but in a diversified portfolio not that risky either. Last year however the Treasury/Agencies returned 7.88% vs. 7.27% when investment grade corporates are added to the blend. To TB, this means for now stick with Treasury’s but when the rebound comes it will be time to switch to Corporates. That does not mean that junk bonds will perform well…and not necessarily emerging markets. Inflation protected Treasury’s (TIPS) and zero coupon Treasury’s could perform quite well in the interim. Of course this is predicated on lower bond yields which with the Fed easing should be the case but Treasury’s will be the big benefactor…not corporates.

Small investors can use ETF’s to do this efficiently. Check out www.ishares.com for a comprehensive list of what is available…including municipal bonds now…general market, California, and New York!

If you like emerging markets…which could be a risk, there is a fund that TB has owned in the past: Morgan Stanley Emerging Markets Bond Fund (MSD). The other day PIMCO’s Bill Gross said there could be opportunities in these types of funds at a discount to the net asset value (NAV)…this closed end fund is trading at a 12% discount to the NAV…in February it was just 0.8% below it…worth checking it out.

TB highly recommends reading John Mauldin (www.frontlinethoughts.com). It is free and comes out weekly…in addition, and perhaps more valuable is his Outside the Box which comes out each Monday and is an article he has read and finds enlightening…they usually are. TB suggests you read the piece this week by John Hussman of the Hussman  Funds which will scare you if you are a bull and also shows how hedging with options, rather than selling out or playing in bear market funds which, like gold/silver stocks overreact to market changes.

Hussman points out that the average decline in a bear market is 30%. Furthermore, we are coming off the second longest bull market in history, 55 months since 2003 vs. of a series of 10-18% selloff’s. Some say that the long term trend (since 1994) is not yet a bear market but is sitting right on that trendline and if you can see a reason for stocks to rally, you see something TB and Hussman does not. TB’s concern has been the valuations which the bulls see as ‘cheap’ yet he, and TB, insist is only due to a series of record earnings that are going to decline thus inflating the P/E’s. TB also points to the record stock buybacks of the past five years…which have also inflated S&P earnings! Another concern, and it should concern you, is the equal weighted performance vs. the capitalization weighted performance of the indices…the equal weighted are underperforming…but with the leaders of last year now in decline that could accelerate ultimately producing a buying opportunity. Furthermore, look at those leaders…all selling at high multiples and based heavily on expectations rather than actual results. Deere (DE) is an exception but with a P/E of 22x trailing and 17.6x expected it is vulnerable to even a global slowdown and worse if there is a recession…the P/E to growth rate is 1.8x which is expensive.

Mauldin outlines his forecast for 2008 and one of the key points is not only that the 18,000 jobs reported last month being weak that number is a distortion based on the Birth/Death of businesses which indicated that there were 71k jobs created in financial services in December…do you really believe that? Furthermore, by this metric, 1,239,000 jobs from February thru November which is greater than the entire 1,208,000 since January…hard to believe…yet we, and Bush, are banking on just that. Read the entire article…then see if you remain a bull.  

Goldman out this morning saying the US economy is slipping into recession…this flies in the face of their former CEO, Treasury Secretary Paulson…who yesterday saw a slowdown…by the way when asked if we had seen the end to the subprime crisis he said he thought we knew the damage but that there were other sectors of concern…read home equity!…credit cards? This is hardly capitulation as only about 50% of investors see a recession coming and those that do, see it as being a short one. TB wants to believe this but given tighter credit standards…and the dependency on the financial markets of the central banks to fee their habit, it is hard to imagine loan availability improving! Also, stop believing that it is OK to buy even if you are a long term investor…the long term is merely a string of short terms and as Keynes said “in the long run we are all dead.”

Lastly, TB finds it amazing and humorous as each investment house downgrades the other Wall Street firms…can’t remember a time that his has happened…guess they aren’t bedfellows afterall, right?