A blue chip by any other name

When it comes to mutual fund marketing, the glass is never half empty: It’s always full. This is why we don’t see funds with names like “The Occasional Outperformance Growth Fund” or “The Somewhat Erratic Income Fund.”

We do, however, have several funds with the words “blue chip” in them. Unfortunately, they may not have the blue-chip attributes you’re looking for.

First of all: What’s a blue-chip stock? The term “blue chip” comes from poker, where blue chips are traditionally the most valuable. “I think of it as a large-cap company that has been around for decades, pays an attractive yield and has an above-average record of raising earnings and dividends for an extended period of time,” said Sam Stovall, chief investment strategist of U.S. Equity Strategy at CFRA. It’s a fairly exalted status that few stocks earn, and fewer keep.  They’re the kind of stocks you’d imagine Uncle Pennybags from Monopoly would buy.

The term “blue chip” has become so popular that there are 15 stock funds with “blue chip” in the Morningstar database. Elizabeth Laprade, research analyst at  Adviser Investments, notes that three of the largest blue-chip funds – T. Rowe Price Blue Chip Growth ($54 billion), Fidelity Blue Chip Growth ($25 billion) and John Hancock Blue Chip Growth ($3 billion) – have between 122 and 429 stocks.

Whether there are 429 or even 122 blue-chip stocks is debatable, at best, and all three funds seem to stretch the definition. T. Rowe Price Blue Chip Growth, for example, has stakes in true blue-chip companies like Boeing and JPMorgan Chase. But its third-largest holding is Tencent Holdings, the Chinese internet advertising company. It also had stakes in Tesla, Monster Beverage and Norwegian Cruise Lines, which are probably not blue-chip companies, at least by Mr. Stovall’s definition.  All three funds own Alibaba.

Distressingly, all three funds have more volatility than the Standard & Poor’s 500 and lower dividend yields, too. This may be because all three are growth funds, and growth stocks often sneer at the notion of dividends. It may also be because of the funds’ expense ratios, which range from -0.78% for the John Hancock fund and O.69% for the Fidelity offering. Those aren’t excessive by large-company growth fund standards, but they do take a bite out of the funds’ dividend payouts.

Even worse is the funds’ maximum drawdown – the most the funds lost from peak to trough during downturns in the past five years. Here again, they didn’t beat the S&P 500, Ms. Laprade notes. “People need to be careful,” she said. “If they’re looking for blue-chip stocks, that may not be the case.”

 

In which matters become more serious

Because I was born during the Taft administration, I remember that 1987 was a very, very good year in the market, at least at first. And I remember an editor, who shall remain nameless, saying, excitedly, “Isn’t it amazing how well this market is doing in the face of rising interest rates?”

The Dow Jones industrial average had climbed 27.6% in the first six months of the year, and tacked on another 7% in July 1987. And, in fact, the yield on the 10-year Treasury note had risen from 7.08% to 8.62% from the first of the year to the end of July.

From there on out, however, interest rates rose steadily, topping 10% on October 16, 1987. And the stock market, like Wile E. Coyote walking off a cliff, suddenly noticed that interest rates were rising. From its peak of 2,722 on August 25, the Dow began to stumble — first slowly, and then more rapidly. On October 15, the Dow fell 2.4%. The next day, it fell 4.6%. The next trading day, it plunged 508 points, or 22.6%, a record one-day drop.

For the past 12 months, the yield on the 10-year T-note has been creeping higher, albeit at far lower levels than 1987. (It’s still hard for me to get too worked up over a 2.84% T-note yield.) And the stock market has been soaring higher. Last year was, in fact, a very good year, with the S&P rising 22%. Even after today’s 666-point carnage (a 2.54% drop) the Dow is still up 3.3% for the year.

It’s entirely likely that interest rates will continue to rise. To quote myself: “The average yield for the three-year T-bill since 1934 is 3.5%. If we want to get rid of the very highest and very lowest yields, we get a typical yield of 3.18% over that 83-year period.” We’re closer to the average 10-year yield than we were, but we’re still a ways off. And being at the average rate of interest isn’t usually a problem for the stock market.

What is a problem is that stocks are generally overvalued. Rising rates only make that worse: Bonds and bank CDs suddenly become more attractive than they were previously. Corporate borrowng becomes more expensive. And, if rates are indeed rising because of a strong economy, higher wages will weigh on future earnings. Events must unfold to perfection at this level of stock prices, relative to earnings. And, as Wile E. Coyote could tell you, things rarely unfold to perfection.

If you’re a long-term investor, you’ll probably do better than 2.84% a year the next decade if you’re in stocks. What you probably won’t get is high returns with low volatility. If the bull market has pushed your stock allocation significantly above your target, it’s time to rebalance your portfolio back to your target. Otherwise, hang on and hope for the best, and keep saving — which is, after all, the single most imporant determinant of how much money you have when you reach your goal.

 

 

 

 

Taking the stock market’s temperature

It’s a balmy 53 degrees here, which isn’t bad for January, but the Standard & Poor’s 500 is hotter than a fire ant’s furnace. As of Jan. 25, the blue-chip index has gained 6.16%, including dividends. How do you know when hot is too hot? You can get one hint from the aptly named Thermostat fund.

A rising stock market, in and of itself, is no reason to panic. Typically, a really good year is followed by at least an OK year. When the S&P 500 gained 26% in 2009, it followed up with a 15% gain in 2010. Similarly, the index gained 13.46% in 2014 after a 32.31% advance in 2013.

What matters is how stock prices measure up against corporate earnings. The basic measure is the price-to-earnings ratio, which simply divides a stock’s price by its previous 12 months’ earnings.

The lower the PE, the cheaper the stock is, relative to earnings. A $50 stock that earned $3 last year has a PE of 16.7. Changes in either price or earnings affects the PE ratio. If the stock’s price drops to $35, its PE is 11.7. If its earnings fall to $2 a share, its PE rises to 25.

It’s not infallible. PEs were high in early 2009 because earnings were so low. Some argue that it’s best to use earnings estimates, rather than past 12 months’ earnings, to measure PE. There’s some wisdom to this: The stock market looks forward, not back. On the other hand, earnings estimates are fiction, and historical PEs are a tad more fact-based. You can get both on Morningstar’s site.

All of which brings us to the Columbia Thermostat Fund (CTFAX), created by storied value investor Ralph Wanger. The Thermostat fund adds bonds to the portfolio as the market heats up, based on the market’s price vs. long-term earnings. When stocks become cheaper, it adds more to stocks and reduces its bond holdings. The fund also has rules to prevent big swings in its holdings.

What’s the fund’s current reading? It’s got just 7.31% of its portfolio in U.S. stocks, and 2.43% in international stocks. Even by the fund’s cautious nature, that’s pretty low. Here’s how the fund’s stock allocation has varied over the years:

Source: Columbia Threadneedle Investments

The fund’s return the past 10 years has been above its category —  conservative allocation, by Morningstar’s reckoning. Nevertheless, its absolute return hasn’t been particularly spectacular. The fund has gained an average 5.35% a year the past decade, in part because it has been so conservative during bull market years.

Nevertheless, the fund serves as a useful market barometer: It’s hard to argue that most stocks are cheap now. If you’re thinking of turning up the temperature in your portfolio, you might want to take another look at the thermometer.

The monster under the bed

Alfred E. Neuman

One of the fun things about being a personal finance writer is the number of “Dear idiot” letters you get. Stories about the Federal Reserve Bank tend to get them. (“You idiot! Don’t you know the Federal Reserve is evil?”). So do stories about taxes. (“You idiot! Don’t you know that Girl Scout cookies are deductible?”)*

Inflation is another source of contention, particularly if you note that inflation has been moderate, which it has been, whether you’re using the Consumer Price Index, the GDP Price Deflator, or even the Billion Prices Project. But your perception of inflation depends on what you spend the most on. If you have kids in college or if you rely on prescription drugs, your personal inflation rate is pretty high.

Those who grew up in the 1970s and early 1980s recall when a 5% inflation rate was considered moderate, as opposed to the most recent 2.2% rate. And they fear a resurgence of inflation, with good reason: It erodes the value of retirement savings and pensions.

The consumer price index has averaged a 1.7% annual gain the past decade, and actually dipped into deflation — a period of falling prices — during the Great Recession. And the forces of deflation are still all around us: The favored tactic of technological disruptors such as Amazon, Uber and others, is to drive prices down and drive competitors out of business. This was a favored tactic of the Gilded Age, aided even further by the gold standard, which tends to favor deflation over inflation. I go on at some length about the subject here.

The Federal Reserve traditionally raises interest rates to slow the economy and cool inflation, and it lowers rates to stimulate the economy and encourage inflaton. The Fed has already nudged short-term interest rates higher five times since 2015, but rates are still extraordinarily low by historical standards. Most think the Fed is acting not out of fear of inflation, but out of fear of not having any ammunition to fight the next recession, whenever that may be.

Tomorrow’s Consumer Price Index report hits the headlines at 8:30: The consensus forecast is for a 2.1% year-over-year change for 2017. Anthing higher, particularly for the core CPI (less food and energy) is likely to make for an upsetting day in the bond market, where yields have been creeping higher and prices lower. The iShares Core U.S. Aggregate Bond ETF (AGG), a useful proxy for the bond market’s total return, has already fallen 0.57% this year, according to Morningstar.

Right now, there’s a balance between inflationary forces — a strong economy and fiscal stimulus — and deflationary ones. In the normal course of events, the Fed tightens too much during inflationary periods, causing the economy to slow, earnings to fall, and stocks to tumble. So there’s reason to watch inflation warily.

Is it time to panic? Well, no. It never is. If you’re particularly concerned about inflation, you might consider a fund that invests in Treasury Inflation Protected Securities, whose price is keyed to changes in the CPI. The current yield on TIPS shows that Wall Street expects inflation to remain at 2% the next 30 years. If you think they’re wrong, then one good pick would be Vanguard Inflation-Protected Securities Fund Investor Shares(VIPSX).

It may well be that technological changes have redefined the upper bound of inflation in the economy. Tomorrow’s CPI print is no reason to go running from the room in terror. But it’s worth keeping an eye on the monster under the bed this year.

* They aren’t, if you eat them.

The busy season for outlooks

Economists and money managers give forecasts because people ask them to, and this is the time of year when people like me ask people like them for their forecasts.

You have to take all forecasts with a grain, if not a block, of salt. Nevertheless, I got the chance to interview some smart people, such as Will Danoff, manager of Fidelity Contrafund, who’s bullish on the U.S. and technology. And then there’s Jerome Dodson, manager of Parnassus, who has the crazy notion that companies that treat employees well will prosper.

Anyway, here’s their outlooks for 2018, along with Mark Mobius of Franklin Templeton, Robert Doll of Nuveen and Joe Davis of Vanguard.

http://www.investmentnews.com/article/20180106/FREE/180109962/2018-outlook-in-equity-investing-is-mostly-bright?issuedate=20180108&sid=outlook20170108

Dogs and diversification

When it comes to investing, you’re better off with a pack of dogs, rather than just one pup. And the returns from Dogs of the Dow this year provesit.

The basic premise behind the Dogs of the Dow is fairly elegant. You’re supposed to buy stocks low and sell them high. But many stocks deserve to be low: They’re poorly managed, like Wells Fargo, or they’re in a dying business, like Gannett, or they’re really just walking catastrophes, like Enron.

Whatever the faults of the Dow, the 30 stocks in the Dow Jones industrial average are large-company high-quality stocks spread across a variety of industries. But each year, some of these companies lag the broad index and others lead. It’s just the nature of the market, which loves different industries at different points in the market.

Rosie, the dog of the day

The ones that are unloved — and, hence, dogs — are the ones with the highest dividend yields. Companies normally don’t have high yields because their executives are swell people who want to dole out profits to investors. Most often, it’s because the company’s stock price has been clobbered.

After all, a stock yield is a function of two factors: Its 12-month payout divided by its current price. A stock with a $1 annual dividend and a $50 price has a 2% yield. Drop the price to $40, and the yield pops up to 2.50%. So typically, a Dog of the Dow has a high yield because its stock price has been clobbered.

Last year’s dogs rose by an average 23.6%, vs. 21.83% for the Standard & Poor’s 500, proving that sometimes it does indeed pay to buy low and sell high. (The Dogs of the Dow have had a spotted record the past few years).

This year’s Dogs of the Dow prove a further point: It’s better to invest in 10 stocks than one or two. Here are how 2017’s dogs fared last year:

1/1/2017
12/31/2017
Investment Ticker Return
(Cumulative)
Boeing Co BA 94.50%
Caterpillar Inc CAT 74.75%
Chevron Corp CVX 10.59%
Cisco Systems Inc CSCO 31.19%
Coca-Cola Co KO 14.39%
Exxon Mobil Corp XOM -3.75%
International Business Machines Corp IBM -4.03%
Merck & Co Inc MRK -1.46%
Pfizer Inc PFE 15.75%
Verizon Communications Inc VZ 4.07%
Average 23.60%
Median 12.49%

Dividends, gains, reinvested. Source: Morningstar.

As you can tell, without the returns from the big dogs — Boeing, Caterpillar and Chevron — the dogs would be whining instead of barking.

The Dogs of the Dow is an interesting lesson in dividends and value investing — but its biggest lesson is that it’s better to own the entire litter than just one pup.

 

 

 

Securities cops: Be careful with crypto

The North American Securities Administrators Association (NASAA) are on the front lines fighting investment fraud. When they start sounding alarms, it’s usually best to listen. And today they’re sounding the alarm on all things crypto.

NASAA Reminds Investors to Approach Cryptocurrencies, Initial Coin Offerings and Other Cryptocurrency-Related Investment Products with Caution

Borg: “Go beyond the headlines and hype to understand cryptocurrency investment risk.”

WASHINGTON, DC (January 4, 2018) – As cryptocurrencies continue to garner national and international headlines, the North American Securities Administrators Association (NASAA) today reminded Main Street investors to be cautious about investments involving cryptocurrencies.

“Investors should go beyond the headlines and hype to understand the risks associated with investments in cryptocurrencies, as well as cryptocurrency futures contracts and other financial products where these virtual currencies are linked in some way to the underlying investment,” said Joseph P. Borg, NASAA President and Director of the Alabama Securities Commission.

Cryptocurrencies are a medium of exchange that are created and stored electronically in the blockchain, a distributed public database that keeps a permanent record of digital transactions. Current common cryptocurrencies include Bitcoin, Ethereum and Litecoin. Unlike traditional currency, these alternatives have no physical form and typically are not backed by tangible assets. They are not insured or controlled by a central bank or other governmental authority, cannot always be exchanged for other commodities, and are subject to little or no regulation.

A NASAA survey of state and provincial securities regulators shows 94 percent believe there is a “high risk of fraud” involving cryptocurrencies. Regulators also were unanimous in their view that more regulation is needed for cryptocurrency to provide greater investor protection.

“The recent wild price fluctuations and speculation in cryptocurrency-related investments can easily tempt unsuspecting investors to rush into an investment they may not fully understand,” Borg said. “Cryptocurrencies and investments tied to them are high-risk products with an unproven track record and high price volatility. Combined with a high risk of fraud, investing in cryptocurrencies is not for the faint of heart.”

Last month, NASAA identified Initial Coin Offerings (ICOs) and cryptocurrency-related investment products as emerging investor threats for 2018. Unlike an Initial Public Offering (IPO) when a company sells stocks in order to raise capital, an ICO sells “tokens” in order to fund a project, usually related to the blockchain. The token likely has no value at the time of purchase. Some tokens constitute, or may be exchangeable for a new cryptocurrency to be launched by the project, while others entitle investors to a discount, or early rights to a product or service proposed to be offered by the project.

NASAA has developed a short animated video to help investors understand the risks associated with ICOs and cryptocurrencies. NASAA first alerted investors of the risks associated with cryptocurrencies in 2014.

Common Cryptocurrency Concerns

Some common concerns investors should consider before investing in any offering containing cryptocurrency include:
  • Cryptocurrency is subject to minimal regulatory oversight, susceptible to cybersecurity breaches or hacks, and there may be no recourse should the cryptocurrency disappear.
  • Cryptocurrency accounts are not insured by the Federal Deposit Insurance Corporation (FDIC), which insures bank deposits up to $250,000.
  • The high volatility of cryptocurrency investments makes them unsuitable for most investors, especially those investing for long-term goals or retirement.
  • Investors in cryptocurrency are highly reliant upon unregulated companies, including some that may lack appropriate internal controls and may be more susceptible to fraud and theft than regulated financial institutions.
  • Investors will have to rely upon the strength of their own computer security systems, as well as security systems provided by third parties, to protect purchased cryptocurrencies from theft.

Common Red Flags of Fraud

NASAA also reminds investors to keep watch for these common red flags of investment fraud:
  • “Guaranteed” high investment returns. There is no such thing as guaranteed investment returns, and there is no guarantee that the cryptocurrency will increase in value. Be wary of anyone who promises a high rate of return with little or no risk.
  • Unsolicited offers. An unsolicited sales pitch may be part of a fraudulent investment scheme. Cryptocurrency investment opportunities are promoted aggressively through social media. Be very wary of an unsolicited communication—meaning you didn’t ask for it and don’t know the sender—about an investment opportunity.
  • Sounds too good to be true. If the project sounds too good to be true, it probably is. Watch out for exaggerated claims about the project’s future success.
  • Pressure to buy immediately. Take time to research an investment opportunity before handing over your money. Watch out for pressure to act fast or “get in on the ground floor” of a new tech trend.
  • Unlicensed sellers. Many fraudulent investment schemes involve unlicensed individuals or unregistered firms. Check license and registration status with your state or provincial securities regulator. Contact information is available here.