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.

Trick or Tweet

     It's the day before Halloween and it has been two months since my last post. The stock market has managed to drop about 9% in that time as measured by the S&P 500 ETF (SPY). While a drop in stock prices is always painful, this is a healthy and normal correction. Is there more pain to come? My guess is yes, stocks will move lower before slowly moving higher. Since I haven't sold anything lately, I haven't realized any losses on my holdings. Valuations of the S&P 500 index based on expected earnings have returned to a more normal 15.6x, down from a lofty 18.8x. I have explained the P/E ratio or "valuation" in my previous post "Exploiting the P/E Ratio", from 11/19/2016. So what should the investor do now? I still think stocks are the best game in town. While I have hedged my bets by buying a laddered portfolio of Federally insured CD's, I am not willing to give-up on stocks at this time. Some good companies are paying attractive dividend yields while trading at very reasonable valuations. One example is AT&T (T) which pays a 6.9% dividend and trades at only 5x earnings. I also like its competitor- Verizon which pays a 4.3% dividend and trades at 7x earnings. Both of those yields beat anything I can get at my local bank or credit union and the stocks offer the potential for capital appreciation over time. While I can't control the next tweet coming from the White House and the market's reaction to it, I sleep better knowing my stocks are actually paying me a return for using my money. One other interesting investing opportunity is playing out in the stock market now-legislation legalizing medical and recreational marijuana in Canada and some states in the USA. So far 9 states have legalized recreational pot and 30 states have legalized medical marijuana. I have been watching 3 stocks that supply the Canadian market-Tilray (TLRY), Cronos Group (CRON), and Canopy Growth (CGC). While I don't own any of these currently, I would consider the last two because of their capital structure and the medical benefits their products offer to patients. I tend to avoid "sin" stocks in my portfolio but I view these companies more like pharmaceuticals that help people who suffer from disease.

Wag the Dog

     Two days from this post, the current President of the United States is going to visit my home town of Evansville,In. This political rally will take place before a packed house at our new arena in the downtown and there will also be a huge crowd of protesters outside carrying signs rallying against Donald Trump. Here is a president who has had two of his campaign organizers convicted of crimes, who has routinely lied to the American public, who has been caught having an affair with a porn actress and a playboy model, then caught buying their silence for the purpose of winning the presidential election and currently is embroiled in an investigation that he colluded with the Russians to influence our election. In spite of all this, he still has the support of millions of voters and can attract thousands of supporters at every event. How can this be? Here's my take; it's the stock market that is the tail that wags the dog. The juice that the Donald has harnessed is the unrivaled ascent of our US stock market since his election. His support is based on bloated retirement accounts, jobs that a healthy economy can support, businessmen who are making fortunes running factories, wall street pros who manage our markets, and wealthy individuals who are getting wealthier by being invested in stocks. The recent tax cut enacted by Congress has given new life to our stock market by increasing the earnings of most American companies. Another powerful force unleashed by Trump is the deregulation of many industries. The combination of deregulation and tax cuts for businesses will prop-up earnings for the duration of his presidency assuming that it goes full term. Forget morality, forget human decency,and the dignity of the presidential office, it all comes down to money and the stock market at this time. On Thursday of this week, the Haves will be inside cheering on their hero and all others will be outside carrying signs of protest. What will change things besides a new chief executive? In my opinion, interest rates. When interest rates get to a level that causes investors to lose interest in stocks and choose safe but attractive alternatives, then some of the steam will escape from Trump's boilers. Right now the Stock Market has little competition for those seeking yield, price appreciation, and the safety of numbers. Our president has recently chastised his Federal Reserve Chairman for his intention to raise rates-a threat to Trumps powers. Further evidence is that Trump routinely uses the Dow Industrial Index as a metric for his performance as president. Someone recently told me that the stock market isn't everything. It is to the Donald.

Change

 One thing is certain in investing in stocks of companies and that is change. Change in the business of the company, change in the valuation, and change of management. I can't think of a single industry that isn't undergoing tremendous change right now. The computer industry is a perfect example. Back in the early 1980's, Apple computers were the rage. They had 64k of RAM and no hard drive. If you wanted to store your work, you bought an external 5 1/4 floppy drive. The whole outfit with a dot matrix printer cost well over $5000. Suddenly, IBM came out with the PC, causing the Apple 2E and 2C sales to plummet. I used to buy Apple computers at yard sales cheap and clean them up, add some software games, then resell them to people who thought they were left-out of the computer age. Then along came the Internet and some internet provider companies started offering  a free computer for signing a 2 year contract for dial-up internet.That ended my little enterprise abruptly.  Most midsize and large companies used to have what they called a"mini"computer to run their operations. It took up a huge air-conditioned room and cost hundreds of thousands of dollars. Now days, companies just contract with "cloud"providers who run the operations in huge data centers for a monthly fee. The makers of mainframes and minis had to scramble to find new businesses to keep the doors open. Any technology company that can't constantly reinvent itself will either be bought-out or die. Currently, some of the biggest names in tech are trying to stay pertinent by transitioning from a manufacturer or software provider to service providers. Microsoft, IBM, Hewett Packard,Cisco, Xerox and many others are searching for new sources of revenue. The auto industry is also undergoing a huge change. Soon, the autonomous car will be commonplace. It will run on batteries and get recharged from household current. Successsful investors of the future will have to determine which companies will benefit from the new products and changing consumer behavior. I have no idea who the winners will be but I will be watching to see how the established companies compete with nimble upstarts who will try to unseat them. Instead of trying to predict the eventual dominate player in a new technology, I would rather invest in the component supplier who makes a "must have" part that is critical to the technology. At the current time these component makers for cell phones are out of favor due to slowing growth in smartphone sales which has investors spooked. I don't see any alternatives to smart phones at this time so I will be adding to my positions of MU, LAM, and possibly NVDA for AI exposure and autonomous technology.

If You Want It Done Right............

      Maybe I am just getting grouchy and particular in my old age, but sometimes when I get "help" out in the garden, I am never satisfied with the results. My fellow gardener, who is 15 years older than me, feels the same way when I help him. Everybody has their own ideas about the way things should be done. I feel the same way when it comes to my investments. Nowdays, people have choices about how they go about tending to their nest-egg. One option is to have a "guy" who is supposed to act in your best interest and make you money. The fact is that this guy will make money regardless of whether you do. If you don't have the knowledge to invest yourself, how do you know he is selecting appropriate investments for you? Another option is to buy all mutual funds. Most mutual fund families actually hire an outside firm as advisor to select the investments for the fund. So your actually hiring a company who hires a company who hires some people to manage your money. Another choice is to buy a passive investment which tracks an index like the S&P 500. This can be a mutual fund or an ETF which simply buys the stocks contained within the index. When the market goes up you might make money and when the market goes down you lose. Your only decision is whether you should be in stocks or not. Another mutual fund option is the "fund of funds" portfolio. This is where your advisor sells you a mutual fund that contains other mutual funds, usually within the same family of funds. I believe in diversification but this is simply dilution and usually a losing position. My last option is to just do it yourself. It takes a little conviction and some homework but the rewards can be worth it. Picking your own investments can be profitable in both up and down markets. Selecting undervalued stocks when the overall market is high can limit your risk and provide income when the averages are declining. Knowing when to lighten up on stocks and select alternatives is something passive investing doesn't do. Most mutual funds are required by charter to have a certain level of stocks in their portfolio. I own some mutual funds, ETF's, passive investments, and even have a "guy" or two to lean on but I like the control I have by owning stocks that I selected myself. Tending to my portfolio is a lot like gardening. If you plan your garden carefully, buy good seeds and stock, then keep it weeded, it should produce good yields. Likewise, buy good stocks, monitor their progress, weed-out the losers, and reap the rewards.