25 Apr / 2013
It’s the Economy, Stupid — Bill Clinton, 1992
It’s the Fed, Stupid — Hardesty Capital Management, 2013
The stock market performed exceptionally well in the first quarter of 2013. In fact, the Dow Jones Industrial Average broke through its 2007 high of 14,400 on March 11 and finished the quarter with a total return of 11.9%. The S&P 500 flirted with its all-time high and closed the quarter at 1,569, just above its former peak of 1,565, and had a total return of 10.6%.
Also notable was the failure of the bond market to keep pace with the stock market, confirming our long-held fears that the bond market was vulnerable to a rise in yields, which occurred in the quarter. The 10-year Treasury yield rose from an all-time low of 1.41% in July 2012 to 2.06% on March 11, only to fall back to 1.86% by March 31. With interest rates at such low levels, even small movements resulted in extraordinary price volatility, both up and down, in bonds.
Since the S&P 500’s closing low of 683 on March 6, 2009, the index has recovered 130% to 1,569. It took the S&P over 4 years to recover to its old highs. Investors have remained fearful of equities long after the 2009 lows were established. As the chart on the next page indicates, large outflows of funds from equity mutual funds continued almost monthly until early 2013. The big gains in equity prices have been accompanied by large increases in earnings. This means that the market is paying the same (or even lower!) price per dollar of earnings. As a result, valuations remain very reasonable (see chart, back page). In addition, many retail stock brokers report strong resistance on the part of small investors to increasing exposure to equities. Perverse as this may sound, the absence of the small investor provides a large reservoir of funds for future equity investment, which in turn will support or even increase equity prices down the road.
25 Apr / 2013
Vodafone is a public limited company (PLC) headquartered in the U.K. The company provides a range of mobile and wired communications services, including voice, data, broadband, and landlines. It is the world’s second largest mobile telecommunications company by both revenue and by subscribers, in each case behind China Mobile.
Vodafone owns a 45% stake in Verizon Wireless, the company that is owned by the familiar Verizon Communications. Vodafone does not have control of Verizon, but Verizon has provided substantial dividends back to Vodafone, which has supported Vodafone’s impressive current 5.3% yield.
10 Jan / 2013
Despite an acrimonious, bordering on uncivilized, debate between the executive and legislative branches of the government, a major tax reform bill was passed and signed into law in the predawn hours of January 2nd. Regardless of when the legislation was signed, it appears our nation has avoided a journey into an economic twilight zone known as the “fiscal cliff.”
The eleventh-hour rescue appears to have temporarily avoided a crisis, but virtually no party to the legislation is satisfied with the outcome. Some would say that the can was again kicked down the road, and major issues remain. Sometime in the first quarter of 2013, perhaps as early as March 1st, additional authorizations will be necessary to increase the Federal debt limit, which created a near-crisis in August of 2011 when it was last addressed. The consequence of that crisis was the loss of the country’s AAA bond rating, and it appears this debt limit problem will be every bit as contentious as that of 18 months ago. Be assured that the hostile environment in Washington associated with economic issues will be with us for quite some time.
10 Jan / 2013
DuPont is the storied chemical giant that is responsible for the development of nylon, Teflon, Mylar, Lycra, and Kevlar, among many other now-common materials. Founded in 1802, the company now employs over 70,000 people worldwide. The company had $38 billion in global sales in 2011, and its diverse operations include nine business segments ranging from Agriculture to Pharmaceuticals.
The chemical industry is classically cyclical in nature. As the world pulls out of recession, those companies in cyclical industries will stand to benefit more than others. DuPont is a chemicals giant with a strong balance sheet that has proven itself through history as able to weather cycles and come out strong. The company’s titanium dioxide (TiO2) business’ issues have been responsible for weaker results recently, but these pressures should abate, and even if they do not, the rest of DuPont’s businesses have promising prospects.
08 Oct / 2012
Economically, the doldrums settled in this summer. This is not altogether surprising considering the myriad issues confronting countries all over the world. The European financial crisis, the Fiscal Cliff, and the Presidential election are all weighing on the minds of corporate and government leaders. As we approach crunch time for these major events, rhetoric has increased and economic activity has slowed. During the quarter, U.S. economic activity stumbled along at a growth rate of less than 2%. This frustrating performance resulted in a continuation of high levels of unemployment and a significant number of workers who have ceased looking for work. This subset of discouraged workers, known as “Series U-6,” has now reached 6.6% of the workforce, and when added to the official unemployment rate of 8.1%, results in a level of 14.7%. While U-6 has improved, it is still unacceptably high.
In spite of these pending issues, our economy continues to push ahead, albeit at a slower-than-desired rate. This, however, is much better than many other parts of the world. Cracks appeared in the great Chinese economic wall, yet Asia as a whole maintained reasonable forward momentum. The same cannot be said for Europe. Finance ministers grappled with lingering effects of excessive borrowings that violated many countries’ pledges for responsible fiscal policies that were accepted as a condition of joining the Euro. Although European economic growth proved disappointing, we sense the financial challenges did not worsen during the quarter.
08 Oct / 2012
I recently met with a prosperous couple, each well-employed and contemplating retirement. They have children that are grown, a house that is paid for, a combined income around $150,000, and employer 401(k)s exceeding $1,000,000. They don’t have an extravagant lifestyle, but see the best years of their lives in plain view. The last thing they want to do is speculate in the stock market, because the stock portions of their 401(k)s have languished and the economic news is frightening. Principle preservation is their primary concern. A safe portfolio of bond mutual funds and annuities sounds right to them.
This financial plan resonates with just about everyone who is retired or thinking about it. A reasonable rate of return with principle protection is doable and worry-free, right? Well, as in most circumstances, perception and reality often take different paths. First, let’s do the math and compare their working income to their potential retirement income at various rates of return:
08 Oct / 2012
Cliffs Natural Resources (CLF) is a major explorer and producer of iron ore, with some smaller operations in metallurgical and thermal coal. Steel is almost 100% iron ore, so Cliffs is a supplier to construction and expansion, and especially follows the trend of urbanization.
As an investment, this company is a play on iron ore. Previously, Cliffs was locked in to long-term deals with U.S. producers that limited its exposure to world iron ore prices. Recently, the company has been moving towards negotiating more and more of its contracts to be based on the world price of ore. As the world urbanizes, it will need more and more steel. For example, it is estimated that 300 million Chinese previously living in rural areas will have moved into cities between 2010 and 2025. This mass migration will require tens of thousands of skyscrapers to be built—and thus, an almost unimaginable amount steel.
22 Aug / 2012
We’re going to try something new on the Hardesty blog. In addition to giving you weekly updates about what we think was important that week, we want to hear from you. With that in mind, we are starting an “Ask Hardesty” column in our blog in which we’ll be answering questions that you send in. The questions can be about an investing concept that isn’t quite clear, something in the financial news, or anything investment-related. Just e-mail firstname.lastname@example.org.
Our first question is seemingly the most basic:
What should I invest in? -Tina D.
It seems the most basic to the asker, but it is perhaps the most complicated to answer. Unfortunately, the answer is going to be, “It depends.” It depends on the timeframe of the investment, your resources, what your goals for the investment are, and your tolerance for risk, among other things.
These are too many variables for just one concise blog post. As such, we’ll look at one at a time in a multi-part post, to be compiled at the end.
Let’s first consider the most fundamental part of your investments: the level of risk you are taking. Generally, investors think of “risk” as “How much money could I lose?” whereas we at HCM prefer to think of this question in terms of “What kind of price swings might I experience?” The difference might be subtle to a novice investor, so we won’t dwell on it. Basically, with risk, you need to know that in order to make money in the long term, you have to be willing to risk losing money in the short term.
Something else that is essential to understand but is not generally well-understood is that risk and return are not only related, but almost interchangeable. A higher return means a higher risk. At HCM, we have seen countless examples of investors losing money in a supposedly higher-return investment that they thought was “safe.” However, what the market is telling you by offering a higher rate of return is that you are taking more risk. There may be some exception to this rule, but we are certainly not aware of one.
In general, stocks have higher returns (more risk) over time than bonds. Bonds return more than money market funds (cash). Even within these categories, we can have differing levels of return: some stocks are riskier than others, as you might imagine.
If you need your money back in two years to pay for a child’s education, you shouldn’t take as much risk as if you are looking to start saving for your retirement that is thirty or forty years away. Over thirty years, you shouldearn the 8-10% long-term average that stocks provide, even if you lose 25% in the first two. But if you need the money in two years, you can’t take those kinds of risks.
If you can’t stomach the thought of a 45% loss of your investments, you will need to choose safer asset classes than just stocks. Similarly, if you are risk-seeking, you might want to take a higher weighting in riskier stocks than others in a situation similar to yours. Whatever your situation, you need to understand the risks you are (or aren’t) taking.
In sum, when investing, you first need to consider how much risk you want to take over your entire investment portfolio. If you are conservative on risk, it doesn’t mean you can’t have 2% of your assets in a tech stock, as long as your overall average risk is where you want it to be.
The concept of risk and return is one we will return to often. If your goal for the question “What should I invest in?” is a hot stock tip without considering all of these things, you may want to reconsider your strategy.
Look for the next segment soon.
03 Aug / 2012
The fast start the economy and markets enjoyed in the first quarter of 2012 faltered as the year progressed. Stocks fell sharply from April to May only to recover modestly in June. For the quarter the S&P 500 declined 2.75%, but for the first half of 2012, the S&P 500 advanced 9.49%. The fixed income markets continued to respond to Federal Reserve Chairman Bernanke’s stated goal of stable, low interest rates. The 10-year treasury began the quarter at 2.22% and finished the quarter at 1.67%.
Signs of a possible economic slowdown in the U.S. emerged late in the quarter as employment gains slowed sharply, retail sales ex-autos stalled, and capital spending slowed markedly. In addition, consumer confidence fell for the fourth consecutive month in June and the ISM Purchasing Managers Index fell below the critical level of 50 (see chart), which means manufacturing contracted. Put simply, the U.S. economy has been unable to establish a steady recovery pattern, and nobody seems to have a clear explanation as to why the economy cannot sustain upward momentum.
03 Aug / 2012
Diamond Offshore Drilling, Inc. (DO) is an offshore contract driller with 46 mobile rigs drilling around the world for natural gas and oil. The company was a wholly owned subsidiary of Loews Corp. until 1995, when Loews sold 50% of Diamond to the public, retaining ownership of the remainder. Diamond offers a broad range of services in various markets, including the deepwater, harsh environment, conventional semisubmersible and jack-up markets. The company was notably not involved in the Deepwater Horizon disaster.
We believe that oil services stocks are, in general, oversold. Stocks in this group have been hit hard. The price of oil has come down a bit, but is nowhere near its five-year low, while Diamond is trading just above its lows. This name offers compelling valuation in a compelling industry group.