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.

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.