Investors Are Worried, But So Far No Panic
Wednesday, June 27th, 2012 @ 11:11AM
In This Issue:
Investors Are Worried, But So Far No Panic
The European Debt Crisis Spreads To Spain
Europe’s Cure Is Known, But Will They Take It?
Corporate Earnings Are Also A Problem
Why Stock Prices Are Holding Up
A Red Carpet For “Dividend Aristocrats”
The Bottom Line
In June, stock investors decided to take a time out from the relatively mild sell-off they started in early May. Perhaps most investors were too busy trying to stay cool during the sizzling heat wave to pay much attention to their portfolios. Whatever the reason, the Dow and the Nasdaq managed to inch ahead 1.9% and 1.7% respectively.
Investors Are Worried, But So Far No Panic
The biggest question about the stock market is why it’s holding up as well as it is. The economic news from nearly all fronts is negative. Europe is in recession. The U.S. economy is expected to dip below 2% this year, and the global economy is also slowing down.
At the same time, the sovereign debt crisis in Europe is getting worse. If the problem can’t be contained, the region may slip into a deeper recession. If that happens, economic growth in the U.S. and China will slide even more.
The European Debt Crisis Spreads To Spain
The Greeks had their important election on June 17 in which they were expected to either back candidates who favor austerity and keeping the euro, or those who don’t. Unfortunately, the election was almost a draw. Although the winners are those who advocate keeping the status quo, they didn’t receive a big enough margin to decide the issue.
In an effort to placate all sides, the new government is expected to ask for a two year extension of the deadline for meeting its austerity mileposts. The EU lenders don’t like the idea, but they may need to accept it. Either way, the Greek crisis is far from over.
At the same time, the debt crisis in Spain, that we warned about last month, took center stage. Since Spain contributes about 10% to the European economy, vs. only about 2% for Greece, preventing its banks from melting down is the EU’s new priority.
It appears that the European Central Bank and the region’s emergency funding agencies will come to Spain’s rescue. However, the paltry $125 billion bailout that’s being offered looks more like a bandage than a cure. As with the situation in Greece, the crisis in Spain promises to drag on and on. Of course, patching the situation up beats having a meltdown.
Europe’s Cure Is Known, But Will They Take It?
Usually when things go wrong in human affairs, the source of the problem can be identified. However, fixing it is rarely so easy.
What got Europe in trouble was giving a common currency to very different types of countries. If the euro had only been adopted by the productive and thrifty Northern Europeans, everything would have been fine. But when less financially responsible nations were given the euro, they went on a 10-year borrowing and spending spree. Now they can’t pay their bills.
The other part of the problem is the European Central Bank is “central” in name only. It is nothing like the Fed, where decisions can be made by one man and his board of advisors and put into action quickly.
In Europe, big decisions about finance (and almost everything else) require the agreement of 17 country representatives who come from different cultures, different economies, and have different priorities. Not all the representatives even speak the same language, and they often don’t trust each other.
Due to the poor harmony within the EU, its leaders only address problems when they reach the crisis stage, and they only do the bare minimum to prevent a disaster. As we said earlier, nothing actually gets fixed.
The bottom line is, don’t expect the debt crisis in Europe to be resolved anytime soon. The best we can hope for is that Europeans will continue to do enough to prevent a disaster that could torpedo the global economy. It makes us think of Mark Twain’s famous comment that the increasing aches and pains of old age are tolerable when “compared with the alternative.”
Corporate Earnings Are Also A Problem
Investors are also facing a problem with the outlook for corporate earnings. Many U.S. companies are now starting to decrease their profit projections. Negative announcements about the current quarter outnumber positive reports by 3.5 to one. We have not seen that level of caution since the quarter that followed 9/11.
Some of the bad news can be attributed to the trend among company CFOs to bad mouth their outlooks and then surprise everyone by doing a lot better. But that game doesn’t account for the level of caution we are seeing this time. There just isn’t any way to put a positive spin on the impact of a softening global economy.
The earnings outlook looks particularly glum for the energy industry. The relatively sudden glut of natural gas from shale deposits is driving energy profits into the basement.
Just three months ago, oil was selling for over $125 a barrel. Now it is about $90, a 30% decline. Similar drops are occurring for coal, industrial metals and other raw materials.
Why Stock Prices Are Holding Up
With all the bad news that’s going around, we might expect stock prices to be taking a swan dive. Instead, the market’s declines have been mild, and have often been flat. So, what’s holding everything up?
We think, stocks owe their resilience to bonds, that are paying even less. Since money needs to be somewhere, the only alternative to bonds for most investors is to buy top quality stocks and enjoy the dividends they pay until the outlook improves.
Dividends, of course, can only stay up if profits do too. Since earnings look soft, we can expect to see some dividend reductions over the next year or so.
But smaller dividend checks aren’t automatic. Many companies favored by insurance companies, pension funds, endowments, and little old ladies will often dip onto their reserves during periods of slow growth, and keep their dividend checks at current levels. Some companies will even maintain their dividend growth rates when earnings are soft.
A Red Carpet For “Dividend Aristocrats”
Every year Standard & Poor’s publishes a list of companies in their composite index that have managed to increase their distributions every year for at least 25 years. Earlier this month, there were 51 companies on the list of “Dividend Aristocrats.” We most humbly note that several of our recommendations are on that hallowed list.
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All our Dividend Aristocrats continue to look good to us. Four of them stand out for their potential to prosper in today’s slower economic growth. The stocks pay more than 10-year Treasuries plus they have excellent prospects for long term appreciation.
McDonald’s (MCD) looks especially attractive when you compare its performance to the stock market. The accompanying combined chart shows the 5-year price history of the company and the Dow Jones Index. You will notice that during the plunge the Dow took in early 2009, McDonald’s barely wiggled. That doesn’t mean the company is impervious to a decline, but it clearly has a history of resisting market scares.
McDonald’s also has good fundamentals. The P/E ratio is 16.6 and the dividend yield is currently an attractive 3.20%. In addition, the company paid a dividend every year for 35 years. We think the stock will continue to be an excellent long-term performer.
Exxon Mobil (XOM) is the world’s largest energy company. Although energy prices are currently down, we think the long-term outlook for the sector remains excellent. Exxon Mobil is particularly attractive now since its P/E ratio is a low 10.0. and its yield is 2.80%. Long-term investors should see excellent returns from Exxon Mobil.
Johnson & Johnson (JNJ) is a leading supplier of pharmaceuticals, medical devices, and personal healthcare products. The company operates over 200 separate divisions that do business in nearly every country in the world. The increasing size of the middle class in Asia is giving Johnson & Johnson an especially good outlook. The company’s P/E ratio is 18.2, which is a bit high, but its yield is an attractive 3.65%.
Wal-Mart (WMT) is also doing well. In most communities Wal-Mart is the lowest-cost supplier of groceries and other necessities that families consume in large amounts. As a result, Wal-Mart is picking up a lot of business from customers that previously shopped at Safeway, J.C. Penney, and other stores that are more expensive. The economic slowdown should push even more shoppers to Wal-Mart. The P/E is 14.1 and the yield is 2.40%.
The Bottom Line
Despite all the troubling news from Europe and elsewhere, stocks remained mostly flat in June. That resistance may not continue if the economic outlook deteriorates further. A new worry about corporate earnings could also tip the scales downwards.
One group of stocks that investors are learning to love is blue chips that have yields much higher than the Treasury offers. Looking especially promising right now are four of our recommendations: McDonald’s, Exxon Mobil, Johnson & Johnson, and Wal-Mart.
Until Next Month
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
Executive Director
John M. Casson
Mr. Casson has been Executive Director of The Association for Investor Awareness, Inc., since inception. He also serves as President/CEO of Casson Media Group, Inc., a publishing, media and communications holding company.