Lots of cash and animal spirits: What could possibly go wrong?

If you’ve ever been to a particularly raucous New Year’s party, you know that there’s a logical progression from the first awkward arrivals and introductions until you’re sleeping in a car full of raccoons and empty Cheetos bags.  And, at the time, each step makes wonderful sense.

Right now, the markets are at a spot where spirits are high and cash is flowing like liquor at your broker’s annual Christmas party. Let’s take a look at the animal spirits first.

University of Michigan, University of Michigan: Consumer Sentiment© [UMCSENT], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UMCSENT, January 1, 2017.

 University of Michigan, University of Michigan: Consumer Sentiment© [UMCSENT], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UMCSENT, January 1, 2017.

As you can see, consumer sentiment has been rising since the dark days of 2009; it now stands at 98.2 — the chart is lagged by a month. Sentiment is now higher than it was in January 2015 (98.1), and the highest since February 2004.

Soptimism-graphmall business confidence is also up post-recession, but it jumped markedly after the election, presumably on the hopes of lower taxes and regulation by the new administration.

And that confidence — plus the 12% gain by the Standard & Poor’s 500 stock index this year — has sparked optimism among investors. The American Association of Individual Investors sentiment survey now stands at 45.6% bullish, vs. its 38.5% historical average. Similarly, just 25.7%  of those surveyed said they were bearish, vs. a historical average of 30.5%. Bullish sentiment is at a five-week high, and its third-highest level of 2016.

At the same time, there’s plenty of money on the sidelines, and some of it appears to be returning to stock funds. In the last week of 2016, investors poured an estimated $118 million into U.S. stock funds. But that’s a piker compared to the previous week, when an estimated $18.6 billion flooded — more than the previous 24 months combined, according to the Investment Company Institute, the funds’ trade group.

As of the end of November, there was $2.7 trillion in money market mutual funds, earning approximately zilch. A roaring stock market provides a great deal of temptation for at least some of that money.  Stock funds had about 3.2% of their assets in cash, which is not particularly high, and that figure’s usefulness has been eclipsed somewhat recently.

Another potential source of cash: Companies in the S&P 500 have a record $1.5 trillion in cash cooling its heels on their balance sheets. They can use this for buying back stocks, paying dividends, or — and this is crazy talk — reinvesting in plants, equipment and their own employees.

The bad news is that the stock market is already expensive. The S&P 500 sells at about 24 times earnings, as opposed to a historical norm of about 17 times earnings. S&P predicts that earnings will rise through 2017, bringing down the PE ratio to about 18. Bear in mind that forecasts are notoriously unreliable, particularly when they’re about the future.

Bear in mind, too, that the Federal Reserve is likely to continue to raise interest rates, and at a faster pace if the economy grows faster than expected.

Right now, it looks like animal spirits and plenty of cash will keep the market party going, and that can be good, clean fun. Enjoy the ride. Just remember that market rallies always last longer than a sober person would think. But remember that many things must go right for the rally to continue. It’s probably a good time to readjust your portfolio back to your original goals. No one ever went broke taking a bit of profits.





This old house: A good investment?

One of the surprising things about being a personal finance writer is volume of “dear idiot” letters you get. You get used to vitriol when you write about inflation (You idiot! Do you know what a pound of chicken costs these days?) or the Federal Reserve (You idiot! Janet Yellen destroyed this country!).

What surprised me a few years ago was the response I got from what I thought was a fairly milquetoast piece on buying a house. I wrote the story in 2012 and said, basically, prices are still low, interest rates are low, and if you can afford it, this might be a nice time to buy a house.

This produced howls of outrage from people who had bought during the housing boom and were still underwater. And, as they learned, housing boom and bust cycles are pretty long. The housing market peaked in 2006 with the median home price — half higher, half lower — at $154,600, down from a high of $230,900 in July 2006. The median price rose to $177,200 in 2012, and stood at $229,400 at the end of the second quarter, according to the National Association of Realtors. In other words, after nine years, the median home price is nearly back to its 2006 peak. That’s a long time to be under water.

What has changed since 2012? Affordability, mainly. While the 30-year fixed-rate mortgage rate is just 3.86%, the NAR says affordability has declined 23% since 2012.  In other words, as housing prices have risen, the number of buyers has declined, thanks to stagnant income and higher prices.

But how good of an investment is real estate? It’s an extraordinarily difficult calculation, but generally speaking: It’s not great, unless you buy at the low and sell in the next frenzy.

Via Shorpy.com
Via Shorpy.com

Consider this fine 12-room home in Chevy Chase, Maryland, which sold for $17,000 in 1919, according to the wonderful history site, Shorpy.com. It sold in 2014 for $2.4 million.

While this may seem a dramatic price gain, it works out to a 5.35% average annual return during 95 years. It’s certainly beat inflation: $17,000 in 1919 dollars was worth $232,630 in 2014, a 2.79% rate, but lagged the Dow Jones industrial average, whose price, excluding dividends, rose 5.73% per year.

Of course, this doesn’t include the cost of owning the house, starting with mortgage interest and property taxes. But as any homeowner knows, the expenses don’t end there. Anyone who has owned an old house knows that this one was probably lovingly coated with lead paint for half a century. Most roofs have to be replaced every 20 years, so it would be due for its fifth one pretty soon. And there’s a little sensor on the furnace that senses when your savings account is too high and sends a big puff of black smoke out your chimney as the furnace dies.

And if you lose your job, owning a home can be a significant barrier to finding new work elsewhere. Even if good times, moving across country while selling a home is stressful. Moving across country and having to rent out a home you can’t sell is pure agony.

On the plus side, there’s the tax deduction for mortgage interest, which generally allows you to have enough deductions to itemize your tax return. And if you put 20% down, you’re leveraging any price gains. (As people discovered in the 2007-2009 financial crisis, you’re also leveraging your losses.)

For most people, a house is basically a forced savings plan that you can live in. And, while upkeep expenses don’t decrease when you pay off the mortgage, having no mortgage is a wonderful thing in retirement. When you rent, you can look forward to increases all your life — and you still have to ask the landlord’s permission if you want to paint the master bedroom something other than eggshell. All in all, it’s probably better to own, if you can afford it.

Cash is never trash

For nearly a year now, pundits have been describing the U.S. stock market as “the least dirty shirt in the closet,” “the least bad-looking market,” “squeakier than a bowl of mice.” Ok, they didn’t use the last one. But the general implication is stocks may be expensive, but hey — they’re not bonds and they sure aren’t cash.

cashYou may have noticed, however, that cash looks increasingly attractive this week. While you’re earning an average 0.02% a year on your money market fund, that’s generally better than losing 1% to 2% a day on your stock fund.

Think of it this way: The average large-company blend stock fund is down 4.26% the past month. If you had 30% of your portfolio in cash, and 70% in your basic large-company stock fund, you’d be down 2.98%. While no loss is good, smaller losses are always better than larger ones.

More importantly, you would have an easily accessible buying reserve for stocks that seem ridiculously cheap. Finding values is more than buying whatever’s on the new low list. But if you can find a good stock that’s selling at a 20% discount or more, then this is a good time to think about buying.

Just recently I posted a list of companies in the Standard & Poor’s 500 stock index that are selling for 20% or more below their 52-week highs. That list has only grown since then. As of yesterday, 141 stocks, or 28% of the S&P 500, were below their 52-week highs. Among the more interesting entries to the 20% discount club:

  • Asset managers. Franklin Resources is down nearly 30% from its 52-week high, and it has now been joined by Legg Mason and Genworth.
  • Luxury goods. Coach is now nearly 60% below its all-time high, and Fossil is 56.5% below its all-time high. Michael Kors is nearly half its 52-week high.
  • Railroads. Union Pacific, CSX, and Kansas City Southern are all at least 20% below their 52-week highs.

The two biggest areas that are getting clobbered are energy and technology stocks. The problems in energy are obvious: Oil is down more than 50% from its recent highs.

The problems in tech are not quite as clear, although the weakness in the Chinese market seems to be the easiest answer. But some tech stocks seem tempting at these levels: Intel sells for just 11.3 times expected earnings, and pays a 3.4% dividend, to boot. Applied Materials sells for 12.3 times expected earnings and yields 2.5%. And Sandisk sells for 12 times forward earnings and yields 2.3%. If you have the cash — and the tolerance for tech stocks — these might good places to nibble.

Reinvesting in the business

If you own a home, you know that somewhere in the basement is a sensor that’s linked to your bank account. Too much cash on hand? There goes the furnace! Getting a bit ahead? Where did that leak in the ceiling come from? Just finishing the car payments? Look, we have bats in the attic!

Chaplin_-_Modern_TimesMany of these woes can be prevented, or at least postponed, by regular maintenance. While spending $5.000 on a new roof is probably the least exciting way to spend a five large, it’s way more fun than replacing your entire kitchen after a downpour, and cheaper, too. For many companies, capital expenditures are unexciting — but good for the firm and its profits in the long run. Unfortunately, it may take Wall Street a while to get used to the notion.

In recent years, companies have been delaying reinvesting in their people and equipment, while hoarding cash and buying back shares. But this, like putting off that new roof, has its drawbacks. If you don’t pay people well, they go away.  If you don’t modernize your equipment, your product quality falls behind.

Furthermore, while capital expenditures detract from a company’s earnings in the short term, they are a powerful driver of the economy. When you start buying new forklifts, computers or delivery trucks, other companies typically see their profits rise — and they start hiring as well. It’s a virtuous cycle.

Reinvesting in capital equipment is good for a company in the long run. Nasdaq has an admittedly obscure index called the Nasdaq US CapEx Achievers Index, which tracks companies that have increased capital expenditures for three consecutive years.

Through 2014, the CapEx Achievers index has gained an average 15.99%, according to Nasdaq, vs. 15.45% annually for the S&P 500. And for the past five years ended July, CapEx Achievers have gained 119.5% vs. 91.7% for Dividend Achievers — stocks that have raised their dividends each year for 10 years or more.

Big investments in business don’t usually please investors, who often have the attention span of a gna. For example, investors punished Walmart stock Tuesday in part because the company has been increasing its investment in its U.S. stores, and raising salaries, albeit reluctantly. (The rising dollar also hurt its returns from overseas). So far this year, several of the CapEx achievers have also been clobbered:

  • Chevron: -19.6%
  • Procter & Gamble: -13.6%
  • Oracle: -10.3%
  • 3M: -6.7%

Nevertheless, capital spending does seem to be coming back into vogue. If you take out energy spending, which is in clear contraction, capital expenditures for companies in the Standard and Poor’s 500 have risen 9.4% the past 12 months.. And, says S&P, strategies to woo shareholders — buybacks and dividend increases — are set to fall slightly in the second quarter both on a quarterly basis and last 12 months.

If, in fact, companies are starting to loosen their purse strings for a bit, that’s good news for the economy. But it may also foretell a slowdown in earnings — and stock prices — in the next few quarters. But that seems like a relatively small price to pay for much-needed improvements.

Bear with us

As anyone knows who has tried to use a wireless printer, sometimes things that are designed to make life easier and better just don’t really do either. (In reality, wireless printers are a Luddite plot designed to get us get back to chiseling words in stone. Reliable. Dependable. Eternal!)

The Romans didn't need no stinkin' wireless printer for this.
The Romans didn’t need no stinkin’ wireless printer for this.

But let’s consider mutual funds. The main reason to own a mutual fund is diversification. For example, the Standard and Poor’s 500 stock index is down a bit more than 2% from its all-time high of 2130.82, set May 21. But about 23% of the stocks in the S&P 500 are down 20% or more. (By tradition, a bear market starts at 20%).

If you decided to invest in a mutual fund, good for you! Unless, of course, you invested in the financial equivalent of a wireless printer. Of the 1,764 exchange-traded funds tracked by Morningstar, 441, or 25%, are trading 20% or more below their 52-week high.

Investors in some of these funds, of course, deserve to be spanked. The Direxion Daily Natural Gas 3X fund, which aims to deliver three times the gain (or loss) from the price of natural gas, has plunged 83% this year. And the VelocityShares 3x Long Crude Oil fund, similarly levered to the price of crude oil, is down 76% this year. Remarkably, the VelocityShares has $826 million dollars in the fund.

But some of the funds that have been crushed in the downturn aren’t entirely silly. iShares Emerging Markets fund (ticker: EEM), is off 46% from its 12-month high. While emerging markets are noted for submerging periodically, this is a significant downturn by most measures.

For those who want to take on the energy sector but don’t want to decide which woebegone stock to pick, there’s Vanguard Energy ETF (VDE). If you’re wrong, at least you’ll lose money in an extremely low-cost, tax-efficient way. (The fund also yields 3.1%, so you’ll get a bit of dividend income as well.)

And speaking of dividends, the SPDR S&P International Dividend ETF (DWX), is down 24.2% from its 52-week high. Blame the soaring dollar. Nevertheless, the fund yields 5.33%.

Many of the worst-performing ETFs are simply silly funds that their sponsors trotted out to try and gain some assets. Buying a heavily leveraged commodity fund is just a really, really bad idea. But if you want a slightly less risky way to invest in downtrodden sectors, it’s worth browsing the biggest loser lists.


Shifting into neutral

In the American financial system, the economy is governed by two separate but equally important groups: The Federal Reserve, which controls monetary policy, and Congress, which controls fiscal policy. These are their stories.

For the past seven years, the Fed has done nearly all the work of trying to raise the economy out of the worst recession since the Great Depression. The Fed has not only cut rates, but launched three massive bond-buying programs to keep long-term interest rates low. By keeping rates low, the Fed has allowed millions of homeowners to refinance their mortgages at lower rates, and allowed businesses to refinance their debt at lower rates as well.

Moody’s Baa-rated corporate bond yields

In both cases,the Fed’s actions have put money back into the pockets of consumers and businesses. Reducing your debt payments is essentially the same as increasing your revenue, all other things being equal.

At this point, the Fed has pretty much used up all its ammunition. Short-term rates are at zero, and the Fed would love to nudge rates higher, if only to give it some room to cut rates during the next recession. Higher mortgage rates would probably spur some brief buying as purchasers scramble to get into the market before rates get too high. And it wouldn’t hurt that long-suffering savers got some return on their investments.

While the Fed has been working hard, the fiscal side of the ledger has been hardly working. During a recession, business spending dries up entirely, as companies focus on survival, rather than expansion. Unfortunately, the net effect of cutting business spending in a contraction is further contraction. When you lay off workers — or even when other companies lay off workers — they cut back spending sharply.


State and local governments, which were in reasonably good shape before the recession, also cut spending. While many states had rainy-day funds, no one expected a downturn of the severity of the 2007-2009 recession.  As a result, teachers, construction workers, police, fire and medical personnel also joined the ranks of the unemployed at an unusually harsh rate. No matter what you feel about government spending, an unemployed teacher is just as unemployed as an unemployed plumber. And, if you’re traveling across country, check out the state of the highways you drive on. If you need a new front-end alignment after your trip to Lake Wippitysnappity, it’s probably because of big cutbacks on basic structures.

State spending in 2009 dollars

Federal spending, too, has been remarkably restrained for a recessionary period. The $152 billion Economic Stimulus Act of 2008, signed into law by President George W. Bush, was primarily tax rebates and tax incentives for business. The $831 billion American Recovery and Reinvestment Act of 2009, signed into law by President Barack Obama, had $288 billion in tax cuts and $105.3 billion in infrastructure spending.

As the economy has recovered, however, state and local spending has started to pick up — as have tax revenues. According to the Brookings Institution, government spending has gone from a net negative for the economy to a net neutral the past 12 months. (For those who argue that government doesn’t create jobs: Please say that to a policeman or fireman and report his response to me. I’ll wait.)


Should the Federal government actually create a long-term fix for the federal highway fund and should state and local governments resume maintaining infrastructure at previous levels, you might start looking at domestic infrastructure companies.

A few suggestions:

* A.O. Smith (ticker: AOS) is in the prosaic business of boilers and heaters, which sounds uninteresting until you remember that every building in the country — including public ones usually needs one.

* Chicago Bridge and Iron (CBI), provides conceptual design, technology, engineering, procurement, fabrication, modularization, construction, commissioning, maintenance, program management, and environmental services worldwide.

* Cummins (CMI), ubiquitous maker of engines, especially those found in heavy equipment.

None of these are guaranteed, of course. But if you think U.S. infrastructure is going to start rising again — and for the sake of my poor car’s front end, I hope so — these might be a good place to start.



Five reasons to love this lousy market

What”s the matter, Bunky? You say you decided to dip your toes in the market and had them nibbled by sharks? You say your biggest speculation today is how long you can look at the Dow Jones industrial average without weeping? You say you visited your broker’s web site, only to discover it’s now run by a bankruptcy lawyer?

Brokers with their hands on their faces.
Brokers with their hands on their faces.

Well, cheer up, Bunky! Someday, the clouds will part, the sun will shine, and you’ll be running with the bulls once again! But until then, here are five reasons to love this nasty market:

1. Tax losses. Let’s say you bought Ali Baba at $119 back in November, and now you’re wishing you’d thrown in your lot with the 40 thieves. BABA is down to about $81. What should you do? Sell it. You can use your losses to offset an unlimited amount of capital gains. If you have more gains than losses, you can deduct up to $3,000 from your 2015 income. If you really backed up the truck, you can carry additional losses over to your 2016 taxes.

2. Cheap stocks. The biggest knock against this market has been that it’s too darn expensive. Valid criticism! But now the market is 5% cheaper. And some areas, such as energy, are much, much cheaper. ExxonMobil, for example, is down nearly 24% and sports a dividend yield of 3.7%. The price of oil is a big wild card, but it’s better to buy a high-quality company like ExxonMobil when it’s cheap than when it’s dear.

3. Rising yields. A rising yield is typically a function of falling prices, not corporate largess. If you have a $50 stock that pays out $1 in dividends, its yield is 2%. If that stock falls to $40, its yield rises to 2.5%. Right now, some traditional dividend favorites are seeing some nice yields. Duke Energy, for example, yields 4.6%. AT&T yields 5.5%. While a high yield is also a yellow flag — the company might cut its dividend, and Wall Street hates that — it could also be a good deal.

4. Rebalancing. As downturns go, this one has been a piker. Normally, you need a 10% move down to be in a correction, and a 20% dive to be in a bear market. So let’s not get overly dramatic yet. But if you want your portfolio to have a set mix of stocks and bonds — 60% stocks and 40% bonds is a traditional conservative blend — you sometimes have to sell some of your winners and add to your losers to get back to where you want to be. You should wait until your portfolio is at least 10 percentage points out of whack. But if you have an aggressive portfolio, you might be approaching those levels.

5. Schadenfreude. For those of you who don’t speak German or have an English major in the family, schadenfreude is a German word meaning, roughly, “laughter at the expense of others.” Have a friend who’s been touting gold all these years? Give him a call.