It is a market cliché that “they don’t ring a bell to signal the top.” Or the bottom. But this panic selling of AAA securities like ROYAL DUTCH SHELL (RDS.B,) bringing that stock to less than 5 times earnings and a more than 8% yield, might suggest otherwise. An even better example may be the preferred stocks of many banks, natural gas companies, metals and mining firms, apartment rental behemoths, and health care corporations which I expect to still be in existence when it comes time to redeem these shares.
Can I foretell the absolute bottom of the market? Of course not. And neither can anyone else. Anyone who says they can read a chart and tell you, within a hundred or two hundred points, where the bottom (or top, for we shall see them again!) is a liar or one lucky guesser. (Even a stopped clock is right twice a day. And the Perma-Bears who lost you so much money a year ago are finally crowing about being “right.”)
I’ll take this a step further – and encourage you to insist that every guru du jour does the same: I can’t tell, with any reasonable accuracy, what one hormone-jumbled teenager will say or do in any given situation. How could I – or anyone else – possibly know what 100 million panicked “investors,” all acting like scared teenagers, do on any given day?
What I can do is study what constitutes over-valuation and what constitutes under-valuation and stair-step out when I suspect the former and back in when I suspect the latter. I don’t sell – or buy – all at once but try to spread, in this case, purchases over what I believe will be a bottoming area. And I can do one more thing – I can avoid panicking when the great majority are selling everything and anything at any price so they can hide their greatly reduced dollars under the mattress. Here’s what I’m doing instead.
Many of our clients and subscribers have good cash positions. When I realized we were not going to get even the wisp of a “honeymoon rally” granted by most new Presidents, I sold a good chunk of each portfolio and went to cash. So – should we now take that cash and do nothing with it? I say no. I have identified some wonderful opportunities as a result of the current decline. Here’s just one example. US BANCORP (NYSE:USB) took just $6.6 billion in TARP money. (“Just!” Look how we now think of such things...) Yet USB’s preferred shares have been panic-sold along with those of the rash and reckless banks.”
Today, I purchased shares of the US BANCORP CAPITAL VI TRUST PREFERREDS (USB pr E.) These preferred shares were issued at $25. If US BANCORP is still in business then, they will be redeemed on March 9, 2035 at $25. If they are acquired in the interim (By whom? All the big banks are Walking Dead!) whoever acquires them will assume this liability to redeem at par. We paid exactly half of that, or $12.50, today. The preferred pays $1.44 a share. At $25, that means it paid a 5.75% yield. At $12.50, however, that same $1.44 equals an 11.5% payout.
Assuming US BANCORP continues as a going concern, we just locked in a guaranteed 11.5% per annum return in a bear market and a guaranteed 100% capital gain if any of us live to 2035. This for an A+ S&P-rated preferred. And that’s the worst case! If the market recovers to, say, 12,000 in the next 3 to 5 years – and I am personally confident it will – it is likely that buyers interested in both capital gains and income will bid these preferred shares back to – who knows? – $15? $18? $21? I’m OK with getting 11.5% and “only” selling for a 50% gain at $18.75.
I am willing to sell something which is down 30% or 40% -- to take my lumps -- in order to exchange it for this type of preferred share that is down 50%. (Down only because of guilt by association. Like the fact that it’s a bank. All banks are not evil. All bankers are not stupid.)
As I’ve written before, we will still use banks as our primary monthly cash flow location of choice, as we do with our bank checking accounts. It’s a bit less convenient to run to WESTERN UNION (NYSE:WU) for a money order every time we want to pay a bill. I can think of dozens of A-rated banks. I do business with one of them. I’d even consider, at these depressed prices, the common stocks of a few banks that have graced the pages of Investors Edge in the past, like SVB FINANCIAL (NASDAQ:SIVB) (which was called SILICON VALLEY BANCSHARES when first added to our model portfolios and BANKOH (BANK OF HAWAII, (NYSE:BOH).)
I can’t promise that stocks like RDS.B and USB pr E won’t decline further, in which case I’ll wish I had waited to get the “exact” bottom. That’s simply human nature. Nor can I “know” that I’ll have the time to acquire the kind of sizable positions in these that I’d like to build -- this market is so oversold now that it could rally to 7500 tomorrow and to 9500 before it reaches serious overbought territory. All I can do is make certain, as I upgrade my portfolios, that I won’t go down one iota in quality and that I will attempt to increase our current income and appreciation potential with every trade. This strategy beats holding 100% cash. Yes, cash provides protection against further decline. But at these levels, I’d rather lock in current income and appreciation potential in quality firms with the idea of making a fair return rather than cowering in the corner.
FULL DISCLOSURE: Long RDS.B, USBprE, and a whole bunch of other depressed preferred stocks!