I was asked by SA to provide my best single stock or ETF idea for their “Just One Stock” series. I submitted the suggested “interview” below, hewing to their questions in previous articles in that series. They decided it wasn’t quite what they were looking for, since that series is for “stock recommendations.” I don’t blame them for passing on my article -- I didn’t discuss a stock! But at this juncture in this market, I honestly believe what follows is the safest, most common sensical “Just One Anything” I could suggest. See if you agree…
1) If you could only hold one stock position in your portfolio (long or short), what would it be?
Safety First, Inc (symbol: C-A-S-H.) Okay, before anyone runs to their Bloomberg to buy such a company, the only “Safety First” you will find there is a privately-held Canadian mortgage company. That’s not the one I’m referring to. And if you look up the symbol CASH, you’ll find it has been cornered by over-the-counter financial services firm Meta Financial.
While either of them may be worthy of consideration, when I say cash, I mean CASH, as in “dollars,” “moolah,” “dough,” “clams,” “smackers,” “filthy lucre” or “cold, hard cash.” This isn’t a stock, but it is the asset class that provides the only truly safe haven when you want to step back from “Just One Stock” or the whole lot of them!
2) Tell us more about the company behind the stock.
The company behind this “stock” is the US government, an entity that is bankrupt of fiscal responsibility and common sense. Fortunately, however, that company is backed by / guaranteed by more than 300 million Americans. While we may take occasional leave of our senses, as we seem to do on more Tuesdays in November than at any other time, we are among the world’s hardest-working, smartest-working citizens who, when government doesn’t stifle us, bring to the fore more entrepreneurs, inventors, innovators, and patent-holders than the citizens of any other nation on earth.
3) How does your choice reflect your (or your fund's) investment approach? Tell us more about your approach and goals.
Unlike those who trumpet “buy and hold”, we believe there is a time to “buy and hold.” We call those times “secular bull markets.” But unlike the contingent that sees buy and hold as the only strategy for all seasons, we also recognize that secular bear markets can, and often do, destroy all the gains you realized during the appropriate season to buy and hold.
We’ve seen the proof of that pudding in our Growth and Value Portfolio, which we instituted January 1, 1999. In those 11 years it is up 234.5% because we are willing to reallocate assets to equities when the market is depressed and the timing is propitious to do so – and to go to cash or other asset classes when the market is overpriced and looks ready for a fall. A buy and hold strategy in the S&P 500 during that same time frame would have lost 11.4%. And that is before inflation, commissions, or index fund fees.
In the “long term” I have no doubt the markets will come back and scale new heights. I believe this because I believe, no matter where the political and economic pendulum swing, the immovable rock remains: the rock of American innovation and entrepreneurialism. But as John Maynard Keynes observed when someone claimed that while their stock was down then, in the long run it would recover, “Yes, but, in the long run we are all dead.”
The alternative, for us, is to buy and hold in secular bull markets and to be willing to be nimble in reallocating assets during secular bear markets. Ah, but how to know when to do so?
4) Can you talk about the industry/sector? How much is your selection based on the company's industry, as opposed to a pure bottom-up pick?
As our firm’s Chief Investment Officer, I make my decisions about investing at the macro level. That transcends both company and industry. It’s even bigger than sector. The first decision we make is “asset class.” Then, if the indicators line up, we’ll move down into sector, industry, and company.
Of course there will be bottom-up special situations that defy the market, and we own a select few of them right now. But basically I don’t try to hold back the ocean with a popsicle stick. When the “sector of all sectors” – the market itself – is overbought or oversold, we like to be on its good side. Do we always succeed? Of course not. But in this business if you can get the basics right 7 out of 10 times and invest accordingly, you will be way ahead of the market.
To make the asset class decision, I look to history and to 3 primary macro indicators. Historically, I find an eerie similarity between secular bulls and bears past, and the present (and likely future) secular bears and bulls. Regular SA readers saw this chart a few articles ago. I take no credit for it. It comes to us courtesy of Sy Harding, one of the smartest technicians I know and I’ve known a few hundred in my career. (Sy Harding’s Street Smart Report 386-943-4081. Sy writes a free daily blog at www.streetsmartpost.com.)
What this long history says to me is that, for over 110 years, the market has behaved in relatively predictable patterns. Beginning with a secular bear market in the early 1900s, there were then 3 secular bull markets and 2 secular bear markets. I believe that we are now in the secular bear market that has followed the rip-roaring, magnificent bull market from 1982 to 2001.
This secular bear began with the dot.com.bom in 2001. It took the Dow from 11,300 to 7,500 in just one year. Then, beginning in 2003, the market mounted a fine rally, mostly thanks to cheap government financing that inflated home prices at the same time it kept rates low enough to suck in millions via cheap, if unsustainable, mortgages. The ensuing rally soared way up to 14,000 and change in 2007, before plunging back to 6626, then the market in March 2009 began a cyclical rally, where we stand today.
Historically, secular bull markets last somewhere between 16 and 20 years. Bears are slightly less, but are still measured in years, not months. Secular bulls are great times to “buy and hold!” But secular bear markets are characterized by a time of “digestion.” They ratchet up, they ratchet down, they go nowhere and do nothing other than destroy the confidence of most investors and cause them to flee to other asset classes at precisely the wrong time.
Juxtaposed against this historical precedent, I then look primarily at three macro trends: the total value of all publicly traded stocks on US exchanges and OTC (which would include a number of foreign firms) divided by total US GDP; the ratio of any stock index to its average inflation-adjusted earnings over the past decade (a ten-year PE ratio); and total equity market capitalization divided by book value adjusted for inflation. When these approach historic lows – Stocks/GDP at 0.7 or less; 10-year PEs at 10 or less;, and total stock cap to book of 0.6 or so; I begin to buy. When they are too high, like Stocks/GDP at 1.5 or more; 10-year PEs at 25 or more; and total stock cap to book of 1.2 or so, I begin to sell.
Using history, these guidelines, and a healthy dollop of experiential Kentucky windage allows us to fine-tune and add or subtract incrementally to our cash or our equity positions as we go.
5) Describe the company's competitive environment. How is this company positioned with regard to competitors?
Cash has no competitors. None.
Among the “cash equivalent” or “market alternative” investments often offered up by those who need you to “keep your cash working” for their own livelihood (new tires for the Ferrari, a remodel of the kitchen on the house in the Hamptons, private school in Switzerland for the kids, etc.) are: bonds, precious metals, dividend aristocrats, and utilities and other high-dividend stocks. None work with any consistency.
Some believe bonds move inversely to stocks. They have from time to time, but in times like these, when rates are so low their next likely move is up (meaning the price of the bonds themselves will decline) it just doesn’t make sense. Treasury bonds, which set the tone for the bond market, are priced at some of the lowest levels they’ve seen in history. We can not print money 24/7 and still attract capital from around the world at historically low rates.
Well, then, why not buy gold and other precious metals? You may, and we have, but not as an alternative to stocks. Gold marches to the beat of its own drummer. If you believe gold will rise because there will be more crises, more martial, political or financial “blood in the streets,” or a major move up in US interest rates, then gold might move inversely to equities. But crisis and inflation are the two typical drivers of gold prices. If we see no major world crises and experience deflation or stagflation, gold writ large will not provide you with an alternative. It may provide you with outsize profits, but it won’t be solely because it moves counter to equities. It doesn’t.
How about if we stick with the best quality companies we can find in defensive industries that also pay big dividends? They will most often plunge with the rest of the market. Their AA credit rating means nothing when investors panic. “Sell everything!” means high yields of 7% become 9% as prices decline, then 11%, then higher -- but there are no takers. If one week’s decline can remove 11% of your principal, how attractive is an 11% annual yield?
To say, “I’m not worried. GE will always come back,” is fine when you’re 20 years old. But at 65, watching it go from 40 to 6, it was scant comfort to know that it is still a going concern.
6) If you don’t like any of these alternatives, where do you go for safety? You aren’t really talking about stashing dollars under the mattress, are you?
No – but I’m talking about the intelligent corollary to doing so. Ultra-short-term Treasuries are a safe haven. Pre-refunded municipal bonds (and bond funds) are a safe haven, since they already have the cash in the till to be redeemed. And money market funds now carry more insurance and tighter regulation than ever before, so they are valid places to stash cash. None of these will yield much more than enough to keep you even with inflation, but in the next cyclical bear downstroke, would you rather have what you started with and be able to buy what you want at 50 cents on the dollar – or be the one whose portfolio fell from a dollar to 50 cents?
I also like floating-rate bonds and bond funds, as well as Treasury Inflation Protected Securities, which both rise if interest rates are rising. If rates don’t rise, they will lose principal but will pay a yield that may well be greater than any loss.
And there are always “special situations.” These are stocks that, like gold, move based upon their own internal dynamics -- dynamics which are strong enough to overcome whatever the market is doing. A junior gold producer that is showing incredibly strong delineations of the rich veins their properties have already demonstrated could leapfrog into being a major producer and see huge returns. I’m reviewing one such firm for our clients right now; if it meets our criteria I’ll write an SA article about it in the next week or two.
Another special situation might be the commodity ETFs, whether they hold companies that produce sugar or grains or coal or natural gas. Again, I’m looking at one here that has been completely beaten down in the midst of the great cyclical bull rally of 2009 and early 2010. If it pans out as well, I promise to write it up for SA readers.
7) How does the stock's valuation compare to its competitors?
They are apples and oranges. No matter whether you go long or short, you can lose real money. Investments in cash may place you on the sidelines when you might have done better in the market, but that only means the loss of a short-term opportunity. I’d rather be on the sidelines during times of turmoil than rolling the dice, hoping to get whole.
8) Describe current sentiment on the stock. Does your view differ from the consensus?
Absolutely. Although there is no consensus. I exchange newsletters with a number of my fellow editors and I read voraciously. Right now, I’d say half the people out there worth listening to believe this pullback is a natural occurrence in a brand-new bull market and has just about run its course so it’s a great buying opportunity. The other half say the rally was the aberration and there is simply no sentiment, no reason, and no spirit to take the market higher – that all the “last 30 minutes of trading” rallies are merely Wall Street program traders trying to middle each other out of a ha’penny a share.
My move to 50% cash says, “I don’t have a clue which way this thing is going to jump. And I’m not embarrassed to say that because it is the only honest thing to say.” Holding cash will always be outside the mainstream consensus because the mainstream consensus is formed by the talking heads on CNBC, the Internet and your SPAM folder who want to sell you something. If you sit with good old safe and secure cash, you aren’t buying what they’re selling.
9) Does the company's management play a role in your selection? If so, how?
Absolutely. If I had greater faith in my government’s competence in balancing the budget, spending only current receipts, and paying down debt, I’d be willing to commit more to the stock market. In fact, the greatest percentage of our cash equivalent holdings are in floating-rate bonds, floating-rate bond funds, and TIPS and TIPS ETFs. I believe my government – the “company’s” management – is hell-bent on decreasing the value of US dollars in order to repay its creditors in ever-less-valuable paper. So I am unwilling to hold even cash-equivalents without some hedge against inflation – and that hedge is well-provided by instruments that rise in value as interest rates rise and the price of the underlying bonds decline.
10) What catalysts, near-term or long-term, could move the stock significantly?
It won’t move significantly – and therein lies the relaxing certainty of this investment. This is the anchor. Using that analogy, when it is time to move your boat forward, an anchor will slow you down. But in times of turbulence, the intelligent sailor – or investor – will seek shelter from the storm and, if they have any experience with such things, will anchor firmly both fore and aft.
We aren’t looking for a catalyst to move our cash. We are looking for a catalyst that will move the market and thus give us a reason to put our cash back at some risk. If I were to hazard a guess, I’d say we are due for some sort of at least a dead-cat bounce, enough to convince a number of undecided investors that happy days are here again. Then I imagine we’ll see a really scary decline until the outcome of the November elections begins to take on a hazy form in a cloudy crystal ball. Then I think we’ll have the usual monster rally that usually begins in the 2nd year of a President’s term and is swept along with various taxpayer-financed stimuli to get the incumbent re-elected.
But the joy of cash is that, if history, my indicators, and my projections are wrong, I can still move quickly to establish positions anew. Stocks are like streetcars – if you miss one that your broker says “is the deal of a lifetime,” just wait till tomorrow. He’ll be calling you with one that is “even better.”
11) What could go wrong with your pick?
The market could soar like a Roman candle from this point. The horrible outcome of that would be – we only participated to the extent our special situations did as well or better than the market. We lost some opportunity. But losing opportunity is, in my experience, a lot less painful than losing half the portfolio. You still have all your marbles; you just didn’t collect any more of the other guy’s.
On the other hand, if the market ratchets up and down and ends up in the same place, we’ve avoided the gut-wrenching, Tums-popping, and hand-wringing -- and can still buy in a month or a year. And if the market goes down, we’re the ones with cash in hand and a sunny disposition looking to pick the flowers that still grow amidst the wreckage.
I promised SA I’d still submit an article for their Just One Stock series. And I promise you, at this time, in this kind of market -- it will be a special situation precious metal, a special situation commodity ETF, or a special situation short ETF!
Author's Disclosure: C-A-S-H is our biggest position. If you are interested, please see previous articles for some of the other special situations we own…
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