Thursday, May 31st, 2012 @ 11:15AM

In This Issue:

Stocks Or Bonds, That Is The Question
Greece Is Still A Big Concern
A Summer Rally Seems Likely
Housing Is Starting To Attract Investors
The Market Is Expanding For Private Services
The Bottom Line

The stock market correction we have been expecting finally arrived in early May. We would have been happier if it had waited a couple of years, but Mother Market didn’t ask for our opinion.

So far, we can’t complain about the downturn. As such events go, this one has been fairly mild. By the end of the month the Dow and the Nasdaq were down just 6.4% and 9.0% respectively. Of course, the bear may just be warming up.

Stocks Or Bonds, That Is The Question

Even before the correction began we felt that stocks were priced attractively. That’s even more true today. Dozens of top quality multinational companies have multiples below 10 and yields above 4%.

By contrast, 10-year Treasury bonds are paying a miniscule 2%. That’s actually a negative real return because it’s below the inflation rate. In effect, bond investors are paying Uncle Sam to take their money. It doesn’t take an MBA in finance to know that’s not how a bond investment is supposed to work.

Of course, the value of bonds has the potential to rise if interest rates go lower. But with rates already barely above the floor, the potential gains from this point appear to be quite small.

Since the returns from bonds are on the thin side, we suspect the reason investors are buying them is due to the shaky economic outlook in the U.S. and Europe. Treasuries may not pay very well but they are reliable safe havens.

Greece Is Still A Big Concern

It’s beginning to look as if Greece may abandon the euro, a currency that has not been forgiving of the country’s borrow-and-spend habits. The only way Greece can get out from under its debt burden is to default on its bonds, or go back to its old drachma currency that it will promptly devalue. If the latter option is used, Greece will be able to pay its creditors with cheaper money.

By itself, Greece is not a major threat to the European economy to which it only contributes about 2% of annual growth. But if Greece bails out of the euro, there is a good chance that Spain, Portugal, and Ireland may do the same. And that, dear reader, would be a huge problem for Europe.

We don’t know how the European debt crisis will turn out. However, leaders in every country are working overtime to find a solution to the problem. We think the odds are that they will be successful.

 

A Summer Rally Seems Likely

If Europe avoids Armageddon, and the U.S. economy continues to cook along at a moderate pace, many stocks seem likely to shrug off the correction and move back up this summer.

Among the stocks we have been following most closely over the past year, several appear to be in the priority line for rebounds.

Alcoa (AA), Caterpillar (CAT), and General Electric (GE) need moderate to good economic growth to prosper. If we are correct that the economy will be better than the extreme conditions many investors expect, these stocks should have a good summer.

Coca-Cola (KO), Colgate Palmolive (CL), Johnson & Johnson (JNJ), Procter & Gamble (PG), and Wal-Mart (WMT)weren’t hit as hard as the industrial companies, but we think they were also oversold. These stocks should have nice bounces in a summer rally.

Consolidated Edison (ED), Eli Lilly (LLY), and Kinder Morgan (KMP) are primarily income stocks. All of them look good to us because their dividends are over twice what Uncle Sam pays on his most popular bonds. Although we are not expecting big price moves from these stocks, we think they offer a nice combination of long-term growth and attractive dividends.

Housing Is Starting To Attract Investors

We are also optimistic about what appears to be the start of a rebound in housing. The turnaround is unlikely to come quickly, but the long-term gains this greatly oversold industry should deliver promise to be exceptional.

There are several reasons that the outlook for housing is improving. The first, of course, is the extreme discounts that are common on most homes. Nationally the decline in prices averaged about 31%. In many cities, the decline was 50%, and sometimes more. Those savings are starting to attract buyers.

Buyers are also attracted by today’s rock bottom mortgage rates. Thirty year home loans are now commonly available for under 4%, a number not seen since the early 1950s. Most prospective homeowners realize that such exceptional rates are unlikely to last very long, so they are making their moves now.

The demand for rental housing is also starting to push prices up. Investors all across the country are finding that for the first time in decades, rents will cover mortgage payments, taxes, and maintenance – and also provide some positive cash flow.

The economics of making housing investments are so compelling, people all across America are starting to buy homes to rent out. Nationally, many partnerships are being formed that often buy dozens of properties. In some cases, whole subdivisions are being purchased and converted to rentals.

The obvious question is, if it costs less to buy than to rent, why aren’t more renters becoming homeowners?

The answer is, many workers no longer feel confident enough about their job security to make 20 and 30 year mortgage commitments. Neither do many people feel they are likely to stay in one place for an extended period. In these uncertain times, buying a home just doesn’t make as much sense is it did years ago.

Many other renters would very much like to buy a home, but they can’t qualify for a loan. Banks that were burned during the housing bust usually want 20% down and a near-perfect credit score to write a mortgage. Those are high hurdles to jump.

There is also a cultural shift occurring among many young adults. Homeownership is less often a part of their American dream. Many expect to be renters all their lives, and are very comfortable with that outlook.

One company that is benefitting from the new housing trends is Equity Residential (EQR), a real estate investment trust (REIT) that specializes in rental real estate. The company owns or has investments in over 400 properties in 16 states plus the District of Columbia.

Equity Residential specializes in upscale apartments in cities with good economies and young professionals who can afford to live well. The company knows how to appeal to its customers with attractive buildings in popular neighborhoods. Many buildings also have pools and exercise facilities.

All in all, EQR seems to be on the right track for an extended period of growth.

The Market Is Expanding For Private Services

The slow economy and weak tax collections are making it difficult for the government to build and maintain the nation’s infrastructure. Almost everything is out-of-date and in need of repair. The solution is to give the responsibility to private companies.

In many communities, trash collection, ambulance services, highway maintenance and even sanitation systems are being privatized. At the federal level, several highways and airport services are also being operated by efficient private companies.

We think a promising way to profit from the privatization trend is to own stock in the Macquarie Infrastructure Company(MIC) .

Currently, Macquarie is focusing on airport services, a rich area that generates a lot of cash and rapidly pays for itself. The company owns or leases parking lots, airport ground transport systems, aircraft fueling services, airport terminals, hanger services, and fixed base operations for private pilots. In every case where the company makes investments, competition is limited or non-existent.

Macquarie also has interests in commercial heating and cooling operations in Las Vegas. In addition, the company produces and distributes synthetic natural gas and liquefied petroleum gas in Hawaii.

We think private companies such as Macquarie will be asked to take over many more public facilities that can no longer be provided by government agencies. This trend will take time to develop, but it has the potential to be enormous.

The Bottom Line

The stock market correction that started in early May continued through the month. So far, the downturn has been mild which leads us to think the market has more support than meets the eye. If we don’t have an economic meltdown in Europe, a summer rally may be in the cards.

Many multinational stocks appear to be oversold and should rebound. Rental housing also looks very good to us, especiallyEquity Residential. The trend towards privatizing government services should have a long run and benefit the Macquarie Infrastructure Company.

Until Next Time

The AIA “Advocate For Absolute Returns”, a publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn’t? Many sources report these issues as abstract facts. We feel that’s not enough. The AIA Advocate’s job is to warn you of what’s important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next time…

Posted by AIA Research & Editorial Staff
Categories: AIA Newsletter