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Brian B. Sullivan, CFA
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Brian Sullivan is President and Chief Investment Officer of Regions Investment Management, a division of Regions Wealth Management. Mr. Sullivan supervises a staff of professionals performing direct investment of discretionary funds and providing investment advice to other portfolios. Mr.... More
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Regions Financial Corporation
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Sullivan's Market $ense
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  • What Cliff?

    The American investor is an interesting subject for study. Since the market collapse of 2008, investors have been running from stocks to bonds. Fund flows have been largely to bond funds during this period. In fact, flows into stock funds reversed and have been outflows.

    Some observers argue that, as the Baby Boomers reach retirement, it makes sense for interest in stocks to wane and bond funds to benefit. This makes little sense to me. A person born at the beginning of the Baby Boom is 66 years young. She should expect to live on average 20 more years, and could live much longer. Bonds have been a much worse investment over past 20-year periods than stocks. The other end of the boomer population is 48 years old. They are not retiring soon, nor are they ready to die. Why would they put their money in bonds? So the Baby Boomer argument makes little sense.

    Meanwhile, since 2008 stocks have done little but rise. In 2009 stocks returned 26%, followed by 15% in 2010, a paltry 2% in 2011, and 16% in 2012. All together, a 72% return for these four years--not bad for all the trouble we've had. 2013 is starting off well, with more than a 3% return in the first half month. As investors tend to be lemmings and momentum followers, why do we see funds flowing out of stocks at the same time as we see the stock market rising? Pricing theory would have stock prices falling if investors are selling more than buying. Why are stock prices rising if investors are selling? Clearly, the mutual funds flow data does not account for everything.

    I asked a couple of colleagues what they thought caused this conundrum. Their thoughts are: first, measuring only mutual funds does not cover all investments into or out of the stock market; and second, prices may have risen from a revaluation rather than a demand surge. These guesses make sense. At Regions Investment Management we mostly deal in individual securities rather than mutual funds. Also, with the exception of 401-k's, most large retirement plans have individual stocks and bonds with some mutual funds. Additionally, there has been a big increase in corporations buying in their own stock. These purchases of stocks would not be picked up in a review of mutual funds.

    Magic is the art of making your eyes see something unreal. The mutual fund survey is telling us that investors are leaving the stock market and buying bonds. The stock market is telling us that there are more buyers of stocks than sellers. I am going to bet on the latter. Prices could not rise for four years in a row without buyers' support, whether from institutions, corporations or individuals. Therefore, I conclude that investors as a whole are optimistic about the future, not overly worried about the debt crisis, and not too worried about the cliff. Cliff? What Cliff? You mean all that hubbub in Washington a couple of weeks ago? It's just noise-- don't pay any attention.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: Please see full disclosure on my profile page.

    Jan 24 9:16 AM | Link | Comment!
  • Evel Knievel Investing

    Daredevil: One who pursues a dangerous course of action without thought or concern for the consequences.

    Today's investors are being subjected to financial repression. In its current form, repression comes from government action to control interest rates, so that the government is not forced to pay, and investors do not receive, a just return. Repression of returns clearly helps debtors of all kinds at the expense of investors. For over three years the Federal Reserve has kept short-term rates near zero, and for over a year they have manipulated long-term rates to a figure below inflation levels. Government has forced these rates down to stimulate investment and demand, with marginal effect. As a consequence, low rates have lowered the dollar exchange rate and diminished investors' income.

    Imagine an investor in Treasury securities who has seen the yield on his portfolio drop to half the former rate over the last ten years. If the investor was already retired and dependent on the income, he will have to cut his spending. Losing income, even in a low inflation environment, is difficult to bear. Investors in other types of fixed-income securities have seen similar drops in their income. Over the past few years, as investors' incomes have declined, they have looked for remedies.

    Remedies for falling yields on portfolios come in two groups; efficiencies and risk taking.

    First, efficiencies. Reducing the number of accounts you have in order to reduce fees and paper work is efficient. Using idle cash is efficient. Adjusting your asset allocation, to the minimum you must have in low yield investments, is efficiency. Forecasting your cash needs and resources to keep every available dollar working for you is efficiency. Managing both your assets and your liabilities for maximum return is efficiency.

    Risk taking is another matter altogether. It is said more money has been lost stretching for yield than at the point of a gun. Think of the clients of Madoff and Stanford if you need current examples.

    But less criminal ways of losing money are also popular. A friend of mine recently discussed a preferred stock of a second tier company he had bought; it carries a double-digit yield. He knew that the yield wouldn't last, it would be cut; but for the time being the yield was very attractive. He is a smart guy using a dumb strategy. He is very unlikely to get out of the investment before the price falls. He is stretching for yield by investing in risky investments, either knowingly or unknowingly.

    Evel Knievel knew that the stunts he performed were risky. He also knew how to reduce the risk (while making a trick appear more risky!) but he pursued his death-defying career because he thought the return was worth it. My friend was risking the whole of his invested money to get a big yield for about six months. My friend's upside potential was five or six percent of yield, while his downside risk was likely fifty percent or greater of his capital. This is not a good risk- reward tradeoff. An investor getting 2% today can increase his risk slightly and get 3%. He can increase his risk even more and get 4%; but to go from 2% to 10%, he must be willing to risk a substantial portion of his principal. Such an investment must have a reasonable likelihood of a very bad outcome, or it would not be available at such a high yield.

    The investment spectrum ranges from very safe and no yield Treasury Bills, to 2%-yielding ten year Treasury Bonds, to stocks with expected returns of about 7%, to venture capital expecting 15%. The further you get from T-Bills in yield, the closer you are to the risk level of venture capital.

    Current yield-enhancing strategies which come with extra risk are: high yield stocks, Hybrid Mortgage REITS, MLPs, Preferred Stocks, Convertible Preferred Bonds, and anything else yielding 8% or more. Some of these investments will work out fine. Maybe all of them will-- but I am sure of this: investors who previously invested conservatively, but who now are desperate for yield, are not really aware of the risks they are taking. If on the other hand you are investing in these not just for their higher yield, but instead for a strategic reason such as diversification, then enjoy the risk, the yield and the diversity. Evel Knievel never took risks he didn't understand, and he never would have risked it all for 10%.

    Some investors better fit the definition of daredevil than Evel Knievel ever did.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: Please visit my profile page to view the full disclosure.

    Jan 16 11:44 AM | Link | Comment!
  • If Economics Were Football, This Would Be The Preseason

    As we weigh prospects for the future, whether of a football team or the economy, we see apparent strengths and weaknesses. However, these strengths and weaknesses are not always as determinative as they first appear. In 2012, Alabama, LSU and USC were all preseason favorites. LSU did not do as well as they had hoped, and USC soon fell apart. Notre Dame, on the other hand, was not even ranked---yet they played for the championship. Predicting the future is chancy.

    So we look at 2013 and handicap the likely good things along with the not so good. First the good: housing, the consumer, energy, and corporate investment.

    The consumer is a major element of our economy, accounting for 70% of domestic spending. For several years the consumer has been on his best behavior, cutting spending slightly while greatly reducing the growth of spending. These behaviors caused savings balances to rise and debt balances to fall, with the result that consumer debt load is less than at any time in the last 30 years. After most recessions, consumers generally satisfy the demand for goods that they have avoided buying during the recession. Not this time; consumer income growth has exceeded consumer spending since the recession. Consumers, should they choose, could increase spending faster than their incomes rise. The holdback for many consumers is the still-poor employment picture, and the uncertainty regarding any number of issues in Washington. Aware consumers know that they will likely see their incomes drop as taxes rise. If they are on Social Security or unemployment, they are uncertain about proposed changes. Employees of small businesses have heard their employers threaten to remove healthcare coverage, or to take other cost-saving measures to remain profitable.

    So Washington is presently the biggest deterrent of consumer spending. Spending will probably increase in 2013, but not if Washington's roadblocks are maintained and augmented. A resolution to the budget impasse will be helpful. A good resolution would hold all the promise of the start of fall football season.

    We are still behind in the building of new homes, whether single-family or apartment. Since the bottom in late 2009 at 400,000 units, we are now building 900,000 units. But we need to build 1,300,000 on average: first, to house our 1,000,000 new households, and then about 300,000 to replace burned, flooded or obsolete housing units. The overbuilding of the 2003 to 2007 period has been more than offset by underbuilding since 2008, and we continue to under build. Residential construction is one of the most powerful cyclical elements of our economy. Building a home spurs sales in construction material, sales of manufactured goods such as carpet, commercial lending in the building phase, mortgage lending at completion and employment. It is estimated that the increase from 400,000 to 900,000 units has created an additional 1.5 million jobs. What then can keep a prediction of substantially greater housing starts from coming true? A lack of confidence is the most likely suspect. As each young person is weighing the decision to sign a lease on an apartment, or each 30-something is deciding on a new bigger house, an element of confidence is necessary. Large among the elements of confidence is job security and prospective income after taxes. Washington's indecision and anti-growth leanings could derail what should be a great year in housing.

    Energy prices are low, and likely to stay there. Gasoline prices continue to fall. Natural gas prices are low by historic standards, and likely to remain low. Demand for natural gas is rising rapidly as the low price stimulates use and substitution. Electric utilities which could switch to natural gas from coal or oil have done so. Municipalities, for environmental or cost reasons, have switched much of the bus fleet to natural gas. Long-distance trucking using natural gas is growing, though it faces hurdles from a lack of filling stations. Several companies are working to improve this situation; a nationwide supply network is expected by 2014. This switching reduces demand for oil and coal, and reduces costs. These cost reductions are similar to a tax cut. They make US-produced goods cheaper while they provide more spending money for consumers. These advantages derive from increased natural gas production caused by hydraulic fracturing and horizontal drilling. In America's history innovation has played a big part in making us strong and prosperous. However, Washington is not comfortable with these new energy technologies, and might intervene to curtail this prosperity.

    Corporate Investment--- Cash on company balance sheets has never been higher. Debt on corporate balance sheets hasn't been this low in a long time. Companies have the wherewithal to spend, to build and to invest in their businesses. In 2013, we could see a change of heart from corporate frugality to corporate boldness. Several obstacles stand in the way: regulatory uncertainty, healthcare uncertainty, and unwillingness to repatriate foreign profits. Many industries, including banking, are still in the throes of regulatory reform. The regulations are unwritten, poorly understood, and ever-changing. This is a poor environment for corporate decision making.

    Regarding healthcare, the process is further along, but is still a quandary to many business owners, particularly smaller companies. Profits made by US companies overseas are stranded by tax law. This leads to the unusual circumstance of companies having piles of money in Europe, yet needing to borrow for operation in the US. These stranded funds promote expansion of business in foreign countries at the same time as they deter expansion in the US. Companies with stranded funds face the dilemma of leaving the funds unproductive in other countries, or giving up 35% of these "after tax profits" to move them home. Clearly, they are choosing to preserve them abroad.

    In sum, we have four huge advantages which should make for a great 2013. Housing, consumer, energy and corporate investment are all poised to be additive. We have one giant problem blocking the way: the federal government.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: See also disclosure in profile.

    Jan 10 9:03 AM | Link | Comment!
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