2011 Will Not Look Like 2010: How to Invest for Current Realities

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 |  Includes: CVX, ECA, KPELY, MRO, OXY, STO, TOT, XOM
by: Joseph L. Shaefer

It depends on who you ask – and when.

Wall Street research analysts used to be paid to separate corporate wishful thinking from corporate reality. So most investors actually paid attention to them. Of course, that was before Wall Street allied themselves against those whose commission dollars and, more importantly, float left sitting in stocks and cash at those firms, support their nasty habits. That is to say, you and me.

The more recent job of Wall Street analysts, it seems, is to tell us stock ABC is a dreadful company with no hope of ever reaching the same earnings they did last year. As most investors rush for the exits, the stock spins into a free-fall. So who buys it? After it’s down 20 or 25%, typically it is those same Wall Street firms. Their “analysts” have done the job they are paid to do, frighten the bulk of the public out of their holdings, so Wall Street’s trading desks can begin accumulating shares at a bargain price.

Then -- lo and behold! It’s almost as if the telephone had been invented! – some other Wall Street firm, which would never collude with another Wall Street firm, of course, issues a “Buy” recommendation on ABC. This news is dutifully disseminated by the allegedly neutral “financial press” and the stock begins climbing, climbing, climbing. As it does so, it begins to attract a following, though none so large as in the final stages of its rise, when the most people believe the most bull being spewed by the touts pushing it higher. But, oh dear, who will sell to all the stampeding masses, yearning to buy high? Ah, that’s when our friends from the firm that originally gave the sell recommendation and bought at the bottom, step in, heroically ensuring an “orderly market” by selling their own shares of ABC to the clamoring public.

This blatant manipulation occurs at the individual security level, but is much more difficult at the macro level, when advising on the US economy and stock markets writ large. The latest consensus view from Wall Street, for instance, is this earth-shaking prediction: “2011 will look a lot like 2010.” According to the learned analysts, U.S. corporations are going to sell the same or more merchandise this year than they did last year and they are going to be just as tough in controlling costs so the bottom line will look just as robust.

Hmmmm. Maybe so, but “a lot like last year” is hardly original thinking. How many of them predicted the demise of autocrats in Tunisia, Egypt and Libya in the first quarter of 2011? The simple truth is, you don’t want to be making investment decisions based upon what Wall Street tells you about the economy, the stock markets, or any particular stock. Their job is to keep you in the game, to keep you coming back for more, no matter what. I don’t know how 2011 will shake out – and neither do they.

I do know this: firms can only increase earnings for so long by (1) skimping on raises, (2) deferring replacement of equipment, (3) switching to HMOs and (4) squeezing suppliers. And I know that no matter how many economists tell me there is no inflation and that the Fed will most certainly not raise rates this year, not only is inflation very real – but if every other nation raises rates we will too (or we won’t be able to sell bonds in the world market which means we’ll actually have to live within our means, anathema to any politician.) I guess these august economists with many degrees and no grounding in Reality 101 actually believe that if corporate earnings will grow 10% you and I will say 'Thank you! Thank you!' to a 2% raise.

It isn’t easy for analysts and economists to deliver bad news. Their bosses like good news. But if they can’t go out on a limb, you and I can. And I believe that, whatever happens in 2011, it will not look just like 2010! As for the markets, I imagine they will do well unless there is a trigger that panics people, that changes perceptions. There are typically 4 'triggers.' In this past century (since the 1913 creation of the Federal Reserve Board), those triggers have been (1) interest rate increases, (2) the fear of higher inflation, (3) a rapid rise in the dollar (which leads foreigners to remove their money from US stocks because, in their currency, they're no longer making money), or (4) declining corporate earnings.

The current devolutions in the Middle East are enough to give you and me investment opportunities but, in my opinion, not enough to change the world or keep oil above $100 (leading to trigger #2, the fear of higher inflation) or even depress the market for more than a few weeks at most. These events have been anything but “revolutionary.” One tyrant is gone from Tunisia but the power elite that spawned him has stepped in to restore order. Another is gone from Egypt and the military, as always, is firmly in control. Only Libya is as likely to descend into tribal warfare as to create a modern nation-state, and that is because Ghadaffi played one tribe against another rather than create a sense of “Libyan-ness” as Nasser did in Egypt.

I expect that this, too, shall pass, and am putting my money where my mouth is, buying quality companies as they pause or decline from their previous ascent and booking a trip to the Middle East today, when all the other business travelers are busy panicking out of their next trip. I expect to see both a clear rise in the companies we’re buying as well as the business class section of our airplane almost to ourselves. I don’t mind being alone or in the minority. It’s crowds that make me uncomfortable – in flight or in the markets.

Among the companies we are buying on pullbacks: every international oil company that is depressed because of the temporary turmoil in the Middle East – Exxon (NYSE:XOM), Chevron (NYSE:CVX), Statoil (NYSE:STO), Total (NYSE:TOT), Marathon (NYSE:MRO), Royal Dutch Shell (NYSE:RDS.B) and Occidental (NYSE:OXY) for instance – as well as other energy producers that have sold off in sympathy like Encana (NYSE:ECA) and rig builder Keppel Corp (OTCPK:KPELY) I’ll let others rush to the “safe” domestic-only plays like those in the Bakken. They can pay increasing prices while we are paying lower prices. Like I say, we don’t like crowded airplanes or crowded markets…

Full Disclosure: We, and/or those clients for whom it is appropriate, are long XOM, CVX, STO, TOT, MRO, OXY, ECA and KPELY. And we are buying more if/as they decline…

The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: we do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.

Past performance is no guarantee of future results, rather an obvious statement but clearly too often unheeded judging by the number of investors who buy the current #1 mutual fund only to watch it plummet next month.

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