Author: Bill DeShurko, 401 Advisor
Covestor model: Dividend and Income Plus
Disclosure: Long or considering purchasing all stocks mentioned
There’s a good reason why the term “liquidity” sometimes refers to money. Like a liquid, money will always flow to fill a void.
In 2012, there will be a lack of attractive voids where money can flow. The one big exception will be the U.S. Despite all of our troubles, to anyone sitting with a big pile of cash (particularly outside our borders), we have to look downright attractive. Picture yourself sitting almost anywhere in the world with a few hundred million to invest. Where would you put it?
China? China’s facing a slowing economy – slowing to a pace we envy, but slowing nonetheless. Slowing means wage stagflation, unemployment and unrest. Remember one big advantage of our political system is that when we don’t like our leaders, we have elections. In China, they have revolutions. I’d steer clear.
Emerging markets? Most emerging market economies revolve around commodities. Slowing global economies mean stagnant or falling commodity prices. No opportunity there.
Europe? Need anything be said?
The one global constant is that the printing presses will likely be running at full throttle to keep each economy afloat.
That leaves the world’s largest economy, with a stable political system (true, it may not seem that stable by November!) and a stock market full of modestly priced stocks of companies chock full of cash on their balance sheets, with modestly growing net earnings to add further to their coffers.
Granted, economic data of late has been mixed, and earnings – while growing – have shown a slowdown in the rate of growth. The fear is that we move into a 2001-type situation, where economic growth and earnings remain positive, but the deceleration in both results in a falling stock market. The difference is that that in 2001 money could flow to the bond market, as investors anticipated a yield reversal (prices up) to reverse the slowing economy. That’s not the case in our current bond market.
So where could global liquidity flow to in 2012? The one prediction I will make with as much certainty as I can muster is that last year’s winners will not repeat their performance.
Utility stocks were the second best performing sector in 2011. The S&P 500’s P/E ratio (a measure of relative value) was at 13.05 as of 12/20/11 and the utility sector was at 13.68 (Bespoke). In addition, the Utility sector is the only sector to have become more expensive in 2011 based on its P/E ratio. So a sector that is considered one of the slower growing, more stable sectors, and one that faces serious pricing pressures depending on the outcome of the election, is one of the most expensive sectors of our economy, after a 19.59% increase in 2011 for the Utilities ETF (XLU).
We will be looking instead at some of the P/E laggards, and focus our dividend strategy on high dividend stocks in those lagging industries. While commodities and energy may not see pricing rallies, I see stability in demand in 2012. It’s not a growth scenario, but it is a good environment to collect dividends.
The material sector sports a P/E of 11.66 and energy has a very modest 10.46 P/E ratio. Among materials stocks we like Southern Copper Corporation (SCCO) and Terra Nitrogen Company (TNH), and in the energy sector we like Enerplus Corporation (ERF) and Penn West Petroleum (PWE).
A new area of interest will be the technology sector. Sporting a P/E of 13.71 and with the NASDAQ posting a loss for 2011, I think that tech is actually a value play. Boasting high cash flows, market leadership, and decent dividends are bellwethers Intel (INTC) and Microsoft (MSFT).
Also, after a negative 5.7% return as measured by KRE, the regional bank ETF, we will look to add to our regional bank names – BB&T Corporation (BBT) and Fifth Third Bancorp (FITB). While the major banks are still in the “avoid” category, regionals generally lack exposure to sovereign debt. Three years after the bottom of the recession, consumers will start to look to add to their debt. As such, staples such as cars and appliances just need replacing.
Finally, I have learned over 25 years that one of the keys to successful investing is to always ask and answer the question, “But what if I’m wrong?” In this case, we’ll continue to:
a) trade SPDR Barclays Capital High Yield Bond (JNK) around its 30 day moving average,
b) hedge our more economically sensitive holdings with some consumer staples (Proctor & Gamble (PG)) and even utilities if their prices come down a bit and afford us a better entry price, and
c) focus on dividend paying stocks that pay us to hold them.
