Seeking Alpha

Tom Au, CFA's  Instablog

Tom Au, CFA
Send Message
In the early 1990s, during the middle of a secular bull market, I began work on "A Modern Approach To Graham and Dodd Investing," that was not particularly suited for the decade of the 1990s, but was ideally suited for the following "Lost Decade" of the 2000s.
My book:
A Modern Approach to Graham and Dodd Investing
View Tom Au, CFA's Instablogs on:
  • Selecting Shelter In Dow Stocks From A Crash In The Dow Averages

    We have been among the biggest bears on this site, having written about "Dow 7000" in 2007 and 2008 on other sites, and being in the camp that the Dow will pull back to 10,000 or 11,000 in what will be remembered as the crash of "2016," but is actually in progress as we speak.

    If we're right, investors that bought stock at inflated levels prevailing recently stand to lose money. That stands even for a blue chip average like the Dow as a whole, but not for every Dow stock. Specifically, there are a minority of Dow stocks that are little, if at all, about 2008 levels, and therefore appear to offer an oasis of relative safety compared to others in the index.

    One way of measuring the loss of money is through the loss of time. That is, if a stock goes down in price, what it is doing is going back to a lower level characteristic of an earlier period of time. Let's say that a stock goes back to a level last seen seven or eight years ago. Then, you could have saved that amount of time by buying the stock at the lower price today, rather than buying it at the same price in 2007 or 2008.

    The Dow Jones Industrials are being used to illustrate the point, because it represents the most widely followed index and stocks. Others, who invest in different universes, can benefit by applying the same principles to the stocks they are more familiar with.

    It has been said that "progress" consists of "two steps forward and one step back." While everyone likes the "two steps forward part," is not so desirable during the "one step back" phase that we believe to be upon us. Which is why we now put our trust in stocks that haven'tmoved up since 2008.

    Among the hardest hit stocks this year are the energy stocks. Many of them prospered less than others during the six-year plus bull market, and they fell hard in August, reflecting the earlier retreat in oil and gas prices. Chevron (CVX) below 75? Exxon Mobil (NYSE:XOM) below 70? Where have we last seen these prices?

    We are using the above source (Dogs of the Dow) for prices at year-end 2007 and 2008, and Yahoo Finance for "recent" prices as of the Tuesday October 20, 2015 close.

    Here, we can see that the August lows in both stocks were below year-end 2008 prices, and even "recent" levels (of 89.99 and 80.83) are not above those of year-end 2007. But note one important difference: Recent dividend yields on Chevron and ExxonMobil were (4.69%) and (3.54%), respectively, versus (3.51%) and (2.00%) at depressed year-end 2008 prices, meaning that the companies have made dividend progress over this time.

    Among relatively stable consumer goods stocks, WalMart's recent price (58.75) is not much above the year-end 2008 level of 56.06. There's one important difference between then and now: a dividend yield of 1.69% in 2008, and a yield nearly double that today. Similarly, the recent 74.43 price of Proctor and Gamble (NYSE:PG) approximates the 2007 year-end level of 73.42, and is less than 25% higher than the 2008 year-end level 61.82 with a dividend yield nearly double that of 2007.

    A similar, if decidedly weaker, buy case can be made for two telecom stocks, A T &T (NYSE:T), and Verizon (NYSE:VZ). A T&T (33.75) is no longer in the Dow, and Verizon (44.24) is trading around its year-end 2007 level. And these two companies have exhibited less earnings and dividend growth than the four companies above.

    On the other hand, the following stocks may be particularly vulnerable, because their current prices are MUCH above the levels, not only of year-end 2008, but also year-end 2007. The prices are presented in the order of Stock (TICKER), (Recent price, 2007 year-end price, 2008 year-end price).

    American Express (NYSE:AXP) (76.95, 52.02, 18.55). The recent price is only moderately above the year-end 2007 level, but over four times the year-end 2008 level, meaning that it suffered greatly in the 2008 crash and may do so again this time around. Besides, credit contraction is a likely theme of the current crash.

    Disney (NYSE:DIS) (109.84, 32.28, 22.69). The current price is roughly three times that of year-end 2007, and five times that of 2008. It is a "fair weather" stock that will likely pull back in harder times.

    Home Depot (NYSE:HD) (122.86, 26.94, 23.02). The stock traded between $23 and $27 for most of 2008, and the current price is FIVE times that range. Besides, the housing boom appears to be just about over.

    "Three M" (NYSE:MMM) (144.19, 84.37, 57.54). The current price is nearly double the 2007 year-end price, and nearly triple the 2008 year-end price. And this former chemical company has developed so many "specialty" products that people sometimes forget that it is quite cyclical.

    A similar, but decidedly weaker, case can be made for selling two defense stocks: Boeing (NYSE:BA) (138.88, 87.46,42.67) and United Technologies (NYSE:UTX) (93.66, 76.53, 53.60). These stocks have advanced quite a bit since 2008, but the uncertainties raised by the global political situation may well support their stock prices.

    The above observations follow a principle learned managing stocks in emerging markets: "Go to where the trouble has been, not where the trouble will be." Or in blunter language: The time to buy is AFTER a devaluation or a crash, not before. All other things being equal, the idea is to buy stocks that have already crashed, and to sell the ones that (probably) will.

    Disclaimer: This article is not a recommendation to buy or sell stocks in the Dow or elsewhere. These examples from the Dow are used only for illustrative purposes. See your own investment adviser as to the best course of action for yourself.

    Oct 21 10:00 AM | Link | 3 Comments
  • Beware Of A Falling Market During A "Pre Election" Year

    Since the end of World War II, the U.S. stock market has always gone up in the year before a Presidential election. That's why the fact that 2015 might be an exception to the rule is a scary thought.

    Even among such "pre-election" years, there are basically two varieties. The first kind is those of 2003 and 2011, with a first term President, who is running for re-election, and favored to win. The second type is that of 1999, or 2007 where there is a lame duck President. In the two earlier instances, there was a change of party control in the following years, that is 2000 and 2008, a factor that did not help a U.S. stock market that prefers "continuity." It is noteworthy that 2015 is much like the latter type of years, with the same stakes, going into 2016. (The market did not react so badly to Presidential elections for most of the second half of the twentieth century, from 1952 to 1996.)

    In 1999, there was a bull market that ended come the year 2000. Although it seldom happens this way, the first trading day of 2000 marked a bear market (as was the case with Japan in 1990). And there was a bear market in 2008. But more to the point, it actually began around mid-year 2007 when the market peaked; it was down for the second half the year (even while leading to a full year gain), seguing into a very choppy 2008. That's why it makes sense to be concerned about 2015.

    In the twentieth century, the stock market in pre election years appears to have been driven by expectations of what would happen in the following election year. It's not even that the U.S. economy necessarily performs better in a pre-election year. Such years as 1991, or even 1979, have seen their shares of recessions. Yet the U.S. markets went up in both of these pre-election years, probably in anticipation of the push that it would receive during the following (election) year. And the market went up in the associated election years, 1992 and 1980.

    Such a pattern has not been happening in the 20th century, and the U.S. economy cannot count on such support in 2016. Normally, the Fed would begin a period of easing, especially since Fed chairmen enjoy greater job security if the next President is from the same party as the one who appointed them. But after years of "quantitative easing," the Fed has squandered this bullet. The U.S. has also enjoyed record fiscal stimulus (at the cost of record levels of national debt) during the Obama term, meaning that the Adminstration has little or no leeway to step on the accelerator in this regard next year.

    Adding to the economic uncertainty is the way the 2016 Presidential race is shaping up as a multi-candidate race. That could make it at least as much a wild card as the three closest examples; 1992, 1980, and 1912. There is still a very crowded field of Republican Party candidates, and suppose one of them "drops out" of the party, and then runs a John Anderson/Ross Perot/Teddy Roosevelt third party type candidacy. (That would be even after Donald Trump has ruled out such a "spoiler" role for himself.) Worries about the economic policies (and capabilities) of an "unknown" will likely weigh heavily on next year's market.

    The last two times that the U.S. stock market didn't go up in the year before a Presidential election were 1931 and 1939. The earlier year signaled the depths of the Great Depression. The later year marked the start of World War II (in Europe).

    The last pre-election year with a lame duck incumbent, 2007, barely (and technically) avoided a down market, and what followed in 2008 was pretty scary. If 2015 features (or barely escapes) a down year, it is likely to foreshadow a 2016 that is as bad as, or worse than 2008. What used to be a safety net (of an upcoming Presidential election) has been badly frayed.

    Oct 05 5:24 PM | Link | 5 Comments
  • The Bear Is Back

    Readers who knew the "Graham and Dodd Investor" (before 2012) probably remember a deep, and seemingly "permabear."

    I "disappeared" from Seeking Alpha in 2012 and 2013, while I tried my hand as a growth investor. I learned certain things during that stint, like how to track earnings and price momentum, and the importance of a low "PEG" ratio. For all that, this represented a walk on the "wild side" for me. The people I worked with are natural optimists, and I'm a natural pessimist, even when using their methods.

    Like Warren Buffett, I believe that growth and value can be joined at the hip. For instance, nowadays I will look at stocks of certifiable growth companies that are also selling below the market P/E multiple. I'm now willing to accept and manage such stocks as "stocks," instead of applying my Graham and Dodd bond value metrics to them. But I still refuse to touch growers selling at a large premium to the market multiple, where there is clearly a race between the longevity of the growth, and the decline of the P/E ratio.

    One thing I learned to do is to buy the stocks of companies with certifiable (greater than 10% a year) growth prospects, selling at a below-market multiple. Stocks in this category include health care and tobacco stocks. A Graham and Dodd investor would say that one should pay no more than an "average" multiple for a stock, because the likelihood is that any given company is no better than average. In this respect, this is different from the Warren Buffett school of investing, which wants clearly above companies (their "classic" is Coke (NYSE:KO)), and are willing to pay moderately above average multiples for them.

    But my original Graham and Dodd (NYSE:RE)-formulation was not about relative value, as described above, but about absolute value. And this is what lead is to a certain bearishness, and the fear that the U.S. market is "too high." The bond value of both individual stocks, and an index, can be measured using the formula, book value + 10Xdividends ("book value plus ten times dividends"). Most stocks are well above that value today.

    As a group, "stocks" ought to sell above bond value, because of their growth prospects. And "historically," (that is during the 20th century), stocks in the Dow Jones Industrial averages have sold for about a 15% premium to "bond value." But recently (and for much of the 21st century), the premium has been closer to 100%. That's why I, and other bears, believe that there could be a sharp drop in the indexes, to e.g. perhaps 10,000 on the Dow.

    And here's where we may differ from the consensus. People like me believe that over the course of a whole (e.g. twenty-first) century, U.S. stock values should be similar to what they were in the twentieth century. The world is not a safer place than it was in say, 1950. Nor is American political supremacy greater than in the early 1950s, when we "drew" the Korean War with China. The U.S. economy is more evolved than it was 65 years ago, and our toys are fancier, but this is balanced by greater global threats (a "9/11" attack would have been unthinkable in 1950, when airplanes barely existed). And while interest rates are low by historical standards, they were similarly low around World War II.

    The U.S. stock market seems to be fairly priced for the world as it is (or was, until recently), but not for the world that may soon arrive. Interest rates have nowhere to go but up. Recently nose-diving oil and commodity prices (which have been reflected in the price of the stocks) appear to portend a similar drop-off in global demand, not yet reflected elsewhere. The boom in global consumption of the past decade has been driven by increases in "basic" goods (food, and the lower reaches of apparel , shelter, and furniture), and may not yet be ready to move "upmarket." On the whole, the concern is that the U.S. stock market seems to be priced for a "new economy" that is increasingly looking more like the old one, that "oldtimers" remember from the twentieth century.

    Tags: KO
    Sep 08 4:57 PM | Link | 1 Comment
Full index of posts »
Latest Followers


More »

Latest Comments

Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.