How To Navigate Backwards Land

Includes: DPZ, F, GM, T, TM, TSLA, VZ
by: Spencer Knight

Backwards Land, the land of the free, the brave, and the land where fundamental analysis is useless. Forget earnings trends, forget economic reports, forget logic altogether. In fact the Fed's asset purchasing programs have caused investors in Backwards Land to hope for and be delighted by a terrible economy. To be fair, fundamental analysis of equities are important, to an extent, but not economic fundamentals.

In fact, Backwards Land is the place to go for stock prices to climb. Who cares that Thursday's Initial Jobless Claims report missed the mark by about 6%, let stock prices soar. And remember the last time there was a hint at Fed tapering? Fortunately that rumor was quashed and stocks rebounded tremendously. Nobody wants to live in the land of Sensible Fundamentals. In fact, in a normal world more QE is not something to praise one bit. After all, the Fed will eventually have to pay substantially higher interest on these debt securities. If that does not scare you then maybe this will from the WSJ:

What happens when things normalize? Under rosy assumptions-no recessions, low inflation and years of fiscal virtue-net interest is projected to be over $820 billion a year in 2023. That would be more than projected defense spending and more than all nondefense discretionary spending.

One way for Backwards Land to avoid this problem is to keep interest rates suppressed forever. This has been done before and, well, it has not ended well.

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Before I digress too far, is it reasonable for investors to rejoice on news that QE will continue and Initial Jobless Claims surpassed expectations? Well yes, only in Backwards Land. Especially when you consider the fact that a higher unemployment rate will lead to QE forever; which ironically seems to be what every investor wants to see.

There are a few reasons why a worse economy is a good thing for stocks. First off, the Fed has stated that asset purchasing will continue until the unemployment rate hits about 6.5% and inflation reaches 2%. This means that the Fed will make projections and begin tapering its asset purchasing program to end when the unemployment rate hits 6.5%. This is incredibly difficult to gauge, but we can assume that if the unemployment rate stays steady at 7.6% +/- 0.2% then we will see some form of QE forever. This logic comes straight from the Fed's own words.

Regarding inflation, it is comical that the Fed thinks QE will lead to higher inflation. Well, here's some news for you. Buying short-term Treasuries does not lead to higher inflation. The money used to purchase these securities are held in bank reserves in order to pay back the short-term debt holder. In other words, the money that is supposed to be entering the system and kicking inflation up is not actually going into the system. Hence a severe drop in the velocity of money.

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On the other hand, the stock of money is substantially higher due to the fact that Federal Bank Reserves are included in the M1 calculation while turnover is not.

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You can take my word that M2 and M2V look similar as M1 and M1V. These two charts should be concerning because it shows that inflation will not increase as the Fed expects.

This brings me back to Backwards Land. In the normal world stagnant unemployment and low inflation lead to a decrease in stock prices because, well, if consumers are not working then how can they buy goods? And if they cannot buy goods then businesses will not improve earnings at rates to sustain their current stock prices. So with that in mind, why are stock prices climbing higher?

One reason for this is income. If investors, especially retirees, are unable to receive reasonable income from Treasuries then they will need to look elsewhere. And with plenty of big time dividend stocks available then who needs income securities?

The key to dividend stocks, especially for retirees, is preservation of capital. With that in mind, some noncyclicals that provide strong yields are AT&T (NYSE:T), Pitney Bowes (NYSE:PBI), AstraZeneca (NYSE:AZN), Vodafone (VOD) and Verizon (NYSE:VZ). All five of these stocks provide over 4% yields and are not likely to take any substantial losses in the medium term. This is important because, similar to bonds, a stock that maintains its value and provides a 4%-7% dividend yield allows investors to receive their principal with quarterly income along the way.

This is one way to navigate Backwards Land. There are many other ways as well. For instance, there is an endless supply of income mutual funds. Without promoting one investment company over another, income mutual funds span the entire investment spectrum from dividend stocks to high-yield bonds and any conceivable income security in between.

On the other hand it is easy for equity investors to navigate Backwards Land. Just buy anything. Well, not really. There are obviously better choices than others. Some of my favorites I have recommended over the last two and half years are Domino's (NYSE:DPZ), Tesla (NASDAQ:TSLA), Regeneron (NASDAQ:REGN), Lululemon (NASDAQ:LULU), and EMC (EMC). EMC and Lulu have not panned out yet, but the other three have surpassed even my own expectations and I believe all five have more ground to cover.

Two other stocks I expect to continue to climb are Ford (NYSE:F) and General Motors (NYSE:GM). I have opined before that both stocks should climb based on the fact that there is a strong correlation between car sales and an improving economy. Not to mention both firms have taken measures to improve margins by cutting production in areas of the world that are suffering a weaker economy (i.e. Europe). More importantly, car sales are still well off of where they were throughout the 2000s. This indicates that Ford and GM, and Toyota (NYSE:TM) for that matter, have a very bright future ahead. I do prefer Ford and GM because Toyota is at the top end of its historical valuation while Ford and GM are well off of their historical valuations levels.

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Oops, wait a minute, I almost forgot, fundamentals do not matter in this market because this is Backwards Land. Oh well, there's nothing wrong with buying a stock with an actual reason to appreciate in value.

The best way to navigate this market is to keep your eye on the Fed. Any mention of a tapering in QE will drop stock prices across the board. Likewise, any mention of keeping the asset purchasing at $85 billion per month will give the markets a reason to soar. One way to project the Fed's statements is to watch the weekly and monthly employment reports. The worse the report the higher stock prices will go. That sounds ridiculous but, remember, this is Backwards Land where fundamentals do not matter.

I am expecting the unemployment rate to tick lower over time. The economy is broadly improving at an incredibly slow pace, but improving nonetheless. Some may argue the improving economy is the reason stock prices are moving higher, but after seeing how the markets reacted to the Fed's most recent press conferences and how the markets reacted to Thursday's giant miss in Initial Jobless Claims leads me to believe that fundamentals do not matter.

Enjoy living in Backwards Land; where stock prices love to say Don't Tread On Me.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.