In a close call, the bull market wins
Weighing the good and bad, this U.S. advisory gives a cautious nod to a bull market and the only two American financial stocks worth buying.
The secret of success with stocks is not to get scared out of them.
In a nutshell, that is the advice of noted fund manager and author Peter Lynch.
In effect, Mr. Lynch said in his book Beating the Street, it is better to invest on a regular schedule and ignore the condition of the markets than to try and time your investments.
But in times like these, it is almost impossible to avoid the waves of news, rumour and opinion that roll in every day. Especially since they seem to contradict each other at every turn.
Fears of a new credit crisis and warnings about a slowdown in China are met with assurances of a slow but steady economic recovery in America — and a brisk one in Canada.
So it makes sense to see what the markets make of all this. For this we turn to a regular source of market analysis, Dow Theory Forecasts.
The latest issue of this Wall Street advisory gives us a fresh look at where the markets appear to be heading. And while it is willing to listen to the bears, it comes out, prudently, on the side of a bull market.
The advisory concludes with a brief look at the only two financial stocks in America it thinks are worth buying today.
15 per cent in cash
Following the market mayhem in May, some stability has been restored, this advisory notes. But trading “remains very choppy,” it adds.
Indeed, that is exactly what we saw yesterday. Stocks rose in the morning and fell by the end of the day, thanks mainly to spreading unease over the Gulf oil spill and its costs.
Now the markets are up again this morning. In this choppy weather, the advisory says, investors would be wise to keep at least 15 per cent of their portfolios in cash.
On the other hand, “abandoning the stock market entirely seems like a mistake.” Because the fundamentals look pretty good.
Cheap high-quality stocks
The readings on inflation, interest rates and corporate earnings have been favourable, says this advisory. Yet the Dow Jones Industrial Average fell almost 9 per cent from its April 26 high.
And its 7.9 per cent drop in May was its worst showing in that month since 1940 — when Hitler’s invasion of the Low Countries (with France and Britain in imminent peril) triggered a fall of 17 per cent.
Yet at the same time, inflation is crawling along in America. Excluding food and energy, the 0.6 per cent price rise in the March quarter was the lowest since 1959.
And while interest rates have finally made a modest move here, they are not expected to go up south of the border until 2011.
The news is equally good in the all-important area of corporate profits. All 10 economic sectors should deliver earnings growth over the next 12 months. Yet with the S&P 500 trading at just 13 times 2010 estimates and 11 times 2011 estimates, the index is moderately valued.
“The median stock is cheaper than the index,” adds the advisory, “and high-quality stocks are unusually cheap compared to low-quality stocks.”
The duck and the umbrella
High-quality stocks at cheap prices will come in handy, says the advisory, because conservatism is still the order of the day. Normally, high-quality stocks include financial stocks, but Dow Theory Forecasts doesn’t think America’s big banks are worth a deposit these days.
Only two financial firms warrant a buy right now. Both are in insurance and each is quickly recognizable from its ads — one employs a duck and the other a large red umbrella. Both of them have a solid foundation, says the advisory, and room to move up.
Aflac (NYSE-AFL) is a long-time favourite of this advisory. Its supplemental medical insurance should help push its per-share profit growth to 12 per cent this year and 9 per cent next year.
The stock has been flat this year, and much of that can be attributed to some $4 billion in bonds it holds from Europe’s PIIGS (Portugal, Ireland, Italy, Greece and Spain). They account for less than 6 per cent of its portfolio, and Aflac could absorb such a loss without issuing new debt. But it hasn’t helped the share price.
Well down from its April high, the price has shot up by more than a dollar in today’s rebound and sits at $42.29. It also yields a tidy 2.7 per cent on a dividend of $1.12.
The company with the big umbrella, Travelers (NYSE-TRV) is trading at a substantial discount to its peers. Expectations are low for per-share profits this year, with a small improvement expected next year. Some of this pessimism may be justified, especially since it may exceed its projected catastrophe losses thanks to the Gulf oil spill.
But this is a strong company, in the advisory’s opinion. It has “a solid balance sheet and a reputation for conservative underwriting policies, attributes that served it well during the recession and should continue to do so during the recovery.”
Travelers’ stock has also risen with today’s rebound, trading at $49.67. It yields a healthy 3 per cent on the $1.44 dividend.
“We tend to side with the bulls,” concludes the advisory, “but we’re listening to the market for a contrary opinion.” Be defensive, but don’t give up the ship.
In short, if you’re following Mr. Lynch’s advice and ignoring the news, you can rest assured. There’s no need to be scared out of your stocks.
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