Reading the headlines from different analysts and different big name investment firms, I am amazed in the wide swing of opinions in the direction of stocks, bonds, markets and recommendations to readers. I feel many are planting scare tactics in investors to attempt to move the markets in different directions or get media time. Let me describe the last 8 years in two short paragraphs and highlights that will lead us to the future.
History: Leading up to the financial crisis in 2007-08, lending institutions wrote many loans to people wanting to own a home that did not have the ability to pay the note. When they defaulted investors were caught holding the bag on bad loans and the government had to bail a handful of companies out costing billions of dollars (which the U.S. government has received more money in return than it paid out, and continues to receive).
Since then, most of the companies have exited the recovery stronger than before (except the GSEs, but that is another discussion). Since March 2008, when the Dow Jones was at 6500 points, the market has increased to over 17,000 points as of August 2014. That is an amazing climb, one that we will not duplicate in the next 6 years. History lesson over.
In describing the future we are looking at a market that includes many realities. Markets do not move in straight lines and daily reports from quarter earnings, to political events, and world events like war, terrorism and accidents all push stocks, sectors and the markets in different directions all at the same time, every day. In describing this 3-dimensional effect I can easily demonstrate by using a stock that reported a quarterly profit, but failed to meet analysts' expectations, and as a result the stock price dropped. An analyst is an educated guesser. The company reports are the true facts. My point demonstrates investors should focus on the results when the financial reports are released and allow the analysts to supplement the facts, not let them drive the view of investors.
Over the last 6 years most companies have been reporting profits quarter after quarter, driving the stock prices upward. During this last round of reports, second quarter, 2014, many companies reported positive reports with positive outlooks for the rest of 2014. This is a good indicator the companies plan to keep business operations in line with current operations. Companies are not planning to lay off workers, which would drive unemployment upward, and have a negative effect on the economy. Most companies are not expanding right now, even though interest rates are low and financing is available, most are comfortable with their current operations.
Since the financial crisis companies are more financially sound to weather any downturn in the economy. Many larger companies have cash reserves and a business plan to manage during the next downturn in the economy. The Federal Reserve Board has instituted many additional requirements on financial institutions, known as the Basel III requirements, along with other regulations. All of this is to prevent another crisis. Although the last 6 years have been painful on them, they are much stronger financially and understand the repercussions of the federal government bailout program. Many will not get caught in that web again.
The QE3 is close to being phased out by the government (buying bonds). The Federal Reserve Board has stated multiple times that their position is to hold interest rates low until the economy gets stronger. No one yet has defined stronger, but the economy keeps growing near the 3% level which is a good long term pattern. As long as this level growth continues and inflation does not grow at a higher level, the federal government can hold interest rates down for the foreseeable future. Interest rates will rise at some point in the future, but there are no indicators today that will force the Feds to allow the rates to increase.
When interest rates do increase, many financial investment companies (the big banks, mREITs and other companies that loan money) will feel the pain of increasing rates. Many of these companies have created hedges to offset the losses, but some losses will occur. The long term benefit will be the companies will have a greater spread between their borrowing and the rate they lend out to create higher profits. This is the normal cycle, but it is important to discuss because of the scare tactics seen to get investors to jump into, or out of investments. There are times to vacate a position for the right reasons, but fear in the marketplace is not a good investment strategy.
We will see corrections in the markets, as is normal, but these corrections are generally followed by growth that surpasses the high prior to the drop.
Dow Jones Industrial Average 5 year snapshot of the market
As you can see the market has a positive growth trend, going back to March 2008, it dropped to a low of 6500 from the 14,001 from 2007, the day before the market began its historic drop. The chart shows the last 5 years' growth with several corrections, but these corrections have been in positive reporting periods from the broad market. The corrections have occurred and if you go back in history to read many analysts' comments, their recommendations were to protect your investments and restructure your portfolio to safer investments. Many of these investments were to low paying instruments that guaranteed low returns. During this growth period investors should be looking to find quality investments that will provide a 10% or better return through the combination of dividends and stock appreciation. Although the market is up 2.89% as of the open on September 2, 2014, the year-to-date is up 15%.
The market is headed up for the rest of 2014. I base this on the solid production of companies in the market that have multiple quarters of good financial reports and business operations. Companies know how to make money and whether they pay higher dividends or grow their stock price through increased value, investors win.
I have read many recommendations to diversify. I have also heard many successful investors say to concentrate your portfolio in quality investments that will be successful in all market conditions. I tend to agree with the successful investors. This is not to say only invest in one sector of the market, but to concentrate your investments across the many sectors in the markets in strong productive companies.
Across the broad market I like Walt Disney Co (NYSE:DIS). Disney is focused on marketing products and making income. They may have the best marketing plan in sales. Year-to-date, the stock price is up 17%, from $76.04 as of the open on January 2, 2014 to the open on September 2, at $89.88. The strength of marketing through its media networks, parks and resorts, studio entertainment and consumer products for kids and adults will grow. Disney pays an annual dividend, and December 2013, paid $0.86, or 1% yield. Look for the strength of return to be the stock price appreciation near $100 in 2015.
A pharmaceutical company that has several profitable drugs on the market and on track for another is Merck & Co (NYSE: MRK). Merck has been a market leader in drugs for years, but also has many over-the-counter products and animal health care products. Merck's stock price is up 20% for the year, opening January 2, 2014 at $49.88 and an open on September 2 at $60.11. Merck pays a quarterly dividend of $0.44 for a 2.93% yield. Merck's current patents of drugs and earnings will keep the stock price appreciating in 2015, with the $70 range expected.
Two categories I monitor are REITS and MLPs. Both of these types of companies return higher dividends or distributions to investors. Although some rate these types of investments as higher risk, I think there is more opportunity than risk.
There is an mREIT that pays a monthly dividend, Orchid Island Capital, Inc (AMEX: ORC). Orchid is a real estate investment trust company investing in mortgage-backed securities. The stock price opened on January 2, 2014 at $12.86 and will open September 2 at $13.86. Less than 1% appreciation, but the real reward is the $0.18 dividend its pays per month. The yield is over 15%, and you can take the cash or reinvest the dividends to grow your investment. There is risk of interest rate hikes, but I discussed the risk/reward issue in more detail in my article on Orchid Island here on Seeking Alpha.
An mREIT that pays a quarterly dividend that I cover extensively is Western Asset Mortgage Capital Corp (NYSE: WMC). WMC is an investment jewel because it provides investors opportunity in several ways. The stock price cycles through with the ex-dividend date. Over the last several quarters the stock price drops after the ex-date, then begins a stock price appreciation to the next ex-dividend date. The dividend paid each quarter this year has been $.67, but the stock price swing has been near $1.50. A great opportunity for investors to buy in after the drop and ride the stock appreciation up each quarter. Even if you buy and hold the yield on WMC is reporting near 17%.
CVR Refining (NYSE: CVRR) is an independent downstream energy limited partnership with refineries in Coffeyville, KS and Wynnewood, OK. I am very positive on CVRR, although for 3Q, 2014 they have some downtime associated with the July 29 incident and will have a reduction in production for the reporting quarter. We anticipate the distribution per unit to be down for this quarter. Dealing with smaller companies, the risk associated with an incident like this can have major impacts on the distribution or unit price. The last two quarters the distribution has been $0.98 in May 2014 and $0.96 in August 2014. The yield is currently at 16%, and even with this next quarter down a bit, the yield for the year and focused for next year will remain near the 15% mark.
Looking for the negatives in the market. Unemployment continues down, there are no signs of overspending to drive inflation upward. The foreign markets are not skyrocketing or falling, with the European markets dragging along at a slow pace and the Pacific Rim countries growing at a sustainable rate. China's growth rate has slowed over the years, but now near the 7% level. This is expected to remain in the 6-7% range for the next 5 years, so another level, limited to no effect on the markets. The effect of war breaking out is likely to cause a short term ripple in the economy, mostly based on investors over-reacting to the news, but not the effects of the event. The only major event that could cause a major effect in the economy would be a major terrorist attack in the U.S., but that would be short lived to several months before the markets return to a near normal state.
2014 will go down in the investment books as a very profitable year for many investors, and average for those who choose to spread their investments across the table for balance. 2014 will be a profitable year for many companies as growth, positive earnings and cash flow were up. Most companies that pay a dividend held their current dividend or increased in 2014. The stock prices of most companies increased, pushing up the value of portfolios for investors.
2015 will extend the business environment of 2014, as we anticipate many companies to continue earning profits of their current business models. The threat of rising interest rates will cause a pullback of stock prices initially, and some companies may have reduced earnings for 6 months as the rates stabilize, but we expect the increase in interest rates to allow companies issuing loans to be able to increase the spread and create higher earnings. This increase in earnings will spur higher quarterly profits, increase the stock prices and allow dividends to grow also. After the increased interest rates the business of loaning money will create a more profitable environment for many REITs and banking institutions providing loans.
One of the industries I am watching is the shipping of crude oil and products around the globe. The Russia and Ukraine war is likely to cause some disruption in oil and natural gas flow to Europe which will cause higher prices for Europe, that will further challenge the economic recovery there. There is sufficient oil production across the globe and within the U.S. oil production is up. This will prevent any major changes to prices for U.S. consumers. This should not affect the markets long term, although a major clash in fighting may see a reaction in the markets, but it will be short lived to a reaction of the news and not a market factor.
Investors that have more say in their portfolio create a better return. 2014 has presented a positive opportunity for investors to grow. I see 2014 and the beginning of 2015 as a great opportunity to prosper. Your total return includes the dividends and stock price appreciation. Invest in good companies that provide a 10% or better total return.
Disclosure: The author is long ORC, WMC, CVRR.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I invest in stocks that provide the 10% total return I discussed in the article.