Think LIke a Millionaire

     When I was younger and raising my family, I had the chance to go to lunch with a group of local multi-millionaires. Needless to say, I was pretty excited because this was my chance to listen and learn how to become one of them. We met at a local pub and after introductions, they began to talk. To my disappointment, the conversation was not about making money or lucrative investments. The entire time was spent on a discussion about how to grow your own potatoes. I came home angry and dejected.. Those guys could easily afford to buy every potato in the state of Indiana without making a dent in their net worth. It wasn't until years later that I realized the lessons to be learned from that meeting. First, these guys were just like anybody else. There was no one secret to their success. They worked hard at what they did for a living and invested their money in whatever they were comfortable with. Second, they were misers. They grew their own vegetables because they liked fresh produce, liked working the soil, and saved a little money in the process. By taking good care of their pennies, they racked-up dollars over time. Privately, they even talked about what tightasses the others were. I remember a story about one in the group, who reportedly was worth $10 million, how he anguished over the purchase of a johnboat for fishing. I seriously doubt that any one of them had any substantial debt. Why would a guy who grows his own potatoes want to pay interest? Another trait they all shared was that real estate was a considerable portion of their holdings. One was a developer and another was a large property manager and landlord.  None of them drove fancy cars or dressed like they were worth a lot of money. They all lived in comfortable but modest homes. The richest guy lived in a duplex and rented-out the other half for income. Bottom line is that most millionaires are not easily recognized. The only difference between them and everyone else is the peace of mind they have knowing they can handle any financial difficulties for them or their loved ones.

MID-YEAR TUNE-UP

     Last December, I wrote my forecast for the year 2019. It is now time to check the accuracy and substance of my comments. First on interest rates, I stated that the Fed would probably not raise interest rates for the immediate future. That was correct, the Fed is actually hinting at a rate cut this year if markets deteriorate. I also predicted a slower growth environment for earnings due to the rate increases last year. That also is proving accurate. I predicted that the trade war with China will drag-on, causing price increases on goods manufactured in China. So far this year, Chinese companies have absorbed some of the additional costs due to tariffs but that will not continue very long. Eventually, costs to US consumers will go up if this trade war with China continues. Higher costs means an increase in inflation which is exactly what the Feds want. I also mentioned that the world oil markets were weak which can hurt our export of gas and oil and reduce employment. The latest jobs report showed an anemic 27,000 new jobs created last month. Oil continues to be weak but I don't believe this is anything other than the dynamics of a the global market for oil. It would take many years for the electric car business to put a dent on world oil demand in my opinion. The electric car batteries will be recharged with household current generated mostly with natural gas and coal. Oil companies will continue to drill and I will continue to invest in them for the foreseeable future, My forecast mentioned the treasury yield curve and how it was inverted late last year. The inversion was between the 5yr and the 3mo notes. Recently long dated treasuries have dropped dramatically to where the 10yr note is very close to the 2% level. Currently many short term notes yield more than the 5yr note. When the yield on short rates exceed long rates, I get a little nervous. It shows a lack of confidence in our economy. Bond buyers should get rewarded with higher rates for buying longer term bonds due to many factors involving greater risk. I am currently selling some of my gainers into pockets of strength in this market and investing the proceeds into fixed income. When I look at my holdings, I consider dividend yield (can I get this from a CD?), market multiple (P/E ratio), political risks (heavy Chinese dependence), defensive posture (I like drugs, medical and health care), and finally analyst opinions. I am not giving up on stocks, just easing back and taking what the market has given me. If stocks do correct this year or next, I want plenty of dry powder to apply to my buy list.

PIPELINE

     In 1962 The Chanteys, a band in California recorded this song as a tribute to the massive surfing waves in Hawaii. The instrumental song started a wave of surfer music and inspired later groups like the Doors with the heavy reverberating base sound (think "Riders on the Storm").  Pipelines also are a recurring theme in my investment strategy. A pure play on pipelines is the Master Limited Partnership or (MLP). This is an investment that generates income monthly and is tax advantaged because the distributions are considered as a return of capital. MLP's typically own what is called "down stream" assets related to oil production like refining, storage, and transportation. Essentially, they are toll collectors for the movement of fossil fuels much like cars and trucks have to pay a toll to travel some highways. If you think that fossil fuels are soon to be obsolete, then you should not invest in their pipelines. I personally think that oil and natural gas will be around at least as long as me. Another reference to pipelines relates to the pharmaceutical industry and their development of new drugs and therapies which treat disease. The strength of a company's pipeline of new drugs is a measure of its investability. It's very risky to make a bet on a drug that is even in the late stages of development because few drugs in the pipeline actually make it to market. One example of the risks associated with investing in promising new drugs is Biogen (BIIB) whose late stage Alzheimers drug failed to show any patient benefit. The stock was hammered so bad that I couldn't resist buying a few shares on the cheap based on its other proven therapies. My third and final pipeline theme is also related to the drug business. I think of the drugstores as part of the supply chain (pipeline) which is responsible for getting drug therapies into patient's hands. One retail store in particular is working to change the way people receive their health care. I'm talking about CVS which has recently purchased Aetna health care in an attempt to offer a one-shop-stop for most non-acute health care needs. CVS offers minute-clinics in many of its almost 10,000 stores which will complement its health insurance business. They also own a large pharmacy benefit management business (PBM) which allows them to buy drugs at a discount due to the large quantities purchased. Larry Merlo, the CEO of CVS wants to change the face of health care in this country and hopefully bring down the cost so everyone can afford to receive treatments. The stock market has recently punished CVS because they didn't want the Aetna deal to go through. At 70 billion, it was a bitter pill to swallow but long term investors should see great benefit in the future and there is a 3.8% dividend to keep me interested while I wait. I have to admit that I bought CVS too early and I am now in the red but I already have orders in to buy more and average down on my entry price. I am betting on Merlo to do for health care what the last 30 years of politicians couldn't,

A Good Problem to Have

     I recently filed my 2018 taxes and got a huge shock. My tax liability was more than I ever imagined because of the following reasons: 1. I took some gains in long-held stocks during the year, 2. I have been investing in income producing stocks and CD's, 3. Many of my stocks have attractive yields in the 3-4% range, 4. Money market funds are finally starting to produce meaningful income, 5. My return had very little tax-deferring deductions like IRA's, depreciation for rentals, or business income and the deductions (expenses) that go along with it. So what can I do to lessen the tax bite? First, I ran down to my Credit Union and made my 2018 contribution to an IRA. This step alone lowered my Federal and State liability by $1600. Since I had no earned income, I had to study the tax law to find out that I could make a contribution based on my wife's income. Tax law concerning IRA's can be complex, so only trust what you read in official government publications from the IRS. I have been given faulty advice from people in the financial community so always double check to make sure you are complying with existing tax law. As a volunteer tax preparer, I always have a copy of Publication 17 on my computer desktop as a reference, just remember, the taxpayer is responsible for what goes on the tax return. The IRS allows taxpayers to make contributions to retirement plans even after the calendar year is over. You have until the filing deadline (April 15) to make a contribution for the previous year. For tax year 2019, the amount a person my age can contribute has gone up to $7000 for each person. So what can I do to ease my tax burden for 2019? Again, I will max out my IRA contributions for myself and possibly my wife (if she qualifies). Then, instead of investing in bank CD's I will start buying some tax-free municipal bond issues in my state. These bonds are free from state and federal taxation. I will also make sure to offset any gains in stocks with losses in other stocks, (last year I could not find any losing positions that I wanted to part with). Finally, my hobby gardening business will become an income producing activity, complete with deductible expenses like mileage, insurance premiums, and input costs. I don't expect to make any money for a couple of years but that is exactly the point.

FAITH

     In 1987 the late George Michael recorded the album "Faith" as his first solo album after the break-up of his band WHAM the year before. In the title song, George sings that "Ya gotta have faith". Yesterday's market action reminded me how important the virtue of faith is in investing. You've got to have faith in your research, your investing themes, and your decisions. More often than not, a new addition to the portfolio will decline in value. A sure way to lose money is to panic and sell a stock just because of normal market fluctuations. Your confidence in your stock selections comes from a disciplined approach to finding value in unloved stocks. My past posts lay out a strategy for finding cheap stocks that should trade higher. Ratio analysis is a great tool to help make intelligent decisions. The price/earnings ratio is a good place to start your analysis. The PEG ratio will help quantify the P/E ratio. Most brokerage sites have good research tools to help compare stocks in similar sectors which helps identify bargains. As I mentioned earlier, the stock market turned in a strong performance yesterday. After a punishing December, some of my picks in the technology sector were losing value and the news made them look hopeless. Faith in my research kept me from selling when most analysts were bad mouthing the tech sector. Suddenly, other investors realized that a company like Micron Technology (MU) was selling too far below its intrinsic value. The fact is that some stocks can languish for months on the s**t list and then like magic, gap-up dramatically in one day. I will be using the rally in this market to continue to take some profits and reinvest them in safe investments like FDIC insured CD's. That is what a retired person my age should do. This is not to say that I have abandoned stocks. I still have a major portion of my assets in stocks but for reasons laid-out in my annual forecast, I remain cautious about the market in general. Even though I will be slanting my asset allocation toward fixed income, I still look for undervalued stocks in all market environments. When I find a company that I want to add to my portfolio, I will place a limit order for it at the price that I find attractive. Sometimes a stock's valuation will get ahead of itself and I have faith that it will return to saner levels. Thanks to George for reminding us to keep the faith, RIP.

2019 FORCAST

     2019 will be a difficult year for investors. The huge tax cuts which propelled earnings for 2018 are wearing off. Corporations will still enjoy the lower tax rates, but earnings comparisons with previous periods will be muted. Higher interest rates combined with higher levels of debt will further crimp earnings. Trade tensions with China will continue to be a drag on market sentiment and cause preemptive price increases to consumers. Turmoil in the White House from the Mueller investigation is another worry for U.S. markets. The impeachment or resignation of Trump could trigger a massive sell-off. Wage growth should continue at a modest pace but unemployment will creep up as economic growth slows. The Federal Reserve is expected to increase rates 2x in 2019 but I believe the 25bp raise in Dec is the last for the immediate future. The Fed can further slow the economy with its quantitative tightening without interest rate increases. The price of crude oil has been very weak at the end of 2018 due to a glut of supply. This could slow exploration of shale oil in the U.S. The resulting decline in profits and employment will be an additional drag on our economy. One reliable indicator of a coming recession is an inverted yield curve. This is when short term treasuries yield more than long dated treasuries. Recently, the difference between the 10 year treasury and the 2 year treasury was only 14 basis points, which is close to inverting. The 5 year vrs the 2 year treasuries have already inverted. I am inclined to take a defensive stand considering all the possible negative events that could occur in 2019. Over the past 12 months, I have been increasing my purchases of laddered CD's to provide income and the safety of deposit insurance. I have also maintained substantial cash balances in money market funds. Due to the Fed rate increases over the past several years, money markets are offering rates in the 2.37% range. Having liquid assets also allows you to pick-up bargains in stocks as the market declines. During difficult times, I like defensive stocks-those that hold up in down markets. Examples of defensive issues include: consumer discressionary companies like Procter and Gamble (PG), drug companies like Pfizer (PFE) and utilities like Next Era Energy (NEE). Diversification can be achieved by buying ETF's in these sectors. Finally, there is one sector picking-up steam and could be recession-proof: the cannabis trade. The excitement around legalization for recreational use and the known benefits of medical use could propel the Canadian stocks like Canopy Growth (CGS) and Cronos (CRON). An added benefit of these two is the large stakes taken by deep pocketed companies wanting a piece of the action. Their capital may be necessary for the rapid growth expected in the future.

A BAD REACTION

     Sometimes two different things just don't mix. This recent market action reminds me of the time I went camping down in Kentucky with disastrous results. I had taken a prescription medicine for my stomach problems before I left the house. When I got to camp, I started drinking wine instead of eating any supper. About 2:30 am I stood-up to get some wood for the campfire and did a face-plant right into the fire. After rolling out of the fire, I fell flat on my face, breaking my glasses and my nose. The next morning I woke-up with black eyes, a burned face and a pounding headache. Alcohol and drugs are a volatile combination. After yesterday's 600 point drop in the Dow industrial average, my take is there were a couple of things that caused this nasty reaction. First up is the uncertainty of the results of the mid-term elections. As expected, the House of Congress has a new Democratic majority. Wall Street is nervous about how this will effect Donald Trump's agenda. A divided government may result in grid-lock which means little can be achieved. Another ingredient for market unrest is increasing interest rates. Higher rates is not a new story, but at some point the market will react badly when the higher rates are perceived as a detriment to stocks. Not only do higher rates increase borrowing cost to corporations, they also give investors an alternative to stocks in the form of fixed income investments. Any reductions to earnings is considered a threat to stocks. If those two factors weren't enough, a third ingredient has roiled this market-the trade war with China will hurt many multinational corporations, especially technology companies. At the same time these factors were weighing on investors nerves, oil was doing its own face-plant into the fire. Add it all up and the market reacted by puking-up half it's gain for the year, leaving the Dow up only 2.7%. Now for some good news: corporate earnings are up this year by some 30% year over year thanks to the Trump tax cuts, consumers are generally in good financial shape, interest rates are still relatively low, and I'm waiting for the annual Santa Claus rally. Bottom line, stocks are still the best option for long term investors especially now that they are even more reasonably priced.